7 Mortgage Myths
Myth #1 - I need 20% for a down payment.
It is amazing how many people (current homeowners, first time home buyers, and even some Realtors) still think that a buyer needs a 20% down payment to purchase a home. 20% down payment is not typically required! It does require paying Mortgage Insurance, but it's a small price to pay to be able to purchase a home and start building wealth for less than 20% down.
Each Mortgage Type has their own standard requirement for down payment:
- FHA - 3.5% down payment required
- VA - No down payment required
- USDA - No down payment required
- Conventional - Minimum 3%- 5% down payment required (There are 3% down programs with restrictive guidelines)
Myth #2 - The down payment is the only cost needed to purchase a home.
Most potential buyers do not take into consideration the Closing Costs and Prepaids required to purchase a home (or even understand what those are). In additional to the required down payment (see below), there are Closing Costs and the Prepaids that must be taken in consideration.
Closing Costs - Closing costs are the 10+ companies that are involved in the transaction. These include, but are not limited to, the Appraisal, Survey (we typically can use the seller's if they have an existing one that nothing structurally has changed to the outside of the home), Tax Certifications, Underwriting, Processing, Wire Fees, Title Fees, Recording Fees, RMCR credit fees, Recording Fees, Closing Attorney, Closing Docs Attorney (who draws your closing docs), etc.
Pre-Paids - Typically consists of 1 year of insurance +3 months in reserve in insurance + 3 months of reserve in taxes. Borrowers will choose their own insurance company (Lenders do not choose it).
A quick calculation to use as a "rule of thumb" (not exact but will be close):
- $100,000 sales price = @$6,000 for closing costs and prepaids $6000.
- For each $1,000 up or down add or subtract $30. So, for example, a sales price of $101,000 = $6,030 but a sales price of $99,000 = $5,970.
- Add the down payment required/requested (see above) to the approximate closing costs to get the approximate total costs to purchase a home. For example, for a $200,000 home sales price going FHA: $7,000 down payment + $9,000 in closing costs = $16,000 in total costs.
Myth #3 - The seller will always help pay closing costs.
Often in our conversations with our clients we hear, "Well, we want the seller to pay everything." In a slow market (what we call a "buyer's market"), a buyer may get a seller to contribute generously to their closing costs. However, in a hot market (a.k.a "seller's market"), there is almost no contribution whatsoever. In fact, asking for Seller Contributions without the advice of an expert Real Estate agent can cause your offer to not be accepted.
Typically, the buyer pays (in addition to the down payment, if required) the closing cost and prepaids. In some parts of the U.S. (and depending if in the negotiations here in Texas), the buyer would pay the Owner’s Title Policy as well. Most of the time we do find the seller still covering the Owner’s Title Policy so it would not be customarily considered a buyer’s costs.
IF the seller is willing to pay the customary buyer’s closing costs and/or prepaids, here are the guidelines for the maximum seller contributions allowed:
- FHA - The seller is allowed to pay any or all of the closing cost and prepaids up to 6% of the sales price provided the buyer has at least 3.5% into the loan.
- VA - The seller is allowed to pay any or all of the closing costs and prepaids up to 4% of the sales price plus the lender fees.
- USDA - The seller is allowed to pay any or all of the closing costs and prepaids up to 6% of the sales price.
- Conventional - The seller is allowed to pay up to 3% of the sales price toward the closing costs and prepaids but cannot pay any of the down payment. If buyer is putting 10%+ more down, seller is allowed to pay up to 6% of the sales price toward the closing costs and prepaids but cannot pay any of the down payment. For an investment property, the seller is maxed at 2% of the sales price toward buyer's closing costs and prepaids.
Myth #4 - Using a First Time Home Buyer Program is always the best route when purchasing your first home.
"Back in the day" there were a lot of programs that were available to FTHBs (First Time Home Buyers). Nowadays, most of these programs no longer have funding (budget cuts) or their criteria is so strict (i.e., seller has to fix all the repairs that the FTHB program requires) that it is very difficult to 1) get the funds and 2) get a seller to accept an offer if a buyer is using the program.
That being said, there are still State bond programs that are available. The loan product (i.e., FHA, Conventional, etc) and the credit score usually determine how much money is available in assistance with these programs. The big down side to these bond programs is the interest rate. The rate is set by the bond program and is typically 0.50%-1.00% higher than market rates. The more assistance being given, the higher the rate. In addition, some of the bond programs require the buyer to pay back the funds once they sell the home, depending on how long that they keep the home as a primary dwelling.
When a potential home buyer is considering doing a bond program, we always want to explore:
- 1) Can they come up with their needed funds to close in a different manner?
- 2) How long do they plan to live in the home? (If they don’t have to pay it back and are only going to live in the home for a few years, then maybe a higher interest rate is not a really bad thing)
- 3) How high is the bond program rate versus using a lender premium/rebating pricing to assist?
- 4) What does the debt to income ratios look like?
- 5) Does the borrower qualify for any of these programs based on their credit score, income limitations, and/or other specific program criteria?
In short, bond programs are available but it is very important to talk to a knowledgeable, experienced Mortgage Expert about the pros and cons, and whether other options would be better. Using a FTHB bond program is not always the right decision.
Myth #5 - All pre-qualifications/pre-approvals are the same.
The definition of a Pre-Qualification and a Pre-Approval can differ from lender to lender (hence why there is so much confusion in the marketplace), but in our 20+ years of experience our opinion is:
Pre-Qualification - An experienced, licensed Mortgage Loan Officer has spoken to the buyer. They have verbally received information concerning income, assets, liabilities, employment, etc and have pulled a tri-merged (all three bureaus) credit report to come up with an approximate figure that the buyer can qualify. This should never be the final step before the buyer finds a home as there are so many factors and guidelines that could drastically change the financial picture. For example, you may not know that a single piece of information on your W-2 or tax return could completely alter your approval, but it could. Which is why it is important to always get a Pre-Approval first, before shopping for a home.
PreApproval - An experienced, licensed Mortgage Loan Officer has spoken to the buyer. They have verbally received information concerning income, assets, liabilities, employment, etc and have pulled a tri-merged (all three bureaus) credit report to come up with an approximate figure that the buyer can qualify. Then, they request from the borrower all the needed supporting documentation (i.e., W2's, Tax Returns, Paystubs, Assets, etc.) upfront so that the experienced, knowledgeable Mortgage Loan Officer can review everything to make certain of the accurate financial picture. Needed verifications have been done and the loan is Pre-Approved and the buyer is ready to shop with confidence. The Loan Officer is a trusted, knowledgeable originator who knows their guidelines and rules and has made certain that there is nothing left hanging that could cause a "blow up" later in the loan process.
Even with a more clear picture of the differences between a Pre-Qualification and Pre-Approval, it is just as important (if not more important) to consider who is performing the qualification. Would you take your care to just any mechanic? Would you get your hair cut by just any stylist? If you were about to undergo major surgery, would you trust any doctor? Of course you wouldn't. Which is why it is important to properly vet the Mortgage Loan Officer you are working with, not just the company.
At Service First Mortgage - The Davidson Group, we feel that all approvals are NOT created equal, due to the expertise of our loan officers. So we have developed our "Unfair Advantage Commitment". It is our commitment to our clients and Realtor partners to help you increase the chances of getting your offers accepted, even when up against multiple other offers.
Our "Unfair Advantage Commitment"
- We review all documents received by our buyers upfront prior to the contract being written.
- As soon as the buyer has written a contract, and they notify us, we will immediately contact the listing agent and let them know that our buyer is "ready to go" for their mortgage, and the strengths of the loan.
- IF we have all the documentation upfront, then we just need 28 days (except for USDA or Bond) to close from the day we can order the appraisal. That's it.
We want our buyers to have an unfair advantage in this market place and we are committed to you to make that happen!
Myth #6 - You need a great credit score to purchase a home.
Below are the minimum credit scores based on loan program:
- What is Lowest Credit Score for Conventional?
620 if putting down a 20% or more down payment (no PMI), 640 if needing PMI. It is important to note that on Conventional financing, the loan must run through an AUS (Automated Underwriting System) and receive an "Accept" status, but a lot of times if the credit score is below 660 it will not. Private Mortgage Insurance (PMI) Companies also have their own overlays (a.k.a. restrictions) when the credit score is low. One downside of Conventional is that the government-backed guarantors (Fannie/Freddie) have required risk-based pricing adjustments which means that the lower the credit score the higher the interest rate on the loan. In addition to a higher rate, it also requires a higher PMI "rate". Both the pricing adjustments and the PMI "rate" hits are significant below 700.
- What is Lowest Credit Score for FHA?
Although FHA will allow down to a 580 credit score with a 3.5% down payment, the industry restrictions for scores that low make it fairly impossible to obtain financing. Most lender restrictions loosen until 640 or higher, but are still very restrictive due to a history of high potential of default.
- What is Lowest Credit Score for VA?
Technically VA does not have a minimum credit score, but the standard in the Industry is 620+. The thing to always remember on credit scores is that not only do lenders need to have the loan insured but we also must be able to get the loan securitized in the secondary market (think bonds, stock market, etc.) and serviced, so that is why you now see lender overlays (restrictions). VA has a big issue with collections and history of non-payment of debt.
- What is Lowest Credit Score for USDA?
Most lenders will not go lower than 620. Credit scores 680 or above will be reviewed more favorably in situations where a borrower has a higher DTI (Debt-to-Income Ratio).
Myth #7 - Once the buyer finds a house (and has a contract), the hard part is over.
Not quite. As a borrower, you still need to work with your Real Estate expert to perform an inspection on the home, shop for homeowner's insurance, schedule movers, pack boxes, fill out Change of Address forms, etc.
On the lender side, did you know that there are over 30 Companies/Entities involved in one single mortgage transaction? In addition to that there are over 10 Verifications/Searches that we are required to do for every single borrower. It is no wonder that 85% of all mortgage files contain between 400-2,000 pages of documentation.
Why, do you ask? Because there are over 45 Agencies or Acts that are part of every mortgage transaction in the U.S.
Luckily, as a borrower you are mostly shielded from these inconveniences (as long as you are working with a good lender). However, do not be surprised if your lender has to ask for additional documentation throughout the loan process. The mortgage process is like a beautiful symphony and the lender is like the conductor. When every plays their part as instructed (like sending in documentation when needed) the concert goes smoothly and can be enjoyable.
In the end, you are purchasing a new home. That is something to be excited about, and every bit worth a little extra effort for a short period of time.