First-time buyers tend to make assumptions about down payments and other facts about the home buying process. The truth is that regulations on mortgage financing have changed since the subprime mortgage crisis upended the industry and kicked off a global recession in 2008.
Federal regulations initially tightened lending standards to prevent defaults and foreclosures. The new standards used stricter assessments to determine whether prospective buyers had the ability to repay their mortgages. In January 2014, however, regulators changed those rules after real estate groups and consumer advocates claimed that millions of Americans would not be able to qualify for housing loans. As a result, the proposed 20 percent down payment rule was dropped. Banks now are only required to document that a borrower has the means necessary to afford a mortgage as long as it does not exceed a certain threshold of debt.
MYTH: A big down payment is required. According to Bank of America, between 5 percent and 20 percent of a home’s purchase price is required for a down payment. Lenders typically require private mortgage insurance for down payments under 20 percent. The purpose of PMI is to protect the lender if you default on the mortgage. PMI typically costs between .05 percent and 1 percent of the loan amount annually. So PMI of 1 percent on a $100,000 mortgage, for example, would cost $1,000 a year or about $83 a month.
Richard Airey, senior mortgage originator with Finance of America Mortgage, said that the 20 percent down payment requirement “is probably the most common misconception I encounter.” He said loans from the Federal Housing Administration require a down payment of 3.5 percent of the home’s purchase price. Loans from the Department of Veterans Affairs and the U.S. Department of Agriculture require no down payment for eligible buyers.
For buyers who only have a small down payment, there could be a way around paying for PMI, said David Hosterman, a branch manager with Castle & Cooke Mortgage. “Consumers can choose to do what is called borrower-paid single premium mortgage insurance to avoid having monthly mortgage insurance,” he said. “This is typically an up-front charge the borrower has, which allows them to buy out of the mortgage insurance for the life of the loan. This is typically only allowed on conventional loans.”
MYTH: I need perfect credit. Your credit report is separate from your credit score. Your FICO credit score, which is a measure of your credit worthiness, is based on your credit report from the three credit reporting bureaus. Scores range from 350 to 850. You can qualify for a conventional mortgage with favorable terms at the 720 level and up. First-time home buyers can secure an FHA loan with a credit score of 620 or above.
Buying a home with bad credit is not impossible. “Borrowers can qualify for government loan programs with a FICO score as low as 580,” Airey said. “These loan programs include VA and FHA loans. The USDA requires a 620 FICO score. Conventional financing requires a 640 score or above.”
Generally, better financing terms are available for those with higher credit scores. Buyers with lower credit scores will pay higher interest rates for mortgages.
MYTH: Fixed-rate loans are best. This myth is based on the belief that mortgage payments on an adjustable rate mortgage can skyrocket along with interest rates. But what’s more important to consider is the length of time you intend to stay in the house.
“If you are planning on staying in the home for anywhere from four to seven years, consider a shorter-term fixed rate or even an adjustable rate mortgage,” she said. “For example, Navy Federal offers a 5/5 adjustable rate mortgage that only adjusts once in 10 years and has a lower rate than the 30-year fixed-rate loan. Remember, the longer the fixed rate, the higher the interest rate.”
MYTH: Location is most important. A quiet neighborhood of homes with white picket fences might be one vision of the American Dream, but Miller suggested that savvy buyers instead seek “hidden gems.”
“Some of the best deals are found in areas that haven’t reached their full potential,” she said. “Look at the community you are buying in. Is construction planned? Are there new housing units being built? Try to glimpse into the future and what the area will look like in five to 10 years.”
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