8 Mortgage Myths And Truths
Victoria Araj7-minute read
February 18, 2023
Mortgage myths floating around on the internet can make it that much harder to understand what goes into being a homeowner.
We’ll clear up some of the most common mortgage myths – and clue you in on the most important truths – about buying a home.
1. You Need 20% Down To Purchase A Home
Many people – especially first-time home buyers – believe that if you don’t have at least 20% down, you can’t buy a home. This isn’t true. In fact, if you take out a conventional loan, you can buy a home with as little as 3% down. Some types of government-backed loans even have 0% down payment requirements.
The 20% myth comes from mortgage lenders’ private mortgage insurance (PMI) requirement. PMI is a type of protection that compensates your mortgage lender if you default on your mortgage loan.
Let’s say you make a home purchase with a conventional loan, and you have less than 20% down. Your lender will require you to pay PMI. PMI affords you no benefits or protections as the buyer and can add quite a bit to your monthly payment.
The PMI requirement is why many financial experts recommend that you wait to buy a home until you have 20% down. Keep in mind that if you do buy a home with PMI, you can cancel your payments once you reach 20% equity in your property.
Other types of loans (like Department of Veterans Affairs (VA) loans and U.S. Department of Agriculture (USDA) loans) don’t require PMI but may require you to pay another type of insurance or funding fee. For example, all Federal Housing Administration (FHA) home loans require a mortgage insurance premium (MIP). MIP may expire after 10 years if you put at least 10% down when you bought a home, given you purchased it within a specific timeframe. Otherwise, you’ll need to refinance to a conventional loan once you’ve reached 20% equity in your home to eliminate the FHA mortgage insurance requirement.
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2. Prequalification Is The Same As Preapproval
The main difference between preapproval and prequalification is the level of verification your lender does before they issue you an estimate. Let’s look at this difference in a little more detail below:
- Prequalification: When you get a prequalification, your lender collects only basic financial information. Most lenders rely only on self-reported financial data when they issue prequalification. This means that these lenders only offer a rough estimate of how much you can afford to take out in a loan.
- Preapproval: When you get preapproved for a mortgage loan, it means that your lender has verified at least some of your financial information. Your lender might require you to submit bank statements or allow them to view your credit report before you get preapproved. This makes a preapproval much more accurate than a prequalification.
As a general rule, you’ll want to get a preapproval before you begin shopping for a home. A prequalification can be a good first step to finding a lender you want to work with but being prequalified doesn’t carry much weight when you want to make an offer on a home.
Two important things to remember:
- First, each lender handles preapproval and prequalification differently. You may run into a lender that uses the terms “prequalification” and “preapproval” interchangeably.
- Second, remember that even with a preapproval in hand, you aren’t guaranteed to close a loan. After you find a home and make an offer, you’ll still need an appraisal before you can secure your loan.
At Rocket Mortgage®, we offer a Verified Approval Letter (VAL) to give your offer a competitive edge. Our VAL verifies your credit, income and assets with documentation you provide us and tells sellers that your finances are in order and you’re ready to buy.
3. You Can Never Pay Your Mortgage Off Early
Some lenders may include clauses called “prepayment penalties” inside the terms of your loan. A prepayment penalty is an agreement that penalizes you if you pay off your mortgage too early.
Lenders earn money on loans when you pay interest on the principal you borrow. The longer you make payments on your loan, the more money your lender gets in interest. If you pay off your loan too soon, the lender earns less money than they expected.
If your loan has a prepayment penalty, it might stipulate that you cannot pay off your loan within 5 years of the date you close. If you do pay your loan off before the date stipulated in the loan terms, your lender might require you to pay any interest they would have earned upfront. This ensures that the lender earns back the money they expected when they issued your loan.
Prepayment penalties are much less common than they once were. Many lenders offer loans with no prepayment penalties at all. For example, if you choose Rocket Mortgage as your lender, you’ll never need to worry about dealing with a prepayment penalty. You’re free to pay off your loan as soon as you want, and you can make an extra payment toward your principal at any time.
4. Your Down Payment Covers Your Closing Costs
When most people think about buying a home, their first thought is their down payment. Your down payment is usually the largest payment you’ll make when you invest in a home, but you’ll also need to pay your closing costs.
Closing costs are processing fees that you pay to your lender in exchange for creating and finalizing your loan. Closing costs cover things like the price of your appraisal and your title insurance. Like your down payment, closing costs are due when you close on your home’s loan. Closing costs are independent from your down payment and can range between 2% – 6% of the total balance of your loan.
If you cannot afford your closing costs, you may ask the seller to cover a percentage of your closing costs (also referred to as seller concessions). However, there are limits to how much the seller can contribute.
5. You Must Have Perfect Credit To Qualify For A Mortgage
Credit plays a major role in your ability to get a home loan. However, this doesn’t mean that you need perfect credit to buy a home. A number of mortgage solutions are available for people who have lower credit scores.
If you have a lower credit score and you’re buying your first home, consider an FHA loan. These are government-backed loans with insurance from the Federal Housing Administration (FHA). This insurance allows lenders to issue FHA loans with lower credit and income requirements compared to conventional loans.
With an FHA loan, you can typically buy a home with as little as 3.5% down and a credit score as low as 580 points. If you have at least 10% to put down on your loan, you may qualify for an FHA loan with a score as low as 500 points. However, the minimum score with Rocket Mortgage is 580.
For most other types of loans, you’ll need a score of at least 620 points – though this standard can vary by lender.
6. Applying For A Mortgage Will Hurt Your Credit
This mortgage myth holds a bit of truth. Whenever you apply for a new loan or line of credit, your credit score will take a small hit. However, this temporary decrease will usually only last a short time.
About 10% of your FICO® credit score comes from your recent credit inquiries. Why? Research shows that if you open a large number of new credit lines, you might be getting ready to make a risky financial move. This makes you a riskier candidate for each individual lender. To prevent you from opening multiple loans or credit accounts in a short amount of time, each new credit inquiry will temporarily lower your score.
When you apply for a mortgage loan, your score will temporarily drop. However, you likely won’t see this effect until after you receive your mortgage preapproval. You can maximize your chances of getting mortgage approval by avoiding applying for new credit cards or loans in the months leading up to your mortgage application.
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7. Having Debt Or Student Loans Is A Deal-Breaker
You might have heard that it’s impossible to get a mortgage loan if you aren’t totally debt-free. However, most people have some kind of debt, from student loans to credit card debt.
One of the first things that lenders look at when they determine whether you can afford to buy a home is your debt-to-income (DTI) ratio. Your DTI ratio is a calculation that represents the percent of your monthly income that goes toward debt and recurring expenses. You can calculate your DTI ratio by:
- Adding up all of your minimum recurring payments and expenses
- Dividing them by your total gross monthly household income
For example, let’s say that each month, you pay $500 for rent, $250 toward your student loans and $250 toward your credit card debt. Let’s also say that you earn $4,000 each month before taxes. In this case, you’d divide your total monthly expenses ($1,000) by your total monthly pre-tax income ($4,000). Your DTI ratio in this example is 25%.
The higher your DTI ratio, the riskier you are as a mortgage candidate. However, if you have a DTI ratio of less than 50%, you’ll usually be able to get a mortgage loan – even if you have debt. Read our complete article on DTI ratios to learn more about this important factor and how to calculate yours.
8. Never Get An Adjustable-Rate Mortgage
Adjustable-rate mortgages (ARMs) are mortgage loans with interest rates that change over time. Here’s how ARMswork:
- First, your loan begins with a period of fixed interest. This fixed interest period may last anywhere from a month to 5 years+.
- During this period, you’ll pay a standard interest rate. This interest rate may be lower than the current market rates.
- Once this period ends, your interest rate will begin to fluctuate. Depending on how market rates move, your mortgage rate will go up or down periodically.
Many buyers assume that ARMs aren’t a good idea because they don’t know exactly what their interest rate will be. If you’re considering an ARM, you might be afraid that if market rates continue to rise, you’ll get trapped in a loan that’s significantly more expensive than the one you signed onto.
However, ARMs have caps in place to prevent your interest rate from rising (or falling) by too many percentage points.
ARMs aren’t right for everyone. If you think that you’ll be in your home for a long time and you need a set monthly mortgage payment, a fixed-rate mortgage might be better for you. However, if you think you’ll pay your loan off early or you aren’t planning on living in your home for many years, an ARM can be a fantastic choice.
The Bottom Line
A number of commonly believed mortgage myths can make the mortgage process more confusing. For example, you might have heard that you can’t buy a home if you have debt or less than 20% down. However, the truth is that you can buy a home with $0 down in some cases, and you can still qualify for a loan with debt.
Ready to begin your house hunt? Start your mortgage application to see how much you qualify for today.
Get approved to buy a home.
Rocket Mortgage® lets you get to house hunting sooner.
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