Buying a home can be complicated, and perhaps no part of home buying comes with more difficulties and misconceptions than the mortgage process.
If you’re in the market for a home and the mortgage process is a source of confusion, you’re not alone. Learn about 12 common mortgage process misconceptions.
1. You need a 20% down payment
The first mortgage myth is that you need a 20% down payment to get a mortgage. It’s just not true. Some conventional loans accept as little as 3% down, and certain government-backed loans don’t require any down payment at all.
The reason that buyers put down 20% on a home is because of private mortgage insurance (PMI). If buyers opt for a down payment of less than 20%, lenders will usually charge PMI to protect themselves in case buyers stop making payments. PMI can be paid as a one-time, upfront fee or as an extra charge on buyers' monthly mortgage payment, increasing the amount.
2. There’s no difference between prequalification and preapproval
Buyer beware: Getting prequalified and preapproved for a mortgage can be entirely different endeavors. Mortgage prequalification is when a mortgage lender collects basic financial information and estimates how much house you can afford. Prequalification typically relies on information you provide to the lender.
Preapproval is when your lender verifies your financial information and credit history. This process involves pulling your credit history, verifying financial information, and possibly even requesting pay stubs and tax returns.
In short, prequalification helps you begin house hunting, and preapproval gives you the actual green light to make an offer on a home.
3. Your down payment covers closing costs
Down payments are pricey, and they don’t cover everything buyers might hope – especially closing costs. Closing costs are processing fees you pay to your lender.
They usually cost between 2% to 6% of the loan and include appraisal fees, title searches, title insurance, credit report charges, and if applicable, mortgage points and private mortgage insurance.
Your down payment will not cover closing costs, which is why it’s important for home buyers to keep cash in reserve.
4. Income alone determines what mortgage you’ll get
Making big bucks is great, but income is not the only component of qualifying for a mortgage.
It's true that a higher income helps buyers qualify for a larger home loan. Other factors, however, also come into play, including the size of your down payment, your credit history, your work history, the value of the home, the value of your collateral, and your debt-to-income ratio.
In all, the mortgage approval process is a holistic reflection of your financial health to help lenders determine if you'll pay your mortgage on time – not a one-off referendum on your salary.
5. You need perfect credit to qualify for a mortgage
When it comes to qualifying for a mortgage, credit is key. However, having imperfect credit will not disqualify you from owning a home.
Conventional home loans often require a credit score of at least 620 out of a possible 850, meaning that many without perfect credit can buy a home.
For those with lower credit scores, Federal Housing Administration loans, which are backed by the government, can help make home buying possible. Still, buyers with lower credit scores should expect to pay higher mortgage rates and mortgage insurance.
6. Applying for a mortgage will tank your credit score
Some prospective home buyers worry that applying for a mortgage will ruin their credit. This fear is overblown. It's true that to approve a mortgage, lenders will conduct a hard inquiry of your credit from one of the three major credit bureaus. In the short term, your credit score will likely decrease a few points.
Over the long term, being approved for a mortgage and consistently making payments will be good for your credit. That’s because payment history makes up 35% of your total credit score. If you apply for a mortgage, get approved, and make your payments, your credit score will likely increase.
7. Debt or student loans make getting a mortgage impossible
For young buyers in particular, carrying debt or student loans can feel like a roadblock to accomplishing their dreams of homeownership. Having debt will not disqualify you from getting a mortgage, but if you carry debt, be aware of your debt-to-income ratio (DTI).
Calculating DTI is straightforward: Lenders will add your total monthly debt, including student loans, credit card loans, personal loans, auto loans, and other personal debts. Then, they'll divide that number by your gross monthly income. Usually, mortgage lenders want your monthly debts to be less than 36% of your gross monthly income.
If your DTI is higher than your lender will approve, you can reduce your ratio by increasing your gross monthly income, reducing your debts, or both.
8. Having a mortgage is a bad investment
Among the most misguided misconceptions about mortgages is that over the long term, having a home isn’t a good investment. There's no doubt that homeownership can be costly, but investing in a home is one of the soundest financial moves you can make.
When you have a mortgage, you build equity by making your payment every month. In addition to boosting your credit score, you build your net worth.
Plus, real estate is traditionally a strong hedge against inflation and economic woes. Americans will always want a place to call their own, which means you should make a profit when it’s time to sell your home.
9. You’ll get the same mortgage rate from every lender
Home buyers sometimes assume that the mortgage rate they receive from one lender will be the same as the rate they'll receive from another. This is wrong. Mortgage rates do, in fact, vary by lender, which makes shopping for the best mortgage rate important.
Every mortgage lender has different objectives when determining mortgage rates. You can be quoted different rates by different lenders because they have different appetites for risk.
In fact, mortgage rates can sometimes be negotiated, so having more than one offer can help ensure you get the lowest possible rate.
10. A 30-year, fixed-rate mortgage is the only option
In the world of mortgages, none are more popular than the 30-year, fixed-rate mortgage, but it’s not your only option. In addition to the 30-year, fixed-rate mortgage, some buyers who want to pay off their home faster may opt for a 15-year, fixed-rate mortgage.
Other than fixed-rate mortgages, buyers may pursue an adjustable-rate mortgage (ARM). ARMs offer a lower preset rate for the first few years before rising to a rate that adjusts over time. In general, an ARM may be a good option if you plan to refinance or sell your home within a few years.
11. Refinancing a mortgage is never worth the hassle
You may hear some say that under no circumstance is the hassle of refinancing a mortgage worthwhile. You shouldn’t listen. Refinancing your mortgage major benefits.
For one, you’ll potentially lower your interest rate and monthly payment. If inflation subsides, that could save you hundreds of dollars per month. Refinancing a mortgage also opens other options, such as cashing out part of your equity, adding or removing a co-borrower or co-signer, and changing from an adjustable rate to a fixed rate.
Refinancing a mortgage, however, does come with drawbacks. You’ll have to pay closing costs once again, and another hard inquiry may slightly ding your credit score.
12. Being denied once means you’ll never qualify for a mortgage
If you applied for a mortgage and didn’t get it, it’s OK. Your dreams of homeownership haven’t been permanently dashed.
In fact, 7% to 14% of mortgage applications are denied each year. Common reasons lenders deny mortgage applications include a low credit score, a high debt-to-income ratio, a higher-than-expected property appraisal, or skepticism about the stability of your employment.
Fortunately, all of these can be fixed. Whether it’s making more money, shoring up your credit, paying off debt, or finding a better real estate agent to help you through the process, you can come back from a mortgage application denial and secure a different loan.