If you have bought a home before, read financial news, or even just watch a lot of HGTV, you might think you're something of an expert in how mortgages work. Alas, you're probably wrong.
"A lot of home buyers think the process is simple, but when you start explaining the details, their eyes glaze over," says Richard Redmond, mortgage broker at All California Mortgage in Larkspur and author of "Mortgages: The Insider's Guide."
In terms of financing, making false assumptions could hinder your ability to find the right home. For example, you might think you can afford a $600,000 house, so you start looking at properties; however, when you meet with a lender you learn your price range caps at $500,000. This is what the experts call "a rude awakening."
Unfortunately, there are some big misconceptions about home mortgages. Here are four of the most egregious myths -- debunked.
You need to make a 20% down payment
Sure, a 20% down payment on a home is ideal. After all, the more money you put down, the less you owe, and the less strain you'll feel to cover your monthly mortgage payments. Still, that doesn't mean you must put 20% down; plenty of loan programs accept far less.
For instance, loans from the Federal Housing Administration let borrowers get a mortgage with a down payment as low as 3.5%, as long as their credit score is 580 or higher. (People with credit scores between 500 and 579 are still eligible but must make down payments of at least 10%.)
The catch? If you pay any less than 20% on a conventional loan, you'll have to cough up private mortgage insurance, an extra monthly fee paid to mitigate the risk that you might default on your loan. And PMI can be pricey, amounting to about 1% of your whole loan -- or $1,000 per year per $100,000. Still, if you're champing at the bit to buy a home, there's no reason to lose hope if you lack a huge down payment.
The best mortgage is one with the lowest interest rate
Todd Sheinin, mortgage lender and chief operating officer at New America Financial in Gaithersburg, MD, compares shopping around for home mortgages to buying a car: "Just because a dealership offers you the cheapest price doesn't necessarily mean it's the best option."
While your interest rate is important because it will affect the size of your monthly payments, don't forget there are other fees that can vary wildly from offer to offer. For instance, there's an origination fee to cover the processing and paperwork of the loan, which can vary from 0.5% to 1.5% of your loan -- that's quite a spread.
To make sure you're getting the best bargain, talk to at least three lenders. "Don't just ask about the interest rate," says Sheinin. Instead, ask the lender for a breakdown of your costs.
"Loan estimates should break down the fees so that borrowers know exactly what they're getting," says Staci Titsworth, a regional manager of PNC Mortgage in Pittsburgh. Another question worth asking is the loan officer's availability: Does the loan officer provide clients a cellphone number?
"If it's the weekend and you need a pre-approval letter on a property ASAP, but your lender only works 9 to 5, you're in a bind," Sheinin points out.
Pre-qualification and pre-approval are essentially the same
Absolutely not. "Pre-qualification is basically having a conversation with a lender," says Redmond. "It means nothing."
On the other hand, a pre-approval entails the lender gathering all necessary documentation -- your tax returns, bank statements, pay stubs, and more -- packaging the loan, and submitting the file to an underwriter for review. The loan will still need to go through formal underwriting when you go to purchase a property, but the lender will give you a letter stating you've been pre-approved for a certain amount. And with that letter in hand, you'll be in prime position to make an offer when you find your dream home.
An adjustable-rate mortgage is only for risk takers
ARMs got a bad rap after the financial crisis, because they offer a lower interest rate for a fixed initial period (typically five years), but then the rate is subject to change based on market conditions -- and could go way up. This is how thousands of homeowners ended up unable to pay their loans, so it's understandable plenty of potential homeowners are now gun-shy.
But an ARM may be a viable option. It can contain postcrisis safeguards, based on your unique circumstances. For instance, if you're planning to move within five years, then you're a great candidate because an ARM's rate won't even start adjusting until you're gone. And in that time, you'll save a ton on interest, because ARM interest rates are typically lower than that of fixed-rate mortgages. This translates to lower monthly mortgage payments and, of course, more money in your pocket.
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