Buying a home is a complex process that has given rise to countless mortgage fallacies. Although this is not an exhaustive list, here are four common mortgage myths that many first-time homebuyers fall victim to:
1. Pre-qualification is the same as pre-approval.
When you’re shopping around for a home, it’s nice to have a ballpark figure of what you can afford. You can go through a “pre-qualification” process with your lender to get a general idea of your budget, but this is not a commitment to lend. Based on your self-declared assets and debt, pre-qualification is a projected amount you can expect to receive when you apply for a loan—it’s not an approval—and it can be a helpful figure when you first start your house hunt.
On the other hand, pre-approval is a much more in-depth process involving a thorough investigation of your credit and financial history. Pre-approval means that a lender will supply the loan amount when you purchase a home, assuming your debt to income ratio hasn’t changed at the time of closing. This is like shopping with money in hand, so-to-speak, and it gives the buyer “purchasing power” over homebuyers that are pre-qualified.
It’s important to note that pre-approval is not always a guaranteed commitment to lend. Lenders may check your credit before you close on your loan, and they can still revoke a pre-approved amount if your financial picture changes. Because of this, you should probably wait to finance your new washer and dryer with 36 months no interest until after your loan closes.
There are some lenders that currently offer you the ability to take your pre-approval one step further, offering a full mortgage credit commitment. It may go by many different names but it is commonly referred to as a TBD Purchase. This important next step gives you an even bigger leg up in the mortgage process for purchasing your new home.
2. Why should I buy a home? Renting is cheaper.
In most cases, the opposite is true—owning a home is cheaper than renting. According to chief economist, Jed Kolko, it’s 38 percent cheaper to buy a home than to rent a comparable one. Of course, buying a home may not always be the best or safest option. For some people renting is more appropriate, especially after a short sale or bankruptcy. But there are a few benefits of buying a home that some people may not be aware of.
For instance, owning a home allows you to build equity, which is kind of like having “wealth.” Let’s say you still owe $200,000 on a house that is worth $250,000. In this scenario, you have $50,000 worth of equity invested into your home, and that speaks volumes to lenders who are risk-averse. Renters, unfortunately, don’t have this perk.
Another benefit of home ownership is the fact that a mortgage can offer a fixed-rate that doesn’t change. A 30-year fixed-rate mortgage for example gives homebuyers the ability to know exactly how much their mortgage payment will be, a stability not offered to renters. Rental costs are subject to change based on the landlord’s discretion, and they’re likely to rise over time.
3. My bank will offer me the best loan rate because I already have an account with them.
In theory this makes sense but it’s usually not true. Just because you hold a checking or a saving’s account with a particular bank doesn’t necessarily mean you’ll get a special interest rate. Lenders determine your loan rate using several comprehensive factors, most notably credit worthiness—it’s not solely based on your loyalty or bank membership.
Some banks offer special discounts such as credit towards a home purchase or a reduced interest rate if you’re already a member, but you usually have to maintain a certain account balance each month in order to qualify. These account balances are almost always out of scope for the average first-time homebuyer on a budget—for example, they can require an available account balance as high as $50,000 per month!
You may be surprised to find that your bank offers the highest loan rate, so it’s a good idea to shop around before you commit to one lender.
4. I can’t get approved for a home loan because my credit score is pretty low.
Applicants with poor credit and no credit can still be approved for a home loan, but the interest rate may be higher than those with excellent credit. To make homeownership a possibility for applicants who have less than perfect credit, some loans are designed to be more forgiving.
For example, a loan backed by the Federal Housing Administration, or FHA loan, requires a minimum credit score of 500 in order to qualify, which is very low in comparison to traditional loans. You can also qualify for an FHA loan if you have no credit, but you still have to demonstrate credit worthiness by paying your bills on-time.