Recently, I had the pleasure of speaking with someone who was telling me how he had been preparing to buy his first home for the last five years. Over that five year period, he was able to save enough money for a 20% down payment, used a free credit reporting agency to monitor his credit scores, and kept a watchful eye on fixed mortgage interest rates. He did everything he had been told to do in order to put him in a place to buy his first home. I applaud his efforts and will congratulate him on his new purchase, rightly so, however, his situation made me wonder if some of these common mortgage myths prevented him from obtaining his goal sooner.
1. Adjustable Rate Mortgages mean “Subprime Lending”
Not too long along, there was an epidemic of mortgage loans made to the more “at-risk borrowers” (i.e. lower credit scores, little or no down payment, higher debt-to-income ratios) known as subprime lending. One of the biggest products offered within subprime lending was the Adjustable Rate Mortgage, as known as an ARM. An ARM is one where the interest rate is fixed for a specified length of time and then adjusts periodically thereafter for the remaining term of the loan. Many lenders used these products to offer an introductory period with a very low rate, which then moved to frequent adjustments, resulting in higher monthly payments. This causing homeowners to no longer afford their mortgages. This phenomenon was one of the biggest culprits to the housing market crash, giving ARMS their bad name. With that being said, there are good ARM products out there, offered by lenders that qualify borrowers, not just on the start rate, but on the adjusted rate as well, projecting that the borrower will still have the ability to pay his mortgage, even if the rate does adjust. Of course, a fixed rate, which is one where the interest rate stays the same for the entire term, is great option; however it may not be the best option for everyone. This is especially so for the buyers who plan on living in the home for a shorter period of time reasons such as expanding, downsizing, or relocating could cause a home owner to only need a mortgage for five or so years. If that is the case, an ARM product with a fixed period of five years or more, at a lower interest rate may save the homeowner a substantial amount of interest over time. Even if the future is not crystal clear, beyond a five year period, it may still be something to consider would discussing mortgage options. Taking advantage of a lower interest rate, typically found with the ARM programs, and applying some of that monthly savings to the principal of the loan, will not only pay the balance down quicker, but it will also create equity faster. Reviewing the terms of the ARM that is being offered and understanding how the loan works is crucial. The Consumer Financial Protection Bureau recently updated the Consumer Handbook for Adjustable Rate Mortgages and it is great resource to those unwary of these products.
2. You Must Have a 20% Down Payment
While having a full 20% down payment is wonderful, it may not always be an option, especially if the goal is to become a home owner sooner than later. What people should realize is that there are other options out there. Opportunities such as loans with private mortgage insurance that require a much smaller down payment, down payment assistance programs, Mass Housing loans with “No MI”, and seller credits are all great alternatives. Down payment assistance programs are a great way to get some extra money to use towards purchasing and, in many cases, don’t require repayment. These can be offered through a mortgage lender or through the City or Town that the property is being purchased in. It would be wise to contact the City directly and ask about the down payment assistance options. Mass Housing also offers some great products including an option to not pay private mortgage insurance and still finance up to 97% of the purchase price. While these are options are very attractive, there are income restrictions, so it is best to contact a lender who offers these products directly. Seller credits are also a great way find some extra money. These would be negotiated within the purchase and sales agreement and in most cases can cover the buyer’s settlement charges, such as closing costs and taxes, up to 3% of the purchase price. This is a great way to maximize your funds towards buying a home.
3. Private-Mortgage Insurance (PMI) is Bad
Private mortgage insurance, or PMI, is an insurance that a lender obtains on loans with less than 20% down payment. The idea is that the closer the loan amount is to the purchase price, the more risky the loan is for defaulting; therefore riskier to the lender. The important part to understand is that a borrower only pays PMI while they are financing above 80% of the value of the home. If a borrower initially is paying PMI, but is able to make a large principal payment later on, the new balance may be at a point where PMI is no longer needed. This same situation can be said if the value of the property increases, after it was purchased, and when compared to the existing loan balance, it is determined that there is now more than 20% equity. In that case, PMI may also not be needed. A borrower would need to check with the mortgage lender to determine if the PMI is still required, but in many loan programs, it is an option. Another thing to understand about PMI is that the initial amount required to pay is relative to the down payment. For every 5% increment a buyer gets closer to the full 20% down payment, the less amount of PMI is required. For example, a borrower who is putting a 15% down payment on a $300,000 purchase price may only pay $47 a month in PMI, whereas the person putting down only 5% on a $300,000 purchase will pay $128 a month. Lastly, PMI has different payment options. Most lenders give their borrowers an option to either pay the required PMI in either monthly payments or a single premium, lump sum. As mentioned previously, negotiating a seller credit within the purchase and sales agreement can be beneficial to the buyers purchase potential and can be used to cover buyer costs such as a PMI. With all of this being said, PMI may be a requirement in many cases for loan approval, it doesn’t necessarily mean that it is bad.
4. Applying for a Mortgage is too Hard
Too much time, too many questions, too much paper work. Right? Buying a home may be the biggest purchase you will make and just as serious as you take this purchase, so should the lender. The lenders job is to make sure that you can afford your new home and that you’ve budgeted appropriately to make the timely mortgage repayments. In order to do so, a lender will need to get a clear picture of your financial profile, including income source, monthly debt, and assets that can be used for future home maintenance, etc. While it may seem like the lender is asking for a pint of blood and your first born child, they are only trying to create a full picture of what your mortgage capacity should be. With that being said, the process doesn’t need to be painful. A good lender will be available to discuss mortgage options, walk you through the entire process, and be there to answer your questions.
If you have any questions about the home buying process, please contact our Home Financing Department at 800-942-9575.
~Erin Kelly, AVP Mortgage Operations