10 Mortgage Shopping Myths Debunked
You’re finally ready to purchase your first home. You have a decent salary, a significant amount in savings and your credit is top-notch. But once the time comes to shop for a mortgage, you find yourself confused.
Decades ago, your father told you not to shop around too much, as doing so could hurt your credit score. Is that still true? You’ve heard that putting 20 percent down is a must, but you can only afford to contribute 15 percent. Should you wait a few more years to purchase a home? You’ve always heard that the only way to go is with a 30-year, fixed-rate mortgage. But what if I plan on moving in four years?
There are countless sources of misinformation surrounding mortgages, and it’s crucial to be as educated as possible before shopping. “Make sure you’re as informed as possible before you get to that closing table and you sign the note, because at that point, the loan is yours, and so is the home,” said Valerie Saunders, executive director of the National Association of Mortgage Brokers (NAMB).
We’ve dispelled the 10 most common mortgage shopping myths so you can be a well-informed buyer.
Myth: Shopping for a mortgage will hurt your credit score.
This myth used to be true more than a decade ago, said Tendayi Kapfidze, the chief economist at LendingTree. It used to be harmful to one’s credit score to have too many inquiries pulled, and in turn, people were afraid to shop around.
However, Kapfidze said the credit scores now don’t penalize borrowers for simply doing their due diligence by shopping around.
“If you get multiple queries — whether it’s for a home loan, an auto loan or just the same type of loan within a short period of time — [the credit bureaus] recognize that you’re shopping, and there’s no detrimental effect from getting those multiple queries on your credit,” Kapfidze said.
Keep in mind that oftentimes, queries need to be kept within a 30-day window to not affect your credit score. “Whether you’ve had one inquiry or two inquiries or three inquiries total, as long as they’re in a 30-day window, and from a mortgage company, that should not have a negative effect on your credit score,” said Bryan Kelly, vice president of mortgage lending at Guaranteed Rate in Chicago.
Myth: Lenders will sell your personal information.
Lenders themselves won’t sell your personal information to telemarketers. However, your information can still be distributed. When you apply for a mortgage, your lender will run your credit through the three major credit-reporting agencies: Equifax, Experian and TransUnion.
When your credit is pulled, your credit report shows that you’ve had an inquiry. Saunders said that if the inquiry is identified as related to a mortgage, credit-reporting agencies know you’re trying to obtain a loan. The credit bureaus can then sell your information, referred to as a trigger lead, to other prospective mortgage lenders who are looking for high-quality leads.
“Trigger leads are sold by the credit-reporting agencies to any entity that wishes to purchase them,” Saunders said, adding that there is currently no way to opt out when it comes to having your information distributed through trigger leads.
Myth: You can qualify for the lowest advertised interest rate.
You see an advertised interest rate of 3.75 percent on a 30-year, fixed-rate mortgage, and your face lights up. This is lower than all other rates you’ve seen while shopping around. But don’t get too excited over the advertised rate, Kapfidze said, because that rate is available only to a very specific borrower, typically someone who’s putting 20 percent down and has a very high FICO credit score.
Kapfidze said you should consider advertised mortgage rates similar to clothing ads. When you buy a piece of clothing, you don’t expect it to fit exactly as it does on the model.
“It’s no different with a model rate for a particular type of borrower, who is not the typical borrower out there,” he said. “It’s not that the advertised rates are false or misleading — it’s advertising, like any product.”
Myth: The loan with the lowest interest rate is always the best option.
Although it’s crucial to consider your potential interest rate, it’s not the only factor to take into consideration when shopping for a mortgage. The full cost of a mortgage is the interest rate plus the fees.
Kapfidze recommends comparing the annualized percentage rate, or APR, which takes both the fees and interest rate into consideration. Also, consider your personal payment preferences, too. “For your personal financial circumstances, what combination of fees and interest rate do you want to have?” Kapfidze said.
For example, if you have extra money that could pay more fees upfront and get a lower, longer term interest rate, you will have smaller monthly payments. On the other hand, if you don’t have much to spare upfront — but you can swallow a larger monthly payment, you might consider settling for a higher interest rate to secure the mortgage.
“It really comes down to individual circumstances, as with a lot of financial decisions,” Kapfidze said.
Myth: The Federal Reserve’s fund rate impacts mortgage rates.
The federal funds rate does not directly impact rates on 30-year fixed mortgages, the most common type of home loan for purchases. Rates on some adjustable mortgages can be more closely linked to the Fed funds rate if they are tied to the prime rate.
Because both rates are reacting to factors in the economy, they can move in the same direction, Kapfidze said. But this doesn’t mean that one impacts the other.
“Right before the financial crisis, the federal funds rate was going up, and the mortgage rates were going down,” Kapfidze said. “Other times in history, the federal funds rate could be going up, and the mortgage rates could be going up. There really is no direct connection between the federal funds rate and mortgage rates.”
Myth: You need to put 20 percent down.
You should strive to put 20 percent down because you avoid paying PMI, or private mortgage insurance, which makes your monthly payment larger. In addition, contributing a bigger chunk of money upfront provides a cushion should housing values dip after you purchase your home.
Just because you can’t afford to put down 20 percent doesn’t mean you shouldn’t purchase a home. Kelly said you should look at your particular financial situation and make an informed decision. For instance, consider a homebuyer who has a 5-percent down payment, but wants to wait until she has 20 percent.
“Why would it be a good idea to wait if they really want to be a homeowner, and they can afford the monthly payment with just the 5 percent down payment today?” he said.
If you’re unsure about putting 20 percent down, speak with an experienced lender to learn about all of your options. “Find somebody you like and trust who’s not interested in pushing you into making a decision, but just educating you so that you can make an informed decision yourself,” Kelly said.
Myth: Once you’re preapproved for a loan, you’re in the clear.
The preapproval process involves a loan officer running your credit to figure out if you’re a viable borrower, Kelly said. But just because you’re preapproved for a loan doesn’t mean you’ll ultimately qualify for that loan.
Your employment status, income or credit score can change between the preapproval and the actual approval. The underwriting process involves a much higher level of scrutiny than the preapproval process, meaning some factors can be discovered that wasn’t evident earlier on.
“Just know that until you get to the closing table and sign those documents, everything is fluid and potentially subject to change,” Saunders said.
Myth: You can afford the loan you are approved for.
Just because you can get approved for a certain loan amount doesn’t mean you can actually afford it.
Although a lender may think you can afford a particular payment based on your financial profile, it might actually be unaffordable once your lifestyle, spending habits and personal preferences are taken into consideration.
“What they want to put away for 401(k)s, or vacations, or children’s college funds and things of that nature are not numbers that a lender looks at when qualifying somebody,” Kelly said. “Sometimes a borrower is going to be much more comfortable at a lower housing payment than what the lender could actually approve them for.”
Myth: A 30-year-fixed rate mortgage is the best option.
A 30-year fixed-rate mortgage is often the best option for many consumers. “The gold standard of what you typically see is the 30-year fixed-rate mortgage, because your payment is going to be lower,” Saunders said.
But depending on your situation, other loan structures could be better.
For example, a 15-year or 20-year fixed-rate loan might be a better option for you if you can afford a higher monthly payment. Although your monthly payment is larger, you can save on interest paid in the long run and build equity more quickly.
An adjustable-rate mortgage (ARM) can be a good option for people who know they won’t be in a home for very long. For instance, a 5-year ARM is structured so that a lower interest rate is locked in for the first five years and then can change every year after that.
This structure could be risky for those who plan on living in their home for the rest of their lives because it’s hard to plan for those rate changes year after year. But if you plan to move before the five years are up, you may get a lower interest rate through an ARM versus a 30-year fixed mortgage.
Myth: You should only refinance if interest rates are a full percentage point lower.
People often believe that if interest rates don’t decrease at least one full percentage point, then it doesn’t make sense for them to refinance, Kelly said.
But this one-size-fits-all mindset isn’t accurate. For instance, a homeowner with a large mortgage might benefit from a half-point decrease. “You have to really look at the monthly savings, and what it costs you to get the refinance completed,” he said.
In addition, some lenders pay the closings costs associated with a refinance, Kelly said, which could make a rate decrease as low as three-eighths of a percent worthwhile, depending on the borrower’s particular situation.
Once you’ve decided to purchase a home, the most important step you can take is to shop around for the best mortgage. Home loans are complex and can be difficult to understand, but you shouldn’t let that stop you from finding the best offer out there.
“A lot of the research has shown that only about half of people shop for mortgages, and even those who shop, they only look at two lenders,” Kapfidze said. “The more you shop, the more you save.”