With housing prices on the rise and mortgage rates set to drop after the recent announcement that the Fed will continue its bond-buying program, you may be thinking it’s the right time to buy a home. But given that this is the single biggest purchase most people will make, you want to get it right. Otherwise, you could end up owning a home that you can’t really afford, don’t really like, or simply isn’t practical for your lifestyle. Here are some home buying myths that can lead to big mistakes:
1) A 30-year fixed mortgage is always the best deal.
That could be true if you keep the home for that long but if you only intend to keep the home for 5-7 years, a fixed rate for 7 years could be more appropriate.. The longer you fix the rate, the higher your interest rate will be so you could be paying a higher rate for nothing.
2) Always choose the mortgage lender with the lowest interest rate.
As with any purchase, cost is always a factor but differences in fees may matter more. In addition, mortgage lenders aren’t just a commodity. In a competitive buying market like many housing markets are seeing right now, the reliability of your lender could mean the difference between getting your dream home and losing to another offer so you’ll want a lender with a good reputation. You’ll also want someone who can work well with your real estate agent so ask your agent for referrals.
3) You can afford a mortgage payment as long as total debt payments are less than 36% of your income.
That 36% rule may be what the lenders use but only you know what you can really afford. Your best bet is to track your actual spending and then see how much more you can really afford to pay towards a home. You should be saving at least that much towards your down payment to see if you can really do without that income. Some financial institutions are beginning to offer budgeting tools that help track your expenses and break down where all of your money goes every month. There are other scenarios that a lender couldn’t possibly know about without you telling them like paying day care on a monthly basis for small children. Nothing is ever black and white when you are budgeting for your new home.
4) You need a 20% down payment.
While putting down 20% is ideal, not everyone can realistically afford that. You can get away with a smaller down payment in exchange for paying PMI (private mortgage insurance) until you have enough equity in the home to have it removed—usually 20%. FHA and VA programs require down payments as low as 3.5% and 0% respectively if you and the property qualify. A few lenders have even started offering piggy-back loans again in which borrowers with strong credit and low debt-to-income ratios can get a second loan (albeit at a higher interest rate) to cover part of the down payment.
5) All you need upfront is the down payment.
The down payment is just the beginning. Closing costs can be another 2-5% of your home’s purchase price. How about any repairs, improvements or furnishings you’d like to add to your new home. Most importantly, you should keep enough in emergency cash reserves to cover at least 3-6 months of necessary expenses, including your new mortgage payment.
6) You need to save for your full down payment.
Again, while this would be ideal, it may not be feasible for everyone. There are a host of government and some private programs that offer assistance, primarily for first-time home buyers but not always, with low to moderate income such as CHFA or NHF Platinum Plus. You can also see if you can borrow from family members. As long as you pay them a competitive interest rate, it wouldn’t be a taxable gift. If they do gift the money, each person can give up to $14k per year to you without having to file a gift tax return.
You may be able to take a loan from your employer’s retirement plan, perhaps for a longer repayment period for a home purchase, but you’ll lose potential earnings on the money you borrow. You can also withdraw up to $10k during your lifetime from an IRA for a home purchase without penalty as long as you haven’t owned a home in the last 2 years. If you meet the 2 year requirement and it’s a Roth IRA that you’ve had for at least 5 years, up to $10k of the Roth earnings can be withdrawn tax and penalty-free (contributions can always be withdrawn tax and penalty free for any purpose). Just remember that the $10k is a lifetime total from all IRAs. Finally, you may be able to take a hardship withdrawal from your employer’s retirement plan but you it would be subject to taxes plus a 10% penalty if you’re under age 59 1/2, you can’t repay the withdrawal, and you may not be able to contribute to your retirement plan for a period of time.
7) The only additional ongoing cost will be PITI (principal, interest, taxes, and insurance).
Don’t forget any applicable homeowner’s association (HOA) fees, which can easily run several hundred dollars a month. Your utilities may also be higher if you’re moving into a larger place. Plus, there are all those other routine expenses, such as water, sewer, and trash, and maintenance costs that your landlord used to pickup. Be sure to leave enough room in your budget for all these incidental costs when figuring out how much of a mortgage payment you can afford.
Whether it’s by causing you to buy too much, too soon, or too late, these myths can cost you dearly in the home buying process. The good news is that by avoiding these myths and following these steps, you can purchase the right home at the right time. Just don’t make your home buying decision like this.