Common Mortgage Misconceptions That Could Cost You Money

Common Mortgage Misconceptions That Could Cost You Money

Homeowners have some common mortgage misconceptions that can cost them thousands of dollars. Learn what they are and the real facts.

The real estate site Zillow recently did a survey of 1,000 homeowners and prospective homeowners that determined many are confused by the mortgage process. Here are the biggest areas of confusion and the real facts. Knowing them could save you a bundle when you buy a home or refinance.

31% of buyers don't think it's possible to get a home for less than 5% down.

There are several ways a homeowner can purchase a home with less than 5% down. FHA Loans, VA Loans, USDA Loans all allow homeowners to buy a home with 0- 3.5% down. These programs cover millions of individuals. Comprehensive information can be found at the article Buying A House with Less Than a 20% Downpayment.

34% of homebuyers don't know what the term APR means.

APR, which stands for annual percentage rate is the interest rate as well as all the other costs that go into a mortgage, including any points, closing costs, origination and underwriting fees, and any other costs. These costs are bundled into the APR metric. So, while the interest rate of one mortgage might be lower than the other, if the APR is higher, you'll most likely be paying more over the life of the mortgage, including larger upfront fees.

24% of buyers believe they can get the best mortgage rate from where they currently have their savings or checking accounts.

While your current bank is a place to start, other banks or lenders may significantly undercut these rates. Be sure to shop around. Check the mortgage rate tables on BestCashCow or other sites to get a feel for a good rate. Talk to other lenders.

26% of buyers believe that once they are pre-approved, they are obligated to get a mortgage with that lender.

This is not true. A pre-approval from a lender does not require you to use them for the actual mortgage. Usually, the homeowner wants to see that you can get a mortgage and the pre-approval serves that purpose. Once your offer has been accepted, shop around and find the best rate. Not doing so could cost you thousands.

Find the best mortgage rates.

Image: Stuart Miles at FreeDigitalPhotos.net
It Is Not One Size Fits All - The Pros and Cons of Paying Off Your Mortgage Early

It Is Not One Size Fits All - The Pros and Cons of Paying Off Your Mortgage Early

The decision whether to pay down, or entirely pay off your mortgage earlier, is largely dependent on your personal economic situation and confort level with alternative ways to deploy your capital safely.

How to manage housing debt is often the single biggest financial decision a person has to make. For those with the luxury to pay off their debt, the question is whether doing so is a wide decision. Although widely discussed, the President and Congress have not yet eliminated the mortgage interest deduction. Is paying off your mortgage early a good idea? 

Pros

  • Paying of a mortgage early reduces the associated interest cost of a loan. On a 30 year fixed rate loan of $300,000 at 4%, the interest cost over the life of the loan is $177,000. That is over 50% of the original loan value. And because it’s a reduction on spending, the savings are equivalent to getting a guaranteed tax free return.
  • An early payoff will increase the value of home equity.  The amount of equity the homeowner possesses will increase which can then be used as a fallback source of capital in tough times.  Given that most retirees live on a fixed income budget, simultaneously lowering monthly expenses and having a source of readily accessible funds should the need arise is a powerful combination. 
  • Peace of mind. Another, less easily quantifiable benefit to paying off a mortgage ahead of time is the psychological lift that one gets from being without such a burdensome debt load.  Particularly in these difficult economic times, where having any debt has become an anathema, this alleviation of a major source of potential concern cannot be easily dismissed.  

Cons

  • You will be losing a tax refund benefit. Assuming that the mortgage interest deduction is not eliminated in future tax and spending negotiations by the Federal government, homeowners receive a significant tax benefit from holding a mortgage. The tax benefit varies depending on how far along you are in your mortgage. Because fixed rate loans are structured so that interest is paid in the early years of the loan, the tax benefit is greatest during this time period. In the later years of the loan, the interest deduction decreases significantly, because the interest has already been paid.

 

30 Year Mortgage Interest Savings

Year

Payment

Interest

Tax Savings @ marginal rate of 25%

1

$17,187

$11,904

$2,976

10

$17,187

$9,619

$2,405

25

$17,187

$7,947

$1,987

 

  • Opportunity Cost. The excess capital that would have been otherwise employed in paying off the mortgage can, instead, be used for any number of other things, such as paying off higher interest rate debt, like credit cards, or accumulating savings to hedge against future emergencies. Maintaining sufficient liquidity to deal with the unexpected developments of life is a wise and safe decision.  These funds can also be invested in securities, like equities, that traditionally have a much higher return than could be expected from the savings generated off the early retirement of a mortgage loan.  In today’s low interest rate environment, finding investments with lower risk profiles than equities that also provide attractive returns is difficult.
  • Loss of capital. This is similar to opportunity cost but subtly difference. The cash that you use to pay off a mortgage is now tied into your house. Pulling it out via a home equity loan or by refinancing is not always a sure thing. The cash is no longer readily available. 

In the end, the decision on whether or not to pay off a mortgage loan can be reduced to a formula.

If the Real cost of mortgage (Future Payments + Future Interest Cost –Deduction Benefits) > Interest on Other Investments + Peace of Mind.

Then you should pay off the mortgage.

If the Real Cost of a Mortgage is less than the interest you can earn on other investments plus peace of mind, then pay off the mortgage. 

Buying A House with Less Than a 20% Downpayment

Buying A House with Less Than a 20% Downpayment

There are a variety of programs designed for homeowners who want to get a mortgage but don't have a large amount of cash for a downpayment. Programs such as My Community Mortgage, VA Loans, and FHA Loans allow an individual to purchase a home with 0% down in some cases.

Before the financial crisis, the “Great Recession,” and the housing collapse, it was common and easy for a homebuyer to purchase a house with 0% down. In some cases, a homebuyer wouldn’t put anything down and would get money back upon closing, which could be used for renovations, home furnishings, or other expenses.

Since the collapse of the mortgage market, it has become common to hear that those days are over. That’s not necessarily true. Although it has gotten tougher and more expensive to purchase a home without a down payment of 20% or more, it is still possible. While 20% down or more is ideal for receiving a conventional loan, and still necessary for a jumbo loan, it is always necessary to purchase a home.

“There are various programs aimed at helping buyers without a large amount of cash to purchase a new home,” said John Shaedel from the lender National Mortgage Alliance.  “The expanded agency mortgage route offers programs such as My Community (3-5% down), HomePath, and various other First Time Buyer Assistance programs.  There is also the government route, with FHA programs (3.5% down) and special case FHA programs as well as Community Assistance down payment programs.  If someone is a veteran, there are VA loan programs (0% down).  If in a qualified area, there are USDA RHA programs (0% down).”

My Community Mortgage

My Community Mortgage is a Fannie Mae program that provides very flexible mortgage options for qualified low-income individuals. The program will finance up to 97% of a home (meaning the buyer only needs a 3% downpayment). It's available to purchase or refinance a single-family home, PUD, condominium, or a 2–4 family home. Other features of the program include:

  • Only requires a 3% downpayment from the borrower
  • Competitive rates
  • Requires PMI for downpayments of less than 20% but at a reduced rate.
  • Not just for the first-time homebuyer and can be used to refinance a mortgage.
  • Available for fixed-rate or variable rate mortgages.

Learn more about My Community Mortgage

Homepath Mortgage Program

Homepath is a program run by Fannie Mae to help sell properties that they have received in foreclosure. Properties held by Fannie Mae are listed as Homepath and buyers of those properties can purchase them  with as little as 3% down. Other features of Homepath are:

  • No need for an appraisal
  • Available for fixed-rate, variable, or interest-only loans
  • No PMI (mortgage insurance) necessary
  • Available for primary residences, second home, and investment properties (some condos are also available).

Learn more about Homepath

FHA Loans

FHA Loans are perhaps the most popular program for those who want to buy or refinance with a small downpayment. The loans allow anyone regardless of income  to purchase or refinance a home with as little as 3.5% down. While anyone can take advantage of an FHA loan, the property must be a one to four unit structure. In addition, there are limits to the loan amount, which vary depending on which state the house is located.

“The biggest drawback to an FHA Loan are the fees associated with it. FHA is charging twice the fees they did a few years ago,” said Jim O’ Malley, a Senior Loan Office at Leader Bank. Compared to a non FHA mortgage, those fees can make a significant difference. FHA loans now have a 1.25% upfront fee and 1.25% PMI fee. So, on a $200,000 mortgage, the upfront fee would cost $3,000 upfront. FHA loans are generally competitive but adding the 1.25% of PMI makes them more expensive. A 3.25% 30-year fixed rate mortgage would become 4.50% with the PMI included.

Learn more about FHA Loans

VA Loans

The government estimates that more than 27 million veterans and active duty military personnel are eligible to receive a VA loan. These loans allow qualified buyers to purchase a home with no downpayment. In general the loans are good up to $417,000, although they can vary depending on the state and geography. Other advantages of a VA Loan include:

  • No mortgage insurance (PMI).
  • Limitation on closing costs.
  • Traditional or variable mortgage loans. Buyers can choose a traditional 30 year fixed rate mortgage, or a variety of ARM options.
  • Loans can be used to buy a house, condo (must be VA approved), or co-op. Loans can also be used to build a house or refinance an existing house, condo, or co-op.

Even if a veteran received a VA loan in the past, they may still be eligible to refinance or receive a new VA loan depending on the number of entitlements remaining or if the prior loan was paid off.

Learn more about VA Loans

USDA Loans

The USDA Rural Development Single Family Housing Guaranteed Loan Program offers guaranteed loans to with no downpayment to rural homebuyers. The program partners with approved local lenders to finance 100% of the value of a house to eligible rural buyers. To quality, a buyer must purchase a home in a qualifying rural area and household income must exceed the limit established for that area. Key features of the program include:

·        100% financing, no downpayment required.

·        Individuals with “non-traditional” or lower than average credit scores may be accepted.

·        USDA offers 30 year, fixed rate loans.

·        Not limited to first time homebuyers.

·        Eligible property types include existing homes, new construction, modular homes, Planned Unit Developments (PUD’s), eligible condominiums and new manufactured homes.

Blended Mortgage

A homeowner can also use a blended mortgage to finance the purchase of a home or refinance a purchase. Common before the financial crisis, blended mortgages allow homeowners to cover part of the downpayment with a home equity loan. A common blended mortgage might be a 80-10-10.

80% - Mortgage financing

10% - financed via a home equity loan

10% - financed via cash downpayment.

In this way a buyer could finance the purchase with less than 20% down and also avoid paying mortgage insurance. Not paying mortgage insurance can save the homeowner a significant amount.

Since the fiancial crisis it has become more difficult to structure a blended mortgage. Lenders have tightened up their standards and according to Mr. O’ Maley, they want to see house and other credit payments comprise no more than 45% of a household’s total income. Blended mortgages are tough with condos.

Jumbo Mortgage Downpayment Options Limited

None of the above applied to jumbo mortgages. Buyers who need a jumbo mortgage to finance their home need to have at least 20% down or it will be very difficult or impossible to get the loan approved. And none of the programs covered above are for non-conforming (jumbo) loans.

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