Buying a home is probably the single most expensive purchase a person will make during his or her lifetime. Homeownership is often viewed as a sign of success in America, and according to recently released third-quarter data from the Census Bureau, the homeownership rate in the U.S. stood at 63.5%. This figure represents the fulfillment of many American dreams.
However, the American dream of homeownership can easily become a nightmare if you happen to fall victim to one of the numerous pervasive mortgage myths. Not understanding the various facets of your mortgage options or the buying process could wind up costing you dearly if you aren't careful. Here are nine mortgage myths you'll want to pay particularly close attention to.
Myth No. 1: You'll need to put at least 20% down on a home
Conventional wisdom says that if you want to buy a home you'll need to put at least 20% down, so you better start saving. However, mortgage loans aren't always conventional. Putting 20% is often a strong suggestion, with the amount of your minimum down payment varying by lender and by the type of loan you're seeking.
For example, a Federal Housing Administration loan allows borrowers to put as little as 3.5% of the total price of house down as long as they have a credit score of 580 or higher (for context, the FICO score sales runs from a low of 300 to a high of 850). People with credit scores in the 500 to 579 range can still be approved for an FHA loan, but they'll need to put 10% down.
Talk with more than one lender and see what options are available. Chances are, most Americans can get by without putting 20% down. Just keep in mind that if you don't put 20% down, you may be required to pay private mortgage insurance on a monthly basis until your equity in the home reaches 20%.
Myth No. 2: You need a very good/excellent credit score to qualify for a mortgage
Make no mistake about it, having a very good or excellent credit score certainly helps your chances of securing a mortgage loan at an attractive rate. However, near-prime and subprime credit scores can also qualify for a mortgage loan.
While having a subprime or near-prime score isn't as optimal and will likely lead to a higher lending rate than if you had a prime credit score, options exist for people with credit scores of as low as 500. The key to securing a mortgage with a lower credit score is being able to make a large down payment. If you can put more money down, lenders may be willing to work with you.
Myth No. 3: Once you're prequalified for a home loan, you're all set
It's important that prospective homebuyers understand that there's a big difference between being "prequalified" for a home loan and being "preapproved." Being prequalified for a certain loan amount doesn't mean you'll be approved for that amount.
The prequalification process for a home loan is relatively simple and mostly surface scratching. You supply a prospective lender with your financial information, such as your income, assets, and debt, and your lender uses this data to provide a crude estimate of how large of a mortgage loan you'll be qualified for.
The preapproval process for a home loan is a much deeper dive. In the preapproval process, lenders will dig into your earnings history, contact your employer, verify your credit report, and analyze your current debt levels. After this deeper dive, your lender should be able to give you an exact dollar amount of what you're approved to buy, as well as provide you with a good idea of the interest rate you'll be paying.
However, you should note that even at the preapproval step, you aren't guaranteed to get the loan. Your lender can check your employment history at any time, and often will do so right before your loan closes. If you've changed jobs or lost your job, your loan could fall through.
Myth No. 4: Mortgage rates are the same everywhere
Another common misconception is that it doesn't matter where you go because you'll be paying the same mortgage rate. This is almost always incorrect.
For instance, credit unions typically look to undercut bigger banks since they have fewer fees, meaning they may be able to offer a lower mortgage rate. Similarly, choosing your current bank as your lender doesn't always mean you get preferential treatment when it comes to loan rates. You should always shop around instead of assuming that you're getting the best deal. Plus, if you have prime credit, banks and credit unions may even be willing to cut their mortgage rates slightly in order to gain your business.
Likewise, keep in mind that the location of your home can affect your mortgage rate. The health of a local housing market, as well as the average price of homes within a city or county, can also influence your interest rate.
Myth No. 5: 30-year mortgages are always the best way to go
Though 30-year mortgages are among the most popular options when taking out a loan to buy a home, they certainly aren't the only option available.
Generally speaking, lenders are willing to offer consumers a better rate based on the length of their loan. Longer loans bear more risk to the lender and thusly higher interest rates, while shorter-term loans have more favorable lending rates. If you can comfortably afford to do so, taking out a 15-year loan instead of 30-year could save you a lot of money over the life of the loan (assuming you make only the minimum payment).
Myth No. 6: Your interest rate perfectly reflects the costs of your mortgage
Prospective homebuyers also should be aware that the mortgage interest rate they'll pay is only part of the total mortgage costs. If your lender is offering a 4% mortgage rate, it doesn't mean 4% is the true cost of your home loan.
As an example, origination fees are usually rolled into the cost of your mortgage and, according to industry experts, can vary from 0.5% to 1.5% of the total loan. Experts strongly suggest paying attention to the annual percentage rate, or APR, when analyzing your true mortgage loan cost. This is why it's particularly important when comparing lenders to focus on the APR and not get too caught up with the front-facing interest rate attached to the loan.
Myth No. 7: Renting is cheaper than owning a home
One of the most common mortgage myths you'll hear is that it's going to be cheaper to rent than buy a home. While this is true in rarer instances where a person moves often, buying a home is usually cheaper over the long run than renting.
To begin with, buying a home allows you to build up equity in the property, whereas the money you pay for rent doesn't lead to any equity. Every cent you paid during your lease is gone once your term is up.
Additionally, maintenance costs will generally be lower if you purchase a home and are financially prepared to cover the costs of repairs. Even though a landlord is responsible for covering the cost of repairs, renters are paying a premium that's included in their monthly rental price that covers the possibility of repairs. Homeowner repair costs are almost always lower than the premium factored into the cost of rent.
Myth No. 8: You should always pay off your mortgage as quickly as possible
Does paying off your mortgage as quickly as possible sound like a great idea? For some homeowners, that is indeed the case as it'll relieve a monthly payment burden. However, rushing to pay off your mortgage may not be the best idea for a majority of homeowners.
Keep in mind that a mortgage is an installment loan. This means that paying extra doesn't lower the amount you'll owe each month. It'll just reduce the principal amount of the loan and shorten the life of the loan. You might be better off investing the extra money you're considering putting toward your principal if you can earn a higher rate than the APR of your loan. As an added bonus, mortgage interest can be deductible, which can help lower your tax liability.
Myth No. 9: Buying a house is a great investment
The last myth that needs debunking is the idea that a primary residence is a great investment. It's true that buying a home will allow you to build equity, and that over time, home prices tend to rise. But what homeowners often confuse is the difference between nominal price appreciation and real price appreciation.
Nominal price appreciation simply accounts for how much your home is worth in the future compared to what it's worth when you purchased it. If your home doubles in value over 25 years, you're liable to be dancing in the streets with happiness thinking that you've made a stellar investment.
Real price appreciation factors in the effects of inflation on your home over time. According to Robert Shiller in his book Irrational Exuberance, home prices between 1890 and 1997 only outpaced inflation by an average of 0.21% per year. That sort of appreciation isn't something you should be counting on for your retirement. A home can be considered a store of value in most instances, but it's not a particularly good investment.