If you are new to the home buying process, you’ve probably been given lots of mortgage advice – some of it helpful, and some of it just plain wrong. However, without experience, you may not be able to tell the difference.
For your benefit, we present five of the top myths about mortgages, and why the “conventional wisdom” is not necessarily conventional or wise.
- A Fixed Rate is Always Best – Fixed rate loans, which often have 30-year terms, are a better deal in many cases – especially true with today’s unusually low interest rates. However, ARMs (adjustable rate mortgages) and hybrid mortgages are preferable for some homeowners.
ARM’s adjust rates based on the current interest rate plus an index-based margin, and hybrids have a fixed interest period (often 3-5 years) before the adjustments begin. Initial rates are lower, leading to lower payments in the short term.
Thus, if you only plan to be in the house for a short number of years – for example, you move frequently as part of your job – you may choose an ARM and benefit from the lower rates, moving before the adjusted rate becomes burdensome.
- Always Pay Off Your Mortgage As Soon As Possible – Making extra payments toward your mortgage can have a huge impact on the total interest you pay, especially early in the mortgage because of the extended compounding. However, if you have high-interest debt such as credit card debt, it is important to pay that off first to keep that debt from spiraling. Moreover, the interest on your home mortgage is tax deductible (up to $1.1 million in loan amount), while credit card interest is not.
Later in the mortgage, when more of your payments are directed toward interest, you may get a better return on your funds by paying the regular mortgage payment and diverting extra funds to higher-returning investments.
- You Should Always Provide a 20% or Larger Down Payment – It’s true that it is both common and smart to put 20% down, especially as banks have tightened standards since the housing crisis. However, you can still acquire a loan with a lower down payment. The FHA and VA loan programs exist for this purpose – to extend home affordability to those with lesser down payment money and lower incomes.
Even without FHA/VA backing it is still possible. Private Mortgage Insurance (PMI) will be required, your interest rate may be a little higher, and it may be tougher to find a loan – but it is still doable. Every situation is distinctive, and your circumstances may dictate going with a lower down payment than 20%.
- Pre-qualification and Pre-approval Are the Same Thing – Pre-qualification takes rudimentary information from you to estimate how much of a home you can afford to buy – it is the browsing stage, if you will.
Pre-approval is more in-depth, with an analysis of credit score information, verification of income and assets, and other relevant information. It is the intermediate step between pre-qualification and a final loan offer.
- The Lowest Interest Rate is Always Best – Advertised mortgage rates will often prominently list an interest rate and then subtly list a higher number as the APR. APR stands for Annual Percentage Rate – it is designed to take into account all of the yearly costs associated with your mortgage, including fees and closing costs, PMI, and other costs over and above the payments on principal and interest.
To assess the better deal, compare APRs instead of straight mortgage rates. Even then, not all banks lump the same costs in their APR reporting – so dig into what costs are included in the APR for each lender. In addition, if you need added cash to pay closing costs, you might prefer to pay a slightly higher interest rate (such as one-quarter percent) over the life of the loan in order to free up cash at closing. Here, also, each situation is unique — so do what is best in your circumstances. An experienced mortgage professional can help you make this determination.
Now that you are armed with better information about mortgage myths and what to avoid, go out there and find the home of your dreams with confidence.