Buying your first home can feel daunting, there’s no doubt about it. While it’s fun to dream about your ideal home and all the ways you can make it your own, first time home buyers might be surprised at just how many steps are involved in making that dream a reality.
Getting a mortgage for the first time is one of the biggest steps, and it’s one that can cause a lot of confusion. A simple online search will dig up a ton of information, including many common mortgage myths and misconceptions. So how do you separate fact from fiction? Keep reading, and we’ll explore the truth about mortgage loans and what you need to know.
Myth #1: You need a 20% down payment to purchase a home.
While many financial experts recommend putting down a 20% down payment when you purchase a home, is it really necessary? The answer is no. You don’t need that 20% magic number. In some cases, conventional loans will accept as little as 3% down, and some government-backed loans don’t require anything at all.
The 20% recommendation simply exists because of PMI, or private mortgage insurance. PMI is a type of insurance that’s typically tacked on by mortgage lenders if you choose not to put down that amount. It gives your lender a sense of security, protecting them if you were to get behind on your payments. You’ll usually see it added to your monthly mortgage payment amount, although some may ask for a one-time up-front premium paid at closing.
While it’s smart to make sure you’re in a good spot financially to buy a home, you don’t have to fixate on the 20% down payment number if you’re OK with paying PMI.
Myth #2: You have to have perfect credit to qualify for a mortgage.
Another common checklist item before buying a home is to improve your credit score. But does it really need to be squeaky-clean and perfect? Nope! This is just another common mortgage myth.
However, you don’t want to have terrible credit, either. Most mortgage lenders will have a minimum requirement, but this varies depending on the type of loan you take out and who insures the loan. A conventional loan may require a credit score of 620 or higher, for example, while an FHA loan may look for as little as 500. The latter is a specific option for borrowers deemed a higher risk due to low credit scores and little money to put toward a down payment. Keep in mind there may be other requirements to hit; however, as well as the need for PMI, which we covered in the previous section.
Something else to note: changes in the marketplace overall have made it easier to buy a home altogether, with experts reporting marked drops in credit standards and mortgage rates as a way of enticing people to buy.
Myth #3: Debt will ruin your chances of getting a good mortgage.
Debt often goes hand-in-hand with your credit score, so another common mortgage myth is that you should pay off all of your credit cards, student loans, and so on before purchasing your first home. Unfortunately, this isn’t always a realistic option for home buyers; these days, student loan debt is widespread among millennials, mostly, and paying off loans can take years — much longer than you want to wait to become a homeowner. The good news is, debt won’t ruin your chances of locking in a good mortgage rate.
What does matter is your DTI, or debt-to-income ratio. Simply put, how much of your monthly income goes toward debt and recurring expenses? That percentage calculation is what your lender uses to assess your risk. Typically, a DTI of less than 50% makes you an acceptable candidate, even if you have debt as part of those monthly expenses.
While a lender might offer a less-risky buyer a better mortgage rate, it doesn’t mean you’re out of the running. This is why it’s so important to shop around for your mortgage loan! Working with a mortgage broker instead of a bank, for example, gives you access to a wide variety of lenders, allowing you to find the right one for your individual needs.
Myth #4: Applying for a mortgage will affect your credit.
Your credit score is quite a hot topic when it comes to mortgages. And it’s no surprise since it’s a number that follows you around (to either your benefit or detriment) your entire life.
But we need to address another common mortgage myth here when it comes to the homebuying process. While we always recommend applying for pre-qualification before you even step foot in your first open house, many people worry that this step will ding their credit score — especially if you’re shopping around, as we suggested above. Good news: you’re in the clear.
About 10% of your FICO score comes from recent credit inquiries. While applying for a pre-approval will temporarily affect your score, you probably won’t even notice the hit until after you’ve completed your full pre-approval, which is typically done once you’re ready to make an offer.
Myth #5: It’s near impossible to get a loan if you’re self-employed.
Let’s go back to your DTI ratio now. What happens if you don’t have a steady income month over month? With so many people taking advantage of the gig economy, this is becoming much more common these days.
Here’s the gist: if you’re self-employed, the process of securing a mortgage is a little different… but certainly not impossible. At the end of the day, the lender is still looking at how much you earn vs. how much you spend. To determine this without a W2, they’ll typically ask for other types of documentation, such as:
- Income tax returns for the two most recent tax years
- Business income tax returns, if you’re operating as a corporation or partnership
- Profit and loss statements
- A copy of your business license
Keep in mind that you may be seen as a slightly more risky loan candidate, so the mortgage myths we listed above — namely, having a solid credit score and a 20% down payment — may be more of a reality for you. Again, shopping around and working with a well-established mortgage broker can help you find the right lender for your situation.
Myth #6: Once you have a mortgage loan, you’re locked in.
So you’ve secured your mortgage loan, and maybe you’re a few years into homeownership. Congrats! But what happens if your financial situation changes? Perhaps you lose your job, and you’re looking for ways to lower your monthly expenses. Or, maybe you’ve worked your way up the corporate ladder and have the means to pay off your loan early.
In most cases, you’re never “locked in” to your mortgage, so these are both options that may be available to you.
As for paying off your loan early, check your paperwork first; some lenders include “prepayment penalties” inside the terms of your loan, so make sure you understand any stipulations or rules in place.
Learn How Mortgage Goat Can Help
We hope that addressing the six mortgage myths above has helped you feel more confident and empowered during the home buying process. And when you’re ready to take the next step on a pre-qualification or pre-approval, we’re here to help!