As you make your way from prequalification to signing an agreement, you may encounter certain fallacies and misconceptions during the home-buying process. While it’s a grave obligation to take your elders and peers’ suggestions into consideration, you shouldn’t believe everything and follow their words like a sheeple.
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Myth 1: The interest rate is directly proportional to the loan cost
Fact: Your annual percentage rate (APR) is a bare-bones number that represents the actual yearly cost of your debt over the term of the loan and not the interest rate. An APR includes all financing charges, fees, and additional costs associated with a loan such as closing costs, underwriting fees, interest, mortgage insurance, and more. Before getting your hands on a particular home loan product, it’s best to compare all the mortgage types based on their APR rather than the interest rate. if your lender offers a 5 percent interest rate, it doesn’t mean this rate is the cost of your loan.
For a quick understanding: Let’s say your friend lends you $30 for a year at an interest rate of 10 percent. By year’s end, you owe him 30+(30*10%) = 30+3, which means a total amount of $33. Now, 3/30=0.10, so the APR is 10 percent. It is a one-year loan period with an interest rate and APR of 10 percent each.
Now suppose you borrow $30 from your friend for a year at 10 percent interest, and he also charges you an additional fee of $5. At the end of the year, you have to repay him a total amount of $38 (30+(30*10%) = 30+3+5). Now, 8/30=0.266, so the APR is 26.6 percent. For a one-year loan period, your interest rate is 10 percent and APR is 26.6 percent.
It’s a huge difference, isn’t it? The same way, while applying for a residential property loan, even a small application or administration fee can make a big difference.
Myth 2: Put at least 20 percent down payment (DP) on the table
Fact: It’s just a big fat misconception. Many home shoppers struggle to come up with a 20 percent DP, however, the low-or-no-down-payment loans can help them obtain the keys to their dream house by paying peanuts. The minimum DP required for conventional and FHA loans are 3 and 3.5 percent respectively. Some special loan programs such as VA & USDA even allow borrowers to acquire a home loan without an upfront cost, i.e., zero percent DP. While it’s possible to get these mortgages with as little as 0 to 3 percent DP, conventional wisdom says it’s best to put a 20 percent upfront payment on the property. This 20% rule is considered ideal because:
• It provides significant financial benefits to the purchasers;
• It improves your chances of getting qualified for a loan;
• Buyers can avoid paying private mortgage insurance (PMI);
• Shoppers can make smaller monthly payments;
• It builds instant equity into a property, and;
• You will pay less over the life of the mortgage (Lower interest rate & closing costs).
Myth 3: 30-year loans are always the best bet
Fact: Traditional mortgages are most common and popular options, but they aren’t necessarily the best bet for everyone. Keep in mind that it’s all about your personal comfort level when it comes to finances.
Borrowers can also opt for 10, 15, & 20-year or even 5-year home loans. Benefits of short-term mortgages are:
• You don’t have to pay a hefty balloon amount;
• You can save heaps of cash;
• Most short-term loans offer lower lending rates, and more.
Myth 4: A longer loan tenure is better than the shorter one
Fact: Not completely true! Both have their own pros and cons.
Impact of a sustained loan repayment period on EMI:
Positive:
• You need to pay a lower equated monthly installment.
• You can reduce your liability when you have surplus money.
Negative:
• A substantial increase in the acquisition cost of the property.
• You are liable to pay more interest to your lender or bank.
How short-term tenure influences EMI:
Positive:
• You can pay off your mortgage as quickly as possible.
• Short-term loans mean lower principal & interest rates.
Negative:
• You will pay wads of cash for EMI.
• You might lose a perfect opportunity to lower your tax liability.
Myth 5: You need a perfect CIBIL score
Fact: It’s no secret that your three-digit FICO score can make-or-break your financial future. Having an excellent or good score (700 to 800) increases your chances of being approved, helps you lock in lower interest rate & better loan terms, and gives you access to better credit cards deals. However, it doesn’t mean you can’t get a mortgage without a perfect score. For example, a Federal Housing Administration (FHA) loan allows home shoppers to qualify for a credit with CIBIL score in the range of 500 to 579, but they’ll need to put 10 percent DP. With a score of 580 or more, mortgagors need to put as little as 3.5 percent only.
Typical minimum CIBIL score by mortgage type:
• FHA loan – 580+ (500-579 can do a magic too)
• VA loan – 620+ (some lenders require 580)
• USDA loan – 640+
• FHA 203K loan – 620+
• Conventional loan – 620+
Under certain circumstances, borrowers can even score a loan with as low as 500 credit score.
Myth 6: Always say ‘YES’ to lower interest rates
Fact: It is one of those fables that have some truth to them. Undoubtedly, obtaining the best interest rate and loan terms on a residential property is necessary, but you should not take only these two factors into account when making a decision.
Some banks or mortgagees may offer you a handsome interest rate of 2 percent, but later they may shock you by unilaterally imposing their exorbitant hidden costs.
How would you feel if your parents promise you a gift on your graduation and then go back on that promise? You would feel betrayed! The same way you might get fooled by #lower interest rates that lenders offer. Remember, there can be numerous expenses and hidden charges included in your ‘Almost Interest-Free’ loan, including:
• Processing & documentation fees;
• Set up & closing costs;
• Private mortgage insurance (PMI) charges;
• Notary & lender’s attorney fees;
• Legal & conversion fees, and;
• Pre-payment charges.
In addition to these, there are various hidden costs applied by lenders to make more money out of you. Therefore, it’s always advisable to check with your bank or creditor on all these costs to avoid any future surprises.
We hope this blog post has helped you clear the misty fog of myths and outright lies around the residential property loans. Moreover, if you are looking for a proficient and competent home loan provider in California, then contact us for a quote. Call us at +1 (951) 634-2477 or drop a message at bb@arrowfinancialco.com.
