4 Mortgage Myths Busted

A mortgage loan is most likely going to be the biggest financial obligation you take on in your lifetime. But despite the fact that deciding to take on this debt is a huge decision, many people believe in some common mortgage myths. You don't want to be one of those people.

To make sure you know the truth about home mortgages so you can make informed choices about buying a home, here are four of the most common misconceptions people tend to have about home loans.

1. You need 20% down

According to the National Association of Realtors (NAR), 35% of people think the required down payment to buy a home is between 16% and 20%, while 10% of people believe their down payment must exceed 20% of the home's value.

This is far off the mark. In fact, NAR reports first-time buyers have typically made a home down payment equal to between 6% and 7% of their home's value since 2018.

Now, it is true that it is ideal to have 20% down. By making a 20% down payment, you can avoid private mortgage insurance (PMI). PMI usually costs about 0.5% to 1.5% of the loan amount annually, so about $2,000 to $6,000 annually on a $400,000 house. That's expensive, especially since this insurance only protects against lender losses in case of foreclosure, not against homeowner losses.

But if you can't or don't want to wait until you have saved 20% to buy a home, don't fall for this myth and assume you'll have to put off ownership until you've grown your savings account balance.

2. You should borrow up to the amount the bank allows

Another misconception is that you should determine how much you can borrow based on what the mortgage lender pre-approves you for. After all, the bank will review all your financial credentials and give you a maximum loan limit, so you may assume that's the right amount to spend.

The reality, though, is the bank only cares how much you can borrow without defaulting -- and your lender wants you to borrow as much as possible, up to that amount, so it can make more money off you. You need to care about other things, like other financial goals you have.

You should decide how much to borrow based on what comfortably fits in your budget. A common rule of thumb is to keep housing costs -- including taxes and insurance -- to 30% of your income at most. You may want to keep your costs lower if you have other huge goals like retiring early or sending several kids to college.

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3. You're guaranteed a loan if you're pre-approved

There are some myths about mortgage pre-approval as well. Specifically, many people assume if they go through the pre-approval process -- which involves sending the bank a lot of financial documents -- that they will definitely get a loan.

That's not necessarily true, though. Most of the time it works out and you get the loan you were pre-approved for. But if your home doesn't appraise for as much as the bank wants it to or you take on new debt before closing and you no longer meet qualifying requirements, then the bank may not give you a final loan after all.

To avoid problems after pre-approval, make sure you don't make any major money moves like changing jobs or getting a new car loan until after your new mortgage closes.

4. Your credit has to be perfect to borrow

Finally, you may assume you need excellent, or at least good, credit in order to borrow. And, again, that's not necessarily true. There are plenty of loan options out there for borrowers with bad credit, including FHA loans, which allow you to borrow with a credit score as low as 500.

Ideally, you will improve your credit before getting a home loan so you can get the best rates. But if you have a good-sized down payment, can easily afford the monthly payments, and are ready to be a homeowner and don't want to wait to get a perfect credit score, then there's nothing wrong with shopping around and seeing what's out there for you.

Now you know the truth about some major mortgage myths and hopefully you can make better, more informed choices so you go into homeownership with both eyes open.