Buying a house for the first time comes with a lot of excitement and carries considerable responsibility and the stress of securing the funds. When looking to finance your mortgage, you need to examine all available options and check to see if you meet the requirements set forth by the lender.
Take the time to fully understand mortgage financing and learn how to arrive at the best type of lender and mortgage vehicle possible.
What Are the Requirements for First-Time Homebuyers?
Depending on the type of loan you are applying for, you will need to meet the criteria for approval. To fall under the category of a first-time homebuyer, it’s enough to meet one of the following requirements:
- You are a homebuyer that has not owned a home in three or more years.
- You are a single parent or displaced homemaker who only owned a home with a spouse while married.
- You only owned a home that was not in compliance with local, state, or model building codes.
- You only owned a home not permanently affixed to a foundation as per relevant regulations.
Even though there are programs that will allow you to buy a home with $0 down, a low income, and a low credit score, you will likely have to meet a set of requirements for most lending programs. These include proof of having an income sufficient to pay the mortgage, a credit score above 620, and a down payment of 3% or more.
Types of Mortgages
The loan types available to you fall under three categories. The first type involves borrowing directly from private lenders, while the other two are government-backed loan programs.
Conventional loans are mortgages that do not have a federal guarantee backing them. They are usually fixed-rate loans and are more challenging to secure than mortgages backed by the government. The strict criteria for qualifying, including higher credit scores, a bigger down payment, and lower debt-to-income ratios, make conventional loans available to a smaller percentage of first-time home buyers.
Conventional loans fall under two categories: conforming and non-conforming loans. Conforming loans follow guidelines set by government-sponsored enterprises (GSEs) that enhance credit in the housing market. Fannie Mae and Freddie Mac, the GSEs that facilitate mortgage lending, buy conforming loans that they then package and sell as securities. The maximum limit for a conforming loan in 2022 is $647,200 but can exceed that amount in designated areas.
On the other hand, nonconforming loans are not subject to these guidelines, as the lending institution that underwrites the mortgage can set its own rules. Unlike conforming loans, regulations prohibit nonconforming loans from being packaged and sold on the secondary market.
Department of Veterans Affairs Loans
The government guarantees Department of Veterans Affairs loans made by qualified lenders. The federal government does not act as a lender but provides its backing so veterans and active duty personnel can get mortgages with advantageous terms.
It is usually easier to qualify for a VA loan than conventional loans. Qualified lenders tend to limit the maximum amount you can borrow with VA loans to match the respective conventional loan limits.
To apply for a VA loan, you will need to request your eligibility from Veterans Affairs. Once accepted, the VA issues a certificate that is necessary for your application.
Federal Housing Administration Loans
Another government-backed loan option for financing your mortgage is a Federal Housing Administration loan. The FHA is part of the United States Department of Housing and Urban Development, and its goals are to improve housing standards and reduce foreclosures by providing mortgage insurance.
FHA loans are optimal for first-time homebuyers due to their lower upfront costs and more lenient credit requirements. Currently, FHA loans require a credit score of at least 580 and a 3.5% down payment.
If your FICO score is between 500 and 579, the down payment increases to 10%. You must prove that you have a steady income and need a debt-to-income ratio below 43%. Private mortgage insurance is required, typically 0.45% to 1.05% of the loan amount per year. The home you are purchasing must be your primary residence.
Income and Equity Requirements
Mortgage lenders determine pricing by quantifying your creditworthiness. This calculation takes multiple factors into account. Lenders start by checking your FICO score from the credit bureaus to ensure that it meets the loan’s requirements.
They also calculate your debt-service coverage ratio and your loan-to-value ratio. Your debt-service coverage ratio shows your ability to pay current debt obligations, while your loan-to-value ratio expresses the ratio of your loan to the value of the home being purchased.
These metrics help lenders decide how much money they are willing to let you borrow and the interest rate they will apply to the loan. Your debt-service coverage ratio shows your ability to pay your current debt obligations, while your loan-to-value ratio expresses the ratio of your loan to the value of the home being purchased.
Your loan-to-value ratio is important because lenders consider you less risk when putting up a greater percentage of the home’s value as a down payment. The higher the loan-to-value ratio, the greater the risk you are to the bank and the higher the interest it will charge you.
This is why you should show any type of qualifying income you are making when negotiating your loan. Even a minor part-time income-earning activity can push you over the line to qualify for the loan you seek.
Fixed-Rate vs. Adjustable Rate Mortgage
When financing your mortgage, you will have to choose between a fixed rate and an adjustable-rate loan. Fixed-rate mortgages carry the same rate throughout the life of the loan, while adjustable-rate mortgages see their interest rates change annually based on the market index, depending on the length of the term. Standard terms are 1-year, 5-year, and 10-year. Your mortgage rate is fixed for that period but fluctuates annually afterward.
Fixed-rate mortgages shield you from unpleasant increases in interest rates that can impact your monthly budget. Adjustable-rate mortgages benefit first-time homebuyers who expect their income to increase over the loan period.
By giving you a lower introductory rate for the first few years, you can qualify for a greater amount than if you had gone with a fixed-rate mortgage. You build more equity in your home quickly because you are paying down your principal faster.
Adjustable-rate mortgages present two risks you should consider. The first is that your income might not increase as you initially expected. Secondly, market volatility and economic uncertainty can cause banking interest rates to rise. As interest rates increase, the terms of your floating-rate mortgage will follow suit.
Other Programs for First-Time Homebuyers
Some financial institutions offer specialty programs that allow first-time homebuyers to finance the property they desire.
Individual Retirement Accounts
Individual retirement accounts (IRAs) allow first-time homebuyers to pull as much as $10,000 out of their account without paying the 10% penalty that generally comes with making an early withdrawal.
If you are buying the house with your spouse, each partner can withdraw this amount from their IRA, providing $20,000 that you can put down toward your purchase.
Fannie Mae’s ReadyBuyer program provides up to 3% assistance toward closing costs when purchasing foreclosed homes that Fannie Mae owns. Eligibility requires taking a home-buying education course before you place an offer on the house.
Down Payment Assistance Programs
You can find down payment assistance programs for first-time buyers at the state level. You will have to check for state eligibility requirements to determine if you are eligible. Down payment assistance is available to public servants and lower-income brackets.
Financing Your Mortgage
Doing some research can help you create a shortlist of options that are best for your finances. Consider variables such as fixed or floating interest rates, private or government-backed funding, and how big a down payment you can afford to make, and weigh them against lenders’ requirements.
You can then move forward by contacting a mortgage lender about the best loan for you. Your real estate agent can often offer lender recommendations if you need a second opinion. Regulations prohibit realtors from accepting kickbacks from mortgage lenders to ensure your agent has a vested interest in your positive home buying experience.
Keep in mind that when borrowing to buy your first home, the loan amount depends on your income, creditworthiness, and the type of mortgage you choose. Loan payments include property tax and homeowners insurance, so keeping up with your monthly mortgage payments ensures you stay on track with all obligations concerning your new home.
Knowing your mortgage options as much as possible means doing your due diligence. From credit cards and savings accounts to insurance and mortgages, Finance is us is a source of knowledge for consumers looking to make informed choices about their money. Trust Finance is us for tips that can help you get a home loan.
Disclaimer: All content on this site is information of a general nature and does not address the circumstances of any particular entity or individual, nor is the information a substitute for professional financial advice and services.