6 mortgage myths that can cost you money

Do you believe that you can't borrow money to buy a house if you have some dings on your credit? Do you think it's always best to pay off the mortgage early, if you can? If so, you subscribe to mortgage myths that can cost you money. Here are six common myths.

Myth 1: A 30-year fixed mortgage is always best.
Myth 2: Pay off that mortgage as soon as possible.
Myth 3: You need a big down payment.
Myth 4: You're stuck with PMI.
Myth 5: Dinged credit? No mortgage for you!
Myth 6: Refinancing means a new 30-year countdown.

Myth 1: A 30-year fixed is always the best way to go.
Adjustable-rate mortgages, or ARMs, constitute one-third of home loans these days. Yet rates on 15- and 30-year fixed-rate mortgages are very low by historical standards. ARM rates are even lower, but they could rise when it's time for them to adjust.

"You're going to hear a lot of financial journalists who say these ARMs are dangerous, you're putting your house at risk, you're crazy to take an ARM at this time of historic lows," says Bob Walters, senior vice president for Quicken Loans. "There's a lot of emotion involved. As with any emotional argument, there's some truth in it."

It's true, Walters says, that a long-term, fixed-rate mortgage is the right loan "if somebody says, 'I'm going to be in that house forever.' That's an automatic 30-year fixed."

But the average homeowner stays in the house about nine years. First-time home buyers, who usually are young and have expanding families and growing incomes, are likely to remain in their starter homes for just a few years before moving on and up.

Adjustables, especially the popular hybrid adjustables that carry an introductory rate that lasts three, five, seven or 10 years, are appropriate for those whom Walters calls "upwardly mobile people, people who are transient, people for whom a payment increase wouldn't be the end of the world."

Myth 2: Pay off that mortgage as soon as possible.
Accelerating mortgage payments is another area where emotion often trumps reason, Walters says. "We're not talking about finances; we're talking about psychology, or at least where the two meet," he says.

Walters advises people to imagine a scenario where they have a 5- percent ARM and are able to deduct the interest from their federal income taxes. That lowers their effective interest rate to somewhere in the neighborhood of 3.75 percent. Instead of paying extra principal on such a mortgage, it makes more sense to pay down higher-interest debt, such as for credit cards and auto loans, or to invest the money where it can earn a return greater than the mortgage interest rate after taxes.

"The way people deal with money and risk is often irrational, and they put much more of a premium on security and safety than they do on getting a return," Walters says.

It's perfectly fine to pay off a mortgage early if doing so satisfies a long-term financial goal. Doug Perry, senior vice president of Countrywide Home Loans, says a lot of aging baby boomers want to eliminate their mortgage debt so they can retire debt-free. That makes sense, especially for retirees who won't exceed the standard deduction on their income taxes and therefore won't be able to deduct their mortgage interest.

Myth 3: You need a down payment of 20 percent or at least 10 percent.
"The perception out there -- that you need 10 percent down at least, maybe 20 -- that's completely incorrect," Perry says. Many lenders have lots of loan programs for people who can afford to pay 5 percent down or less -- including zero down. In the mortgage industry's horse-and-buggy days, the only zero-down loan was available from the Veterans Administration. That's no longer the case.

"A lot of people are caught in a cycle where they're paying a lot every month for rent and are paying bills on time, and they don't have a lot of money to save," Perry says. "They think they're trapped in the renting cycle with no way out, but they have several options." That takes us to the next myth.

Myth 4: You have to pay mortgage insurance if you don't have enough money for a 20 percent down payment.
"What's called 'piggyback financing' is now almost 50 percent of home purchases," says Peter Bonnikson, senior vice president for E-Loan. A piggyback loan lets you avoid paying for mortgage insurance.