With mortgage rates regularly hitting record lows, you may be thinking it’s a good time to purchase a new home. But if you’re a first-time homebuyer, or it’s been a while since you last bought a home, you might believe some outdated myths about applying for a mortgage that simply aren’t true.
Here are four prevalent misconceptions about mortgages, along with some key takeaways that will help you qualify for the right mortgage for your needs.
YOU HAVE TO MAKE A 20 PERCENT DOWN PAYMENT
Plunking down 20 percent for a down payment on a home is often recommended because it allows you to avoid paying private mortgage insurance (PMI), which protects the lender in case you default on your loan. That may explain why 44 percent of Americans said in a recent NerdWallet survey that they believe they need a down payment of 20 percent or more to buy a home.
However, there’s no hard-and-fast rule that says you must make a 20 percent down payment in order to get a mortgage. In fact, more than half of recent U.S. home buyers said they put down less than 20 percent, according to a Zillow report. “As home prices increase, buyers have to save even more money for a down payment,” says Keith Gumbinger, vice president at HSH, a mortgage information website. “That makes amassing a 20 percent down payment unrealistic for a lot of buyers.”
To qualify for a conventional mortgage, you typically need a down payment of at least 5 percent — although Conventional 97 loans, which were introduced by Fannie Mae and Freddie Mac several years ago, allow you to put down as little as 3 percent on a home.
In addition to conventional loans, there are a number of special mortgage programs that have low down payment requirements for borrowers, including loans from the U.S. Department of Veterans Affairs (VA), which allow for down payments as low as 0 percent, and Federal Housing Administration (FHA) loans, which require a minimum down payment of 3.5 percent.
YOU CAN ONLY GET A MORTGAGE IF YOU HAVE A HIGH CREDIT SCORE
A credit score of 740 or above can enable you to qualify for the best mortgage rates, says Guy Cecala, chief executive and publisher of Inside Mortgage Finance. But there are still ways to qualify for a mortgage if your credit needs a little TLC.
Cecala adds that credit score requirements can vary from lender to lender, but you can usually qualify for a conventional loan with a credit score of 650 or higher. (Note: Conventional 97 loans allow credit scores of as low as 620.) Meanwhile, FHA loans require a minimum credit score of 580, although borrowers with a credit score of 500 to 579 can qualify by making a 10 percent down payment. VA lenders typically look for a credit score of at least 620, although the VA doesn’t set a specific minimum credit score for borrowers.
AN ADJUSTABLE RATE MORTGAGE IS TOO RISKY
An adjustable-rate mortgage (ARM) offers a lower interest rate for a fixed initial period (typically five to 10 years), and then the rate is subject to change based on market conditions. During their introductory rate period, ARMs usually offer lower rates than fixed-rate mortgages, which means they can help you save a big chunk of cash early on. But a lot of potential homeowners find them risky because after that initial period is up, the mortgage rate — and thus their monthly payments — could shoot up.
But ARMs can be a good loan option depending on how long you plan to own your home, Cecala says. If you know that you’re going to sell it in the next five years, opting for a five-year ARM over a 30-year fixed-rate mortgage may allow you to nab a significantly lower monthly payment while you own your home. But if you don’t know how long you’ll own your home “you’ll need to crunch the numbers,” he adds, as you do run the risk of potentially paying more in the future.
A MORTGAGE PRE-QUALIFICATION IS THE SAME AS A PRE-APPROVAL
Many prospective homebuyers make the mistake of using the terms mortgage pre-qualification and mortgage pre-approval interchangeably, but they’re different. Pre-qualification, or “pre-qual,” entails a cursory overview of your finances to determine your eligibility for a mortgage. To get pre-qualified you provide information to a mortgage lender about your income, assets, debt and credit without supplying any paperwork. In exchange, the lender may give you a verbal commitment for a loan, but it’s not a guarantee that you’ll get approved for a mortgage, Gumbinger says.
Getting pre-approved for a mortgage requires a substantially more comprehensive vetting process. The goal is to get a written commitment from a lender stating the lender will provide you with financing up to a certain loan amount. In order for that to happen, a lender’s underwriter will perform an in-depth review of your income, assets and credit by looking at your recent pay stubs, tax returns, proof of funds for your down payment, checking and savings account statements, as well as any investment accounts, among other paperwork.
Why get pre-approved instead of pre-qualified? A pre-approval letter will carry more weight with a seller when you make an offer because it gives them greater reassurance that you’ll be approved by a lender, getting you one step closer to your new home.