Buying your first home is an exciting time.
You’re close to finally realizing your dream of homeownership..
Hire a Realtor and get a mortgage, that simple right?
Here are 10 misconceptions about home buying and common first time buyer mistakes to avoid.
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1. You need a 20% down payment to get a mortgage
Many first time home buyers believe you still need a 20% down payment before you can get approved for a mortgage. While that used to be true a few decades ago, that’s no longer the case these days. Many years ago home loans were only for people with perfect credit and a 20% – 50% down payment. The Government wanted more American’s to be able to achieve the dream of home ownership. They created the Federal Housing Administration which offered “FHA Loans”.
These Government backed loans were not given by the FHA, they were insured against default. Meaning they acted as a type of insurance to the mortgage loan. If a borrower ever defaulted on a home loan the FHA would pay the remaining balance to the lender and take possession of the home. This made lending to borrowers with lower down payment and credit score requirements much less risky and boosted home ownership.
The FHA will back a loan where the borrower have a 500-579 credit score or higher and a 10% down payment. If you have at least a 580 credit score you just need a 3.5% down payment to qualify for an FHA mortgage. On a $200,000 home that comes to just a $7,000 down payment needed, making buying a home much more attainable for consumers.
2. You need a 640 credit score to qualify for a home loan
Again, this used to be true many years ago, but with the introduction of Government loans into the market, lenders have lowered their credit score requirements for mortgages. While some mortgage loans such as conventional loans still require a 620-640 score. FHA loans are available to buyers with bad credit scores. In fact, FHA has the lowest credit score requires of any type of mortgage offered today. Credit scores as low as 500 can qualify for an FHA loan with a 10% down payment. However, having a credit score in the 500-579 range makes it very difficult to qualify even if you have 10% down. It’s recommended to working on increasing your credit score above 580 before applying.
A 580 score is the minimum score some reputable mortgage lenders require for FHA. There is a lot more lenders look at than just your credit score. You should have no more than a single late payment in the past 30 days. No judgements or liens, and minimal collection debt to qualify.
3. You can save money by not using a real estate agent
Realtors are so important to the home buying process you can’t afford to not have an agent on your side. Real estate agents do get a 3% commission, but the home buyer does not pay their fee. It is paid by the seller and is built into the selling price. Every seller expects to pay a buyers agent commission. If you show up without one thinking you can get a 3% discount on the price you will quickly regret it. Realtors help you get the lowest purchase price with their expertise and using comparables.
Real estate contracts are long and quite difficult to comprehend for the average consumer. There are many items such as home appraisals, inspections, opt-out clauses, etc. that you need to know about in depth in order to protect yourself. The reality is that not have a Realtor is a receipt for stress, and wasting time and money.
4. It’s cheaper to rent than it is to buy
Rent prices are skyrocketed over the last couple of years making the cost of renting about the same as mortgage payment would be. There are much higher up-front costs associated with home buying. You have the down payment, closing costs and fees, and mortgage insurance. However, over the course of 4-5 years buying is cheaper than renting. If you plan on staying in the same property for at least 5 years then buying is considerably cheaper than renting is.
5. Buying a home that needs a lot of renovating will be cheaper
Everyone has seen the HDTV shows where people buy an ugly home for really cheap and invest some money into and make it into their dream home. While this is great, in principal. It rarely every happens in reality. Tearing down walls and completely redoing kitchens are much more difficult and expensive than they appear on TV.
Many people may plan on doing these upgrades but knowing the time and money investment it takes will never get around to renovating that old home. Then what happens? You’re stuck in a home you don’t like and are ready to buy a new one. Make sure you like the house how it is. If it needs new carpet or paint, that’s easy. If you need to tear down walls to make it look nice then it’s best to move on.
6. You don’t need a home inspection on newer homes
Surprising even new homes need a home inspection. Home builders make mistakes, some even cut corners or rush jobs overlooking poor work. You should always get a home inspection even if the house you are buying is brand new. A home inspection will help you uncover any items that may cause issues in the future. You will be able to get those items repaired before you close on the mortgage and it’s too late. The average home inspection is between $300-$400 dollars. It’s well worth the investment to have any home inspected prior to closing.
7. Don’t have too many lenders check your credit because it’ll hurt your score
Actually it’s a good idea to get as many loan offers from as many mortgage companies as you possibly can. By comparing quotes you can help negotiate a better rate and lower closing costs. FICO, the company that computes the credit scores lenders use. Allow consumers to “rate shop”. A consumer can have multiple credit inquiries from lenders for a period of 30 days in order to shop for the best interest rates. Even if 100 mortgage companies pull your credit as long as it’s within a 30 day period, it’ll only count as a single inquiry.
8. You should buy a home for the maximum you’re qualified for
Just because you get approved for a home loan up to $500,000 doesn’t mean you need to buy a $500,000 house. When choosing the maximum loan amount lenders use your DTI (debt-to-income) ratio. Typically your maximum DTI ratio needs to be no higher than 36%. Sometimes it can be stretched to 41%. Even though on paper it appears as if you can afford a certain payment, doesn’t necessarily mean you can.
You have to factor in your other expenses that may not be included in your DTI ratio. If you have several kids, spend a lot on entertainment or other luxuries what you think you can afford, becomes unmanageable. Use this home affordability calculator to figure out how much house you can afford comfortably.
9. Adjustable rate mortgages are a bad idea
While adjustable rate mortgages were at the heart of the 2008 housing marketing crash. Where initial low fixed rate terms ended and the rate ballooned to a much higher amount than homeowners could afford. There are situations in which an adjustable rate mortgage term such as a 5-1 ARM are a great idea.
A 5-1 ARM means that for the first 5 years of the loan you will have an initial low rate that will adjust annually after the 5 year term is over. If you’re someone who is planning on paying off their mortgage within 5 years, or are sure you will be selling your home in less than 5 years it makes a lot of sense. The rate you get with a 5-1 ARM can be a full percentage point less than with a 30 year fixed rate.
10. You just need enough for the down payment in savings
There are several upfront costs to consider when getting a mortgage. The down payment is just one of those upfront costs to consider. Your lender will also require you to pay for a home appraisal before closing. The typically costs of an appraisal is between $400-$500. You will have to pay this fee by credit card before you can close.
It’s not only unwise to use all of your savings for a down payment, the lender won’t accept it either. Most lenders will want to see at least 2 months of mortgage payments in reserves. Closing costs are often rolled into the loan so you don’t need to pay them upfront. Let’s say you are buying a $300,000 home.
The down payment is $10,500. You will pay about $500 for a home appraisal, another $400 for a home inspection. And about $4,000 to cover 2 months of mortgage payments in reserves. In this scenario you will need to have about $15,000 in savings to be able to purchase a $300,000 home assuming a 3.5% down payment.
Buying a home is not a simple process there are many moving parts involved. Hopefully these common misconceptions about the home buying process can help clear up some of the questions you may have. Buying a home in 2017 doesnt take perfect credit and a 20% down payment.
This makes is easier for many consumers to get approved for a home loan.
Are you ready to buy a home?
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Randall has over 15 years of experience in the mortgage and credit industries. He spends a chunk of time helping consumers understand their credit, advise them on how to increase their credit, and lending his mortgage expertise to help them find the right type of loan. Randall lives in Dallas, Texas with his two sons.