Campaign Against Financial Myths:
Part 4 - Mortgage & Home Ownership

(This article is a part of the series aimed at dispelling some of the popular financial myths. Please refer to the full index for myths related to other financial topics. Oh, and a quick disclaimer: I am not a financial advisor. I have made every effort to research the facts before presenting them here. But, if you have a reason to believe any of the statements are incorrect, please feel free to correct me.)

  1. Myth: “If I can afford the mortgage payments, I can afford to own the house”

  2. There is a lot more to owning a house than the mortgage payments. If you have been living in an apartment then when you move to your own house which is likely to be larger in size, almost all the bills will increase dramatically. I wrote about the comparison between our expenses when we rented an apartment Vs when we own the house here. Even if you move to a similar sized home, you will still have to pay property taxes, home-owner’s insurance, HOA fees, maintenance costs etc. So, if planning to buy a house, make sure you account for all these in your budget planning.

  3. Myth: “I can save a lot of money on my taxes if I buy a house, since interest payments are tax deductible.”

  4. This is not always true. If you are a median income family filing taxes as married and you buy a median priced home, then there is very little advantage to itemizing your taxes, and you may as well claim standard deductions. There is a lot of detailed information about this myth in this bankrate article.

  5. Myth: “I cannot afford the payments for a 30 year mortgage. My bank offers me an option of 40 or 50 year mortgage. Sounds like a good idea!”

  6. The 40 and 50 year mortgage usually come with a higher interest rate, and when amortized over the period of the loan, the monthly payments do not really go down much. Paying the larger interest for a longer period of time means you throw away a lot more money in the name of interest. And since the bulk of initial payments go towards the interest, it will take you a lot longer to build equity. Finally, do you really want to carry mortgage payments well into your retirement years? I have written more about this in detail here if you want to see some examples with numbers and some alternate approaches to make the 30 year mortgage affordable.

  7. Myth: “I need to enroll in the mortgage company’s bi-weekly payment program to shave a few years off my mortgage.”

  8. Many mortgage companies charge you a fee for bi-weekly payments. While it is true that bi-weekly payments will reduce the length of your mortgage, it is not true that you need to enroll in your mortgage company’s program to realize the benefits. Here is how the bi-weekly payments help. Since there are 52 weeks in a year, by making bi-weekly payments, you end up making 13 payments a year instead of the 12 payments you would make with the regular monthly payments scheme. This additional payment is applied directly to the principal and so the time it takes to payoff the mortgage decreases. Contrary to popular belief, mortgage companies will NOT apply your payments to your account once every 15 days. Instead, they will keep the money in the holding account till the end of the month before applying it to your mortgage account. You can obtain similar benefits to the mortgage company’s bi-weekly payment program by making an extra payment every year on your own, or by increasing your monthly payment by (1/12)th of your regular payment and save yourself the fees charged by the mortgage company. Here is a Realtytimes article that explains this in more detail.

  9. Myth: “Unlike renting where my rent can increase every year, if I lock in a fixed-rate mortgage, my monthly payments will remain constant.”

  10. It is true that when you buy a fixed-rate mortgage, your monthly payments to the bank are fixed and locked in. But home ownership is way more than just paying the mortgage. You may need to fork out for several preventive maintenance projects each year. As the age of your house increases, so are the chances that you will need repairs. Also, as the age of the house increases, your insurance rates might go up. As the value of the home increases, so will your property tax. And don’t even get me started on the cost of the numerous home improvement projects undertaken to keep up with the Joneses. If you prorate all these costs for any given year across the 12 months, you will find that home ownership is anything but fixed expenses!!!

  11. Myth: “If I cannot put 20% down payment, I have to pay PMI.”

  12. According to this bank rate article a “piggyback” loan allows to you avoid the PMI even if you don’t have 20% to put in down payment. The way the loan works, instead of taking one single loan for more than 80% of the home purchase price, you take two different loans from the same lender. For instance, in a 80-10-10 arrangement, the main loan is for 80%, the piggy back loan is for 10% and your down payment will be 10%. (Other arrangements such as 80-15-5 or even 80-20-0 may be possible depending on the lender.) The piggyback loan will usually have a higher interest rate than the main mortgage loan of 80%. If you were to go for the regular arrangement (with a PMI), you can call your lender and cancel the PMI when your home equity grows to 20%. So, before jumping on the piggyback loan bandwagon, carefully analyze which option will cost you less in the long run.

  13. Myth: “If I refinance my loan, my clock starts over and I have to pay mortgage for another 30 years.”

  14. Many lenders that offer refinancing allow you to amortize the loan, so that you may payoff your loan using the same schedule as your original loan. Even if your lender does not offer this, as long as they do not charge a pre-payment penalty, you should be able to make additional payments towards the principal each month, and pay it off according to the schedule that you prefer.

  15. Myth: “Shopping for the lowest rate can result in multiple inquiries and ding my credit score.”

  16. This is not true. Quoting from this article on the myFICO.com website, “Looking for a mortgage or an auto loan may cause multiple lenders to request your credit report, even though you’re only looking for one loan. To compensate for this, the score ignores all mortgage and auto inquiries made in the 30 days prior to scoring. So if you find a loan within 30 days, the inquiries won't affect your score while you're rate shopping. In addition, the score looks on your credit report for auto or mortgage inquiries older than 30 days. If it finds some, it counts all those inquiries that fall in a typical shopping period as just one inquiry when determining your score. For FICO scores calculated from older versions of the scoring formula, this shopping period is any 14 day span. For FICO scores calculated from the newest versions of the scoring formula, this shopping period is any 45 day span. Each lender chooses which version of the FICO scoring formula it wants the credit reporting agency to use to calculate your FICO score.”

  17. Myth: “I should shop for the house first and only after I find the house, I need to start looking for loans.”

  18. Most sellers do not take a buyer seriously unless he/she is already pre-qualified or pre-approved for a loan. The pre-qualification process does not involve a check into your credit history. But based on ratio of your income to the debt that you carry, the lender gives an estimate a ballpark range of how much loan you qualify for. Pre-approval on the other hand involves a thorough look at your credit history and provides details about the maximum amount the lender is willing to loan and possibly the types of loans you qualify for. Going through the steps of obtaining pre-qualification or pre-approval before you buy the house will ensure that you will look for a house within the limits that you qualify for and boost the sellers confidence in you as a serious prospect. Here and here are good places to start finding more information about this process

  19. Myth: “By buying a house, I own a big asset”

  20. Wrong. Until you payoff your mortgage, what you have is just a big debt. Technically, the lender owns a big chunk of the house, and if you slip on your payments, the lender can have you out of the house and sell the house in an auction to recover the remaining amount on the mortgage. Additionally, if you fall behind on your tax payments, the government can slap a tax lien on your property. So, while it is true that the house is a huge assent, technically, until you pay off your mortgage, it is not quite your asset.


    Update: I decided to strike that one out based on this comment below. While I still believe that technically you do not own the house until you pay off your mortgage, I will admit that, that is probably a subjective opinion and not necessarily a "fact". The intention here is not to push my agenda against debt but to try and present the facts and clear up some myths. So, for now, I have to take it off the list. Maybe someday I will come back and revisit this and we can have a discussion...



So, those are some of the popular myths and misconceptions about mortgage and home ownership. Over the next few weeks, I will cover more about the common myths in other finance-related matters - so stay tuned. Once the series is complete, you should be able to access the full list of myths via this index.



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11 Comments:

Everyday Finance said...

Great, great info for people entering the market (and actually, for plenty of those in it). Although Option ARMs are a terrible offering, there are some positives to straight ARMs. I did an analysis of the net present value of an ARM vs. conventional with the thought being "why pay principle to the bank that you're not going to earn interest on?"...plus a bigger tax writeoff. Feel free to check out and request excel analysis if interested.

Dan

ispf said...

Dan, Thanks! I keep going over - "why pay principle to the bank that you're not going to earn interest on?"... argument myself. But somehow, I conclude each time that I would rather be debt free. Any investment carries with it an amount of risk, whereas mortgage payments offer me a guaranteed rate of return (interest saved). I guess I am trading off higher returns for more peace of mind... it's just a matter of priorities, I guess.

Frank said...
This comment has been removed by a blog administrator.
Campaigner against bad financial advice said...

----
Myth: “By buying a house, I own a big asset”
Wrong...
-----

BULL!!! You own the house despite ANY lien against it, including your mortgage. The asset may be offset by a debt, but it's still an asset for the homeowner/mortgage borrower. The mortgage company owns 0% of your asset regardless of your loan-to-value status. In many cases, if you don't pay your taxes, the bank will to protect their interest and then charge you higher payments to cover it, or they may just foreclose since you're not holding up your end of the bargain. All mortgage companies do is put up the capital so sellers can move on with all their money. "The mortgage company owns my home" is the real myth. Shame on you for spreading it.

Technically, the only interests the mortgage company has to your property are spelled out in your mortgage, and I've never seen a mortgage that says "Lender owns property." This sort of thinking is why, among other stupid home ownership acts, people disappear when their home goes into foreclosure instead of saying SOMETHING to protect their largest asset and their credit. Usually, there is a way to either prolong a foreclosure and live in the house longer during foreclosure if not get the foreclosure thrown out entirely. Also, if a home sells for more than is owed against it in a foreclosure, the lender doesn't retain the equity, the homeowner/borrower gets it back and most states require the attorney to return the money, if not all states.

ispf said...

Campaigner against bad financial advice (Ouch!!): I have updated the post to strike that one out the list. I still believe in what I said, but I do see your point. And will keep subjective opinions out of a list that attempts to present the "facts". Stop by again - maybe you will be pleasantly surprised that there is more to this blog than occasional bad (I prefer subjective) financial advice :)

Campaigner against bad financial advice said...

I can appreciate the view; it's very widespread albeit damaging. Also, I don't mean to come down so hard on anyone (especially the guy who's giving great advice otherwise!) but I've worked in foreclosure law firms and as a mortgage broker and am working on an MBA and have a psychology background. The view of bank 'ownership' by way of a lien has a psychological affect on people's financial actions and I can't think of a time in all my experience when I've seen it affect for the better. When people think the bank 'owns' their property, they don't stand up for their rights during times of distress and they don't take advantage of the fact that you can drastically improve your investments AND drastically reduce the bank's desire to foreclose your home by keeping it mortgaged and the cash in your pocket. It all goes back to the whole "a bird in the hand is worth two in the bush" (bird=dollar, bush=home) Also, if your mortgage is at 50% of the value of your home, meaning you have 50% equity from paying down you mortgage, and you miss a payment, the bank KNOWS they'll get their money by foreclosing. If your mortgage is equal to 90% of the value, the bank is a much more hesitant to foreclose and more likely to work with you to catch up your payments. I advocate mortgaging at least 80% of your home's value at all times, not because it would be better for me as a broker, but because it's better for the homeowner. Equity in real property is a dead investment because it has no return. If your house is mortgaged, you still gain on the value increases. Find a better investment for your money!

ispf said...

Campaigner against bad financial advice: I had not realized that a house with 50% mortgage is an easier target for a bank foreclosure than a house with 80% mortgage! This blog has been as much a learning experience for me as I hope it is for at least a few others. Thanks for taking the time to share this information.

That said, I doubt I will be able to maintain a 80% mortgage ever! I understand that by paying off our mortgage early, we are sacrificing some of the interest that we could earn if we invested the money elsewhere. But based on both the better half's and my aversion to debt, we think the sacrifice is worth the peace of mind it brings us. (I wrote about it more in detail here in case you are interested)

Ben, fka campaigner against bad financial advice said...

Well, peace of mind should be a high priority in investing, even if the investment strategy is digging a hole and burying rolls of quarters in your back yard. This has been a good discussion and I think I'm going to have to come up with my own blog to counter these 'pay down the mortgage' posts!! :) I appreciate the responses. I don't agree with you on this, but your blog is excellent overall and I hope readers don't discount you due to my ridiculous pseudonym. Try this blog for more info on being 'conservative' with a mortgage. http://www.themortgagereports.com/2005/03/want_to_be_cons.html I'm about to marry a lovely young woman who leans more toward your thinking regarding debt. We've compromised on many things and have found that there is a time and place for both strategies, as I'm sure most people would find. And everywhere in bewteen, there's headbutting. Anyway, I'm a subscriber now to Grad Money Matters and look forward to future posts.

ispf said...

Ben: You should start a blog! You write very well and you are passionate about what you write... those are the ingredients for making a great blog!

And thanks for the pointer to the 100% mortgage article. It is a very interesting article, but not for us. My thoughts mostly align with some of the comments more than the original article... I understand that its just psychological, and maybe someday in the future all of you mortgage pre-payment naysayers might just convert me... we just have to wait and watch :)

I enjoyed the discussion too, and glad that you have subscribed to the feed. I hope I will see more of your comments here.

And don't forget to tell your fiancee that there is a stranger in the blogosphere rooting for her, whenever you butt heads on this topic :)

Staci Carsten said...

Hi! I just found you today.

A lot of good information here, but I have some disagreements. I linked to you with my comments here: http://allpacificmortgage.blogspot.com/

Bob said...

About the stricken myth...

Since I rent a house and have never had a mortgage, do you get the deed to the property at the beginning of the mortgage, when you move in, or after the 30 or so years when paid off? Isn't the deed the proof of ownership, like the title of a car? I think the lender would be the owner 'til paid in full...no?