The American dream may no longer include homeownership for many millennials, but there are still plenty of people out there willing to drop five to six figures for digs of their own. The only problem? There are also plenty of mortgage myths that cause people to lose money in the pursuit of becoming homeowners.
We talked to seven financial experts to find out what they believe are the biggest mortgage myths and what prospective homeowners need to know.
Myth 1: Interest rate and APR are the same thing.
Truth: When shopping around for a mortgage, interest rates are one of the most important factors to compare. Getting the lowest rate possible is key; even a difference of 1 percent can either save you or cost you tens of thousands of dollars over a 30-year mortgage.
But a more important measure is the annual percentage rate, or APR, said John Pak, a certified financial planner and founder of Otium Advisory Group in Los Angeles. Although the interest rate on a mortgage determines how much you’ll pay on a monthly basis based on the loan amount, “The APR is the rate that gives you clues as to what fees are included in the loan terms,” Pak said.
That’s because the APR represents the aggregated cost of doing business with the lender, according to Pak. “It includes the interest rate, discount points (if applicable), broker fees and closing costs, to name a few,” Pak said. “While the interest rate simply tells you how much your monthly payments will be, the APR is a great tool to compare overall fees charged by different lenders as you shop around for financing.”
Myth 2: It’s always better to own a home than rent.
Truth: Many people want to own a home because it’s considered an investment, whereas renting is often thought of as throwing money away. But in today’s post-Great Recession world, owning a home is no longer a sure bet.
According to Samuel Deane, co-founder of Deane Financial in New York City, there’s no doubt home ownership can offer plenty of advantages, including the chance to grow equity and claim tax deductions. But on the other hand, homeownership can present unique financial challenges that renters don’t have to deal with.
“Unlike renting, homeowners can also be burdened by maintenance costs, property taxes and the [lack of] flexibility to move to a new city for a great job offer,” Deane said. Plus, recent tax law changes have made it tougher to take advantage of mortgage-related deductions (more on that next).
For millennials especially, “It probably makes more sense to improve your creditand savings before taking the big leap of purchasing a home,” Deane said. In other words, there’s no shame in renting ― and sometimes it makes more sense than buying.
Myth 3: Buying a home is worth it for the tax deductions.
Truth: It’s true that homeowners are eligible to write off expenses related to their mortgages at tax time, including mortgage interest and property taxes. Although that’s a great perk of home ownership, it certainly isn’t the only reason to buy.
One thing to keep in mind is that tax deductions on mortgage interest and property taxes don’t cut your tax bill dollar-for-dollar; they reduce how much of your income is taxed. Your actual savings will probably pale in comparison to how much you spent on your house.
“Take, for example, someone in the 25 percent tax bracket,” said Scott Vance, a financial planner and owner of tax advice site TaxVanta. “If they itemize $10,000 of mortgage interest and taxes, they will only reduce their [taxable income] by about $2,500,” he said, noting that’s just a rough estimate.
Vance also pointed out that due to recent tax law changes, it will be a lot tougher to itemize and take advantage of mortgage write-offs at all. That’s because for the 2018 tax year, the standard deduction was raised to $12,000 for single filers and $24,000 for married couples filing jointly.
“Probably about 90 percent of my tax clients who itemized this year, largely because of the mortgage interest deduction and property taxes, will not exceed the standard deduction for 2018,” Vance said.
Myth 4: You can afford the loan amount you were approved for.
Truth: You’d think that the bank wouldn’t let you borrow more money than you can afford, right? Think again.
“A mortgage lender is not concerned about the cash flow it takes for you to save for retirement, pay for daycare or private school, save for your kid’s college education, a vacation etc.,” said Lauren Zangardi Haynes, a certified financial planner and owner of Spark Financial Advisors in Richmond, Virginia.
In other words, your mortgage lender wants to make sure you can pay back the loan, but they’re not necessarily concerned about how that mortgage payment will impact your other financial goals.
“Owning a home is an important goal for many people, but it’s usually not their only goal,” Haynes explained. “Take a minute to really see how a new home payment would fit into your budget and include all of the ancillary expenses as well [such as] insurance, taxes, maintenance, higher utility bills, yard upkeep and HOA dues.”
Myth 5: Once you’ve been pre-approved, you’re done.
Truth: Getting pre-approved for a mortgage can simplify the whole home buying process. But just because you were approved doesn’t mean you’re in the clear.
Ashley Foster, a certified financial planner and owner of Nxt: Gen Financial Planning in Houston, Texas, had one client who was pre-approved for a mortgage but unexpectedly decided to change jobs before the final approval was given. “The client experienced several weeks of unemployment, and during that time, the lender asked to check their finances,” Foster said. “The borrower had to state that they were unemployed, and the lender almost denied the mortgage application,” he added.
Fortunately, after writing a letter to the lender explaining it was a temporary change and he had a job offer, the buyer was approved. “It was a nightmare,” Foster said.
So even if you are pre-approved for a mortgage, it’s important to not make any changes that could affect your employment, income or credit until those keys are in your hand.
Myth 6: You need a 20 percent down payment.
Truth: A longstanding rule of home ownership is that you need to save up a 20 percent down payment before taking on a mortgage. But many financial experts are challenging that rule.
The problem is that earnings often don’t keep pace with skyrocketing home values, especially in high cost of living cities like San Francisco and New York. For the average person, trying to save up 20 percent might be like running on a treadmill. Sometimes taking on a bit more debt or temporarily paying private mortgage insurance is the only way to realistically afford a house.
“A client believed that putting 20 percent down to avoid private mortgage insurance was the only way they could buy a home,” said Lucas Casarez, a certified financial planner who runs his firm Level Up Financial Planning virtually from Fort Collins, Colorado. “After digging into it and showing a few different calculations, I was able to open up their perspective that purchasing their first home does not have to be light years away, and they don’t have to eat ramen just to make that dream happen.”
Myth 7: Paying off your mortgage is always a good idea.
Truth: Living a debt-free free life is an admirable goal. But if you have a mortgage, it might not be the most prudent.
“With mortgage rates being relatively low, a mortgage allows buyers to leverage their money,” said Charles Horonzy, a certified financial planner, a certified public accountant and founder of Focused Up Financial in Chicago.
For instance, Horonzy gives the example of a $300,000 house and mortgage rate of 5 percent.
“Instead of paying $300,000 [with cash] and having no mortgage, you get a mortgage for $240,000 and pay $60,000 (20 percent down),” Horonzy said. “You now invest the $240,000 in the market and potentially earn 8-10 percent in return.”
In this case, you’d leverage the money you have to earn an additional 3 to 5 percent each year, rather than sinking all your cash into the property. This not only allows you to grow your wealth faster but keeps a good portion of it liquid in case you need it, he added.