“Everyone wants a house, but no one wants a mortgage!”
Brian Swanson
If you’re ready to start house hunting or just starting to think about homeownership, it’s essential you brush up on your home loan and mortgage knowledge. The financial aspect of buying a house can be the most confusing, and most stressful, part of the process. You might be thinking ‘How do I even get approved for a home loan? How long will it take me to save up for a downpayment? How much do I need for a downpayment? Will my student loans keep me from being approved?’
There are a lot of misconceptions about mortgages, home loans, and down payments. If you talk to your parents about buying a house, they might offer you the advice they first received when they bought a house 15-30 years ago. If you talk to your friends about buying a house, they may give you conflicting information depending on the home loans and lenders they used. So which information is right?
We talked to two loan experts to get the answers: Brian Swanson, the branch manager of the West Des Moines office of Inlanta Mortgage, and Terry Gearhart, the Director of Lending for the Neighborhood Finance Corporation.
Brian Swanson is the branch manager of the Des Moines, Iowa office of Inlanta Mortgage. He’s worked in the mortgage and financial services industries for years and offered a wealth of insight and expertise into all of the questions and issues laid out in this guide.
Terry Gearhart is the Director of Lending at the Neighborhood Finance Corporation (NFC) in Des Moines, Iowa. The NFC provides home loans and downpayment assistance to buyers who are moving to neighborhoods in need of revitalization.
Let’s break down five of the most common mortgage myths and misconceptions. We’ll tell you if they’re true or not and what you can do to prepare to buy your home. To jump to a certain point, just click the links below:
- Do I need to have a 20% downpayment?
- Will my credit score or debt keep me from being approved for a loan?
- Does everyone have a 30-year fixed-rate loan?
- Is mortgage insurance too financially risky?
- Will my credit score be affected if I meet with multiple lenders?
Mortgage Myth #1: You have to put down a 20% downpayment.
Verdict: False!
A lot of first-time homebuyers think they need to have at least 20% of the purchase price of the house saved up for the downpayment. For years, banks have required a large downpayment as a method of determining your credibility as a buyer. You’ve probably heard from them that anything less is financially risky, you’ll get stuck with mortgage insurance or you just might not be approved for a home loan.
This is not true anymore! While a 20% downpayment would help lower your monthly mortgage payment and overall life of the home loan, today you can buy a house with a much smaller downpayment. In fact, waiting years to save up a 20% downpayment may cost you more than it would to just put down a smaller amount- especially if you are renting.
“There are so many options out there for programs with smaller downpayments,” stated Brian Swanson. “The cost of waiting [to buy a house] will be [more] detrimental in the long run.”
Most lenders will tell you that nowadays the minimum downpayment you’d need is 3% of the house’s purchase price. That’s a big difference! Some loan programs, like a VA loan, can waive the downpayment completely.
Of course, this varies by individual. Other than the size of your downpayment, the biggest factors influencing your ability to get a home loan are your credit score and financial health. We’ll talk more about credit scores and debt in the next point, but most new buyers won’t need a 20% downpayment.
Some lenders, like the Neighborhood Finance Corporation (NFC), have their own requirements for downpayments.
“Specialty lenders, like the NFC, require 3% of your own money then you can use 2% from a qualified gift or downpayment assistance funds. That’s only a minimum 5% downpayment,” explained Terry Gearhart.
Keep in mind that some lenders will raise your interest rates if your downpayment is considered low. Ultimately, it will vary by financial situation. Your lender will help you determine how much you will need to put down.
Mortgage Myth #2: Your credit score or debt will keep you from being approved.
Verdict: Possibly!
This mortgage myth is what makes anyone with student loan debt or little savings think they won’t ever be able to afford a house. This is not always the case!
Lenders look at quite a few aspects of your finances. One of those is called a debt-to-income ratio– your gross income in a month versus your monthly debt payments.
Each lender will have a different standard, but if your ratio is too high they will advise you to pay off more of your debt before applying for a home loan. Some loan packages, like an FHA loan, are designed to assist people who do have high debt-to-income ratios and low credit scores. Your eligibility for this type of loan can be determined by your lender.
Not all debt is bad. In fact, making regular payments on any outstanding loans you may have while building up your savings establishes a credit history. You’re showing lenders you are capable of managing your finances and won’t miss a payment. They want to see that!
Your credit score will affect what kind of loan you could be eligible for. “Many lenders like to see a minimum of a 580 credit score for some of their more aggressive programs,” explained Swanson. “As your credit score increases, the risk for the lender decreases, and the interest rates improve. A score of 740 and up will get you the A+ best-rate programs.”
“Credit scores are a predictive risk model of loan default. The lower the credit score, the more risk of default persists.”
Terry Gearhart
You can sit down with your lender before applying with a loan and review your debt-to-income ratio, credit score, and other financials. If the lender determines that your debt is too high or your credit score too low for you to qualify for a loan, they can give you advice on what to do to improve your eligibility.
“Don’t overutilize credit, but don’t underutilize it either,” said Swanson. “Keep the balances on your credit cards below 30% of the limit to get the best addition to your credit scores. The only way to establish and build a credit history is to have debts you continue to pay on time.”
While your debts and credit score will affect your eligibility for certain loan types and the terms of those loans, having debt or a lower credit score are not necessarily the roadblocks you think they are. If you’re wondering if you’d be eligible for a home loan, set up a meeting with your lender to review your financial state.
Mortgage Myth #3: Everyone has a conventional 30-year fixed-rate loan.
Verdict: False!
“Many lenders are ‘order takers’ and assume that every single client wants a 30-year fixed rate,” said Swanson. “Clients think this too because that’s all anyone ever talks about. But it’s the lender’s job to have a discussion with the client to figure out what their financial position is.”
Are you familiar with the differences between home loan terms? If not, here’s a quick overview:
Fixed-rate mortgage
Your interest rate will be set at the same percentage every year for 15 or 30 years. Your monthly payments are predictable and easy to budget for, however, you tend to pay out more in interest to your lender over the life of the loan. If you plan to stay in your home for a while and have to be able to budget for a set monthly mortgage payment, a fixed rate would be an ideal choice.
Adjustable-rate mortgage (ARM)
Your interest rate can fluctuate in accordance with the current financial markets so your payments will change. Many lenders will offer you a low starting rate which can be set for five, seven, or 10 years, after which the rate will change based on the market. The benefit of an ARM is that you can take advantage of low rates when they occur which can help you pay off your loan faster. However, you have to be prepared for higher payments if rates rise.
Different loan types
The most common type of home loan is a conventional loan that is backed by a private company, such as Freddie Mac or Fannie Mae. But you could also get:
- A VA loan backed by the U.S. Department of Veteran Affairs, if you or your spouse are active or former military. VA loans do not require a downpayment and typically offer low interest rates without adding on mortgage insurance. However, they may require funding fees.
- An FHA loan is backed by the Federal Housing Administration and is designed to make home loans accessible to those who would not otherwise qualify for a conventional loan. They are structured for people with high debt-to-income ratios and low credit scores and therefore will always have mortgage insurance and require two mortgage premiums.
- A USDA loan is backed by the U.S. Department of Agriculture and is issued to buyers in designated rural areas. USDA loans do not require a downpayment but your household income must be at or below the income limit set by the USDA.
The most common type of home loan is a conventional 30-year fixed-rate loan. This basically means you’re repaying the loan over 30 years with the same interest rate every year. For most buyers, a fixed interest rate is the best for their budgets. You can always account for how much you’ll pay each month and that stability is important to a lot of home buyers.
That doesn’t mean it’s the perfect fit for everyone’s financial situation and long-term plans.
Swanson offered an example of someone who may not need this type of loan: “If you are working with a corporate executive who is transferred every 3-4 years, a 30-year fixed-rate loan could be costing them more money when a 5-year adjustable-rate mortgage (ARM) may be priced more aggressively in the short term.”
It’s your lender’s job to review your financial state and future plans before working with you to find the best loan type for you.
Mortgage Myth #4: Mortgage insurance is financially risky.
Verdict: False!
You’ve probably been warned that you’d be stuck with mortgage insurance if you don’t have the savings for a big downpayment. What is mortgage insurance?
Private mortgage insurance (PMI) is issued on conventional loans if your downpayment is less than 20%. It’s basically insurance for the lender in case you stop making your monthly payments. Most of the time PMI is added on to your monthly mortgage payments but sometimes you pay a lump sum upfront.
“There are different types of mortgage insurance available. Some you pay monthly- which is normal. Some are single premium, split premium, or lender funded, which means you end up paying a higher interest rate,” explained Swanson. “If you are putting down less than 20% and have one loan, you are paying mortgage insurance somehow even if it doesn’t show that on your monthly statement.”
PMI can be anywhere from 0.5 to 1% of the total loan amount each year, depending on your lender and the terms of your loan.
For Example:
For a $100,000 loan, you could expect to pay about $500-1,000 a year or an extra $41.67-83.33 a month.
The good news is the PMI payments won’t last for the entirety of your loan. Each lender varies but some will end your PMI once you reach a certain amount of equity in your home or they’ll set a predetermined length of time.
Spending extra money every month on mortgage insurance probably doesn’t seem ideal, but it’s not the end of the world!
“Even though it’s not great, it does give someone the opportunity to purchase and start to build equity long before they may have been able to if they waited to save a full 20% downpayment,” explained Swanson. “The amount of equity they gain in the property will offset the cost of the mortgage insurance premiums.”
Some loans don’t require PMI for downpayments of less than 20%– think VA and USDA loans. But FHA loans will always require PMI and conventional loans will for downpayments less than 20%.
Talk to your lender about your options and work with them to calculate if it’s in your financial interest to start earning equity, even if it comes with PMI every month.
Mortgage Myth #5: Talking to multiple lenders will hurt your credit score.
Verdict: False!
Like any other product, you should shop around before you pick a lender to work with on a home loan. There are so many organizations you can work with on a home loan: banks, credit unions, national companies, startups, and independent contractors. You’ll find each one is a little different when it comes to overlays (the lender’s qualification requirements), loan packages and the loan officers themselves.
“I wish homebuyers would be more concerned about the person they are working with instead of focusing just on the interest rates,” said Swanson. “Rates are important but if you’re put into the incorrect product for a lower rate of only .125%, it could still cost you more money in the long run. Talk to your loan originator. Get to know and understand them as a person and learn about their background. Ask yourself ‘Do I trust this person with the largest asset I have purchased? Do I feel they are going to look out for me not only now, but as the market changes?”
It’s in your best interest to meet with more than one lender to find the one you can trust, work well with, and know will find the best loan package for you. But how do you “shop around” if loan officers have to do credit checks to pre-approve you for a loan? Multiple credit checks (or “pulls”) can negatively affect your credit score.
“If you are doing multiple pre-approvals with different lenders within a 14-day span, the inquiries will be bundled as one if the lenders are registered as official mortgage lenders with the credit bureaus,” said Swanson. Not every mortgage lender is considered an official lender, so you should check with the credit bureaus first.
If you are asking for multiple pre-approvals, you will have to provide a letter of explanation to the credit bureaus explaining that you are searching for a lender and looking for the best rate.
Some lenders can do a “soft pull” which only checks your credit with one credit bureau and won’t show as a credit inquiry on your record. You would have to specially request this and not all lenders have the ability to do this. A soft pull minimizes the number of inquiries on your record, but it doesn’t give a lender the full picture of your financial state.
Once you find a lender you want to work with you can start the official pre-approval process and get the ball rolling on your house hunt.
If you’re starting to think about buying a home, your first step is to get your finances in order and talk to a lender about home loan packages and what they will require. Everyone’s financial situation is different and different lenders may offer slightly different loan packages. Take the time to talk to more than one loan officer and evaluate your financial state and what you can afford in the long-term.
If you’re unsure about your next steps beyond talking to a lender, check out our first-time homebuyer series. It covers everything you need to know about buying a house from pre-approval to house hunting to home inspections to closing. You’ll have all the information you need for a successful purchase right at your fingertips.