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By Leslie Cook
December 8, 2021
Unicorn with a percentage horn in the middle.
Chris Gash for Money

A lot of work goes into applying for a mortgage — from rounding up your financial records to making sure your credit score is in tiptop shape. Another important item for your to do list: looking out for misinformation and bad advice.

There are plenty of myths surrounding home loans. Believing them can cost you both time and money. We’ve rounded up some of the more common misconceptions and explained what you really need to know.

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Myth #1: Low mortgage rates mean you need to buy a home ASAP

Don’t let mortgage-rate FOMO lead you to make a big financial mistake. Sure, current mortgage rates are very low. (Well-qualified buyers have been able to snag rates around 3% since late 2020.) And, yes, lower rates mean paying less per month or affording a higher-priced home.

However, low rates have also helped push home prices up more than 19% this year. You could end up overpaying for a home just because rates are low, says Aaron Bell, a wealth advisor for Northwestern Mutual. Adding, “just because the interest rates are low it doesn’t mean it’s the right time to buy a home.”

Many experts are forecasting rate increases through the end of this year and into the next, with the average ranging between 3.15% at the end of 2021 and 3.7% by the end of 2022.

While the projected increase may make a home purchase more attractive now, the reality is that mortgage rates have been moving lower for decades. In fact, rates peaked in 1981 averaging 16.63%. Even if you do buy a home at a higher rate, you’ll have the opportunity of refinancing to a lower rate in the future (whereas if you buy at a low rate, the odds of being able to refinance at an even lower rate are smaller).

The decision to purchase a house should also always be based on your goals and how ready you are to take that financial leap, not interest rates alone.

Myth #2: You need perfect credit to get a mortgage

If you’re worried your credit score won’t qualify for a home loan, relax. There are options for borrowers who want a mortgage despite bad credit.

For instance, borrowers with credit scores as low as 500 can qualify for FHA loans. VA loans usually require a score range of 580 to 660, but lenders look at your whole financial picture. USDA loans also have lower score requirements than conventional loans.

Other factors besides your credit score also determine your eligibility for a mortgage, says Rob Heck, vice president of mortgage at online broker Morty. Lenders will also look at your income, how much savings you have accumulated, your debt-to-income ratio and the size of your down payment.

“If you’re in good shape in several of these categories, it can be enough to overcome having a low credit score,” says Heck.

Myth #3: You need 20% of the home price for a down payment

The average homebuyer put down just 12% this year. For first-time buyers, the average is even lower at 7%.

To be sure, making a large down payment has advantages. You start out with more equity, may qualify for a lower interest rate and, at 20%, avoid having to pay for private mortgage insurance (PMI) — which protects the lender, not you.

However, putting 20% is not always possible — or required.

FHA loans only require a 3.5% down payment if your credit score is 580 or higher. If your score is between 500 and 579, 10% is needed. VA loans don’t require any down payment at all, nor do USDA loans. If you are considering a conventional loan, some lenders will require a down payment of as little as 3% and may waive the PMI requirement if your earnings are high enough.

You can also consider down payment assistance programs. These are typically administered by state and local governments or charitable organizations. Funding options include grants, low or 0% interest second mortgages and forgivable loans.

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Myth # 4: Find a house, then worry about a mortgage

This is bad advice at any time, but in a hot seller’s market like today’s, believing this myth can lead you to miss out on a home altogether.

Get pre-approved for a mortgage before you start seriously looking at homes. A pre-approval means that the mortgage lender has reviewed your financial information and is willing to lend you up to a specific amount of money.

It’s basically a guarantee that (unless something changes) you will have the necessary funding to buy a home. This process will tell you how large a loan you can get and will allow you to act quickly when the right house comes along.

Desirable homes are selling quickly, spending an average of 45 days on the market in October — eight days faster year-over-year and 21 days faster than in October 2019. Many sellers won’t bother considering an offer from someone who hasn’t been pre-approved.

Also remember to shop around and apply for a mortgage with different lenders. It’s the only way to make sure you’re getting the best rate.

Myth #5: A 30-year fixed-rate mortgage is always the best choice

More than 75% of borrowers opt for a 30-year fixed-rate mortgage, drawn by the long payback and resulting low monthly payments. But other options may be better suited to your goals.

If you can afford higher payments, you can own your home outright in less time and for less money with a 15-year fixed-rate mortgage. Shorter-term loans also tend to have lower interest rates.

If you plan on selling your home in the near future, you can consider an adjustable-rate mortgage. The interest rate on an ARM will be fixed for a time before it becomes adjustable and starts to reset. With a 5/1 ARM, the initial interest rate is usually very low. Once it starts to adjust, however, the rate can jump significantly.

Myth # 6: You should spend the maximum amount you qualify for

You’ve worked out your budget and calculated how much home you can afford. You feel comfortable buying a home in the $400,000 range. You apply for a mortgage and, lo and behold, you get approved for $475,000. Should you bump up your budget?

A lot will depend on how comfortable you feel with higher monthly payments. You may be able to make those payments, but it could come at a cost — you may not be able to save as much for retirement, put money into a college fund for your kids or pay down credit card debt.

There’s no rule that you have to spend the maximum mortgage amount you qualify for. Your mortgage payments should complement your overall financial goals. Don’t feel the need to overspend.

Myth # 7: Refinancing a mortgage isn’t worth the hassle

For some borrowers, the thought of going through the mortgage application process again can be stressful. But the advantages a refi provides make at least finding out if it’s a good time to refinance worthwhile.

Lowering your interest rate by 0.5 to 1 percentage point can lead to big savings. Mortgage analytics company Black Knight estimates 11.2 million well-qualified buyers can reduce their rate by 0.75 percentage points and save an average of $279 per month at the current rate. Some 1.2 million borrowers could save $500 per month. That represents a savings of $3,348 to $6,000 per year.

Consolidating debt, reducing your loan term or cashing out equity in your home to pay for repairs are other reasons to consider a refinance.

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Myth # 8: You can’t pay your mortgage off early without paying a penalty

There was a time when paying a mortgage off early meant incurring a prepayment penalty. These fees were either a percentage of the loan amount or an amount equivalent to a specific number of monthly payments. In either case, they added thousands of dollars to your prepayment budget.

The good news is that many lenders don’t charge these penalties anymore. The ones that do, typically only levy the fee during the first three to five years after closing. You can pay the loan off without penalty after that period ends and you can pay extra toward your loan at any time.

Paying your mortgage off early can provide a number of advantages, such as owning your home outright sooner, saving on interest and freeing up money for other purposes.

When you apply for a mortgage, ask your lender whether there is a prepayment penalty and what the terms and conditions are if there is.

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