Setting the Record Straight: 5 Myths about Real Estate and Home Buying
Nov 24, 2024PO1 Hart: "I'm so excited -- our first house! I can't believe we finally did it, babe: we're homeowners! Finally!"
Husband: “Yeah, it feels totally surreal. I never thought this day would come, especially after our truck got totaled and we had to use all our savings. But we did it!"
PO1 Hart: "I can't wait to get settled and get things just how we want it. Because it's ours."
Husband: "Well, not really. I mean, I guess I just can't get too excited knowing that the bank owns our house for the next 30 years until we pay it off. That's a lifetime from now! I kinda feel like we're still just renters.”
PO1 Hart: “Wait, what? No, the bank doesn’t own anything. We do. The deed is in our name.”
Husband: “But the mortgage? You remember signing all those papers that listed the bank right next to our names. It's like so long as the mortgage is there, it's still not ours, right."
PO1 Hart: "Not at all: ownership is on the deed, the bank is just listed on the lien. It's just you and me on the deed, so it really is ours."
Husband: "But doesn't that mean they can the house anytime if they want it?”
PO1 Hart: “Not at all. So long as we make the mortgage payments on time, they can't touch it. If we don’t pay the mortgage, they could foreclose, but even then I've heard you can refinance or get assistance to make ends meet and not lose the house.”
Husband: "So then we really do own it! Now I'm ready to celebrate! Thanks for explaining this!"
Sound familiar? Conversations like this happen all the time. Many homeowners—or those dreaming of buying their first house—aren’t quite sure what owning a home with a mortgage really means. And that's just the tip of the iceberg when it comes to the true-and-false of real estate. Let’s cut through the myths and misconceptions about homeownership, starting with the big one: “Who really owns my home?”
Myth #1: The Bank Owns My Home Until I Pay It Off
The idea that the bank owns your home until you pay off the mortgage is a persistent myth, but it’s far from the truth. Ownership of the house is tied to ownership of the land underneath it, and that ownership "conveys" from the seller to the buyer via a deed or title. The deed is the legal document that proves ownership and specifies what is owned. When you buy a home, you (or you and your partner's) name(s) go on the deed -- the bank's name does not -- which means you own the land and the house.
But you'll still have to sign documents that have the bank's name on it. This is called a "lien", and the lien means that someone else fronted the money to buy the house. A "lien-holder" has a right to get their money back, which is why you have a mortgage and send the bank payments. But if you stop making payments, the bank or lien-holder still has a right to get their cash back. So the lien establishes your house as "collateral", or something else they can take if they don't get their money.
If you stop making payments, however, they can't just take the house: they have to go through a process of foreclosure. During foreclosure they have to file specific legal notices with you and the county where your house is, and during this process you have an opportunity to catch up on your payments. So if you miss a payment instead of panicking, contact the bank or lender and come up with a plan to catch back up to avoid foreclosure or losing your house. Make sure you read your loan terms and know your rights; if you get a Notice of Servicing Transfer, that means the bank sold your mortgage to another company that will start collecting the mortgage payments. This doesn't change anything -- but you should make sure to read your new loan terms and repayment schedule!
Myth #2: You Need a 20% Down Payment
This is one of the most common myths in homebuying, and it’s kept many people from even starting the process. The truth? A 20% down payment is great if you can afford it, but it’s not mandatory. In fact, in the military we often think that we are special in not needing a 20% down payment because we can use a 0% Down VA Loan -- and that, too, is only partially true!
The reason for a down payment is so that the house is worth more than the balance owed on the mortgage, aka the amount financed. This is so that in the event of foreclosure the bank can feel confident that they will get all the money they lent you back. Foreclosure is expensive, so they want a little bit of margin (the difference between the value and the amount owed) to cover those costs. There is also the risk that the property could lose value, so they want a buffer. For example, if there is a recession in the broader U.S. economy, house prices typically drop 10-15% before recovering. If you make a 20% down payment of $40,000 on a $200,000 house, the amount owed is $160,000. If the value of the house drops 15% it would be worth $170,000, still more than what is owed on the mortgage.
So, sure, 20% is the standard, but banks will still issue mortgages with just 3%, 5%, 10%, or 15%. This happens when a homebuyer has exceptional credit (>740) and the bank is very confident in the housing market and the value of the home going up.
With the VA Loan, the 0% down option is the most well-known and most popular, but in fact you can put any amount down. In the event you choose to make a 5%, 10%, or greater down payment with a VA Loan, you will be rewarded with a lower VA Funding Fee. The Funding Fee is what you have to pay the VA in order to get the great terms (low down payment and lower interest rate) you get with a VA Loan.
There are other loans for first-time homebuyers that allow for extremely low down payments as well. The Federal Housing Authority (FHA) loan offers a 3.5% down payment, and specifically targets buyers with lower credit scores. The VA Loan typically has a cutoff of 620, but borrowers can qualify for an FHA Loan with a 580 credit score -- and sometimes as low as 500 (but then you need 10% down). Since this is a one-time option, if you have a credit score of at least 580 and serve in the military, you may want to consider using the FHA loan first, then come back later to use your VA Loan in the future to maximize benefits!
One thing to be cautious of is Primary Mortgage Insurance (PMI) and Mortgage Insurance Premium (MIP). A conventional loan with less than 20% down will require you pay PMI, and an FHA loan requires you to pay MIP (for the life of the loan if you paid 3.5% down, or for 11 years if you paid 10% down). A VA Loan does not require either.
It is often tempting to skip the FHA loan or make at least a 20% down payment with a conventional loan to avoid PMI. But PMI might be only $50 a month, or $600 a year; if the house costs $200,000, 20% down is $40,000 while 10% down is only $20,000. You would have to pay PMI for all 30 years of the mortgage and still not spend $20,000, while you keep that $20,000 in your pocket for furnishing, repairs, improvements, or something else entirely.
Myth #3: Prepaying My Mortgage Will Get Me Penalized
Some people hesitate to make extra mortgage payments or pay off their loan early because they fear penalties. But prepayment penalties are largely a thing of the past. Most modern mortgages allow prepayments without penalty. Making extra payments can significantly reduce your total interest costs over the life of the loan.
For example, you could make a bulk payment to pay down the principal. If you receive a reenlistment bonus or Continuation Pay, you may choose to spend the money like this. Your payment plan will continue on as normal, but the part of the payment that is interest will be less after the bulk payment. Interest is profit for the bank, while principal pays down the loan and "builds equity" for you. So this will save you future interest.
You can also make payments more frequently than every month. So long as your lender allows it, they will apply the payment when you make it, which will reset the clock on interest. You still pay the same amount every month (for example instead of $2,000 once a month, $1,000 twice a month), so you can stick to your budget. And just by making this shift you will save thousands over the life of the loan. For example, if you have a $400,000 mortgage, your total interest payments over 30 years will be $510,177 at current interest rates -- but if you pay every two weeks you will only spend $388,860 on interest and will pay off your mortgage in just 25 years! That's a $121,317 savings!
Just be careful and check Your Terms. Some lenders will allow you to make additional or more frequent payments, but will not apply them until the end of the month. In cases like these, you will not save anything from more frequent payments, only if you pay extra each month. Also, while rare, some loans—like adjustable-rate mortgages (ARMs) or jumbo loans—may include prepayment penalties.
Myth #4: All Debt Must Be Paid Off Before Buying a House
It’s natural to want to be debt-free before making a major purchase, but you don’t need to eliminate all debt to qualify for a mortgage. In fact, lenders don't care at all about how much debt you have: they care about your Debt-to-Income ratio, or DTI. This is how much you pay each month on debt compared to how much you earn. The housing market collapse in 2008 was triggered primarily because lenders didn't have to consider DTI, only the payment on that mortgage compared to income. So people could -- and did -- get loans on 10 or 12 houses by qualifying for each. But then they had a DTI of 4 or 5 or more.
That meant they might earn only $5,000 a month, but owed the banks $20,000 or more in payments. If they rented out those houses, they could cover the payments, but as soon as the renters moved out or lost their jobs and couldn't afford the rent, these borrowers couldn't pay the mortgages. This started mostly in Florida, and the wave of foreclosures quickly swept across the country.
As a result, the U.S. Congress passed the Dodd-Frank Act of 2010, which requires lenders to account for all your debts and ensure your overall DTI doesn't go above .43. If you make $5,000 a month, your total debt payments can't be more than $2,150. But as you start to add rental properties to your portfolio, you can count the income from your renters as part of your total income. An E-6 with two rentals might be able to claim a total income of $10,000, and now be able to get another mortgage so long as they don't go over $4,300 a month in loan payments.
For this reason it's not necessarily true that you need to pay off all your debt, rather that you should probably get rid of any short-term or revolving debts like credit cards, payday loans, or auto loans. Student loans can also count against you, but those are in a gray area of whether or not to pay off. Ultimately, you need to stay on top of your DTI, and avoid or pay off any debts that make your DTI too high to qualify for a home loan. Also, you may still be able to qualify for a mortgage that you didn't qualify for with 0% down if you make a down payment. For that reason it can be wise to save cash for a down payment even if you can and plan to use a VA Loan eligible for 0% down.
Myth #5: A 30-Year Fixed Mortgage Is Always the Best Option
The 30-year fixed mortgage is the go-to choice for most homebuyers, but it’s not the only—or always the best—option. The reason it's preferred is that spreading out payments over 30 years makes your monthly payment smaller, and homeownership becomes more affordable. Also, you can lock in super low payments for 30 years! Your parents who bought a house in 1994 may have a mortgage payment of only a few hundred dollars today, meaning as you get older -- and especially in retirement when you stop earning a paycheck -- you can continue to afford to keep your house on a fixed income.
But the 30 year mortgage is also optimal for the banks, because they get to collect the most interest -- and make the most profit -- on these 30 year loans. That's because they front-load the interest. On a 30-year loan your payments in the first 5 years might be 80% interest, meaning your principal balance hardly goes down at all. If you sell in these first 5 years, you might not even break even because all you were paying was interest: after paying closing costs and agent's commissions, you might even lose money.
For that reason it makes sense to consider other types of loans, such as:
- 15-Year Fixed Mortgage: Higher monthly payments but significantly lower total interest paid.
- Adjustable-Rate Mortgages (ARMs): Lower initial rates that adjust after a set period. ARMs can be a smart choice if you plan to sell or refinance before the rate adjusts.
For the typical American family, they will own their home for 12-14 years before moving, as they tend to settle down until their children finish high school. For them, an ARM may not make much sense at all, while the 15- and 30-year mortgages ensure low payments in the future. In the military, on the other hand, we move every 2-6 years. If you're able to secure a 7/1 ARM with an interest rate that's lower than a 30-year loan for the first 7 years, and intend to sell the house in 6 years, you can save thousands in interest payments with this option. Just know this will require a conventional loan and a down payment.
Conclusion: Understanding Real Estate Myths Can Save You Thousands
Owning a home is one of the most significant financial milestones in life. But navigating the process can be tricky, especially with so many misconceptions floating around. If you just "float along" in the process and follow the herd, you'll likely use a 0% down VA Loan over 30 years and pay tens of thousands in interest to the bank while you own your home. This leaves you with little equity -- and little profit.
But when you understand the options available to you and have a wise strategy to use different types of loans in a buy-and-hold strategy to grow your rental portfolio, you can save tens of thousands of dollars in interest while quickly increasing passive income on your way to financial freedom.
At Military Wealth Coach, we help service members and veterans build financial security, with a strong emphasis on doing it through real estate. We can help you develop a strategy to move from an FHA loan to the VA loan, then utilizing conventional and investor loans, to rapidly grow wealth and income.
Stay tuned for more tips on building wealth through real estate as we close out the year, and look for our helpful checklists that will help you take control of your finances and homebuying journey!
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