What types of loans are available for first-time homebuyers?
Many first-time homebuyers don’t have excellent credit histories and many others don’t have large down payments available, but some do. Some have served in the Armed Forces and can access VA loans, while others might be able to explore USDA financing if their homes are in certain rural areas.
With that in mind, here’s a quick overview of the four major mortgage types first-time homebuyers can use to give you a better idea which might be the right choice for you.
- Conventional mortgages: The majority of purchase mortgage loans in the United States are known as conventional loans. This is a broad term that refers to loans that aren’t guaranteed by a government agency. The lack of a guarantee means that conventional mortgages generally have stricter qualification requirements than the other loan types listed here. But they could still be excellent options for first-time buyers with strong credit scores. There are several conventional mortgage programs for first-time buyers that allow for down payments as low as 3% of the purchase price. Find out more in our guide to buying your first home.
- FHA loans: FHA mortgage loans are guaranteed, or insured, by the Federal Housing Administration (FHA). Because of this guarantee, credit requirements are generally looser than other types of mortgages, and down payments can be as low as 3.5%, even with a relatively low credit score. While there are a few drawbacks to FHA loans, especially when it comes to costs, they can be a great way for buyers who don’t have stellar qualifications to become homeowners.
- VA loans: A VA loan is a mortgage that is backed by the U.S. Department of Veterans Affairs, and these are available to certain military members, both past and present. VA loans have no down payment requirement, low interest rates, and flexible credit qualifications, so they are definitely worth looking into if you qualify.
- USDA loans: A USDA loan is a mortgage that is guaranteed by the U.S. Department of Agriculture. To qualify, a home must be in an eligible rural area, and the borrower’s income must be below certain limits. If both borrower and property qualify, USDA loans don’t require any down payment whatsoever.
It’s also important to mention that in addition to these types of loans, many lenders have their own proprietary mortgage products, and some are specifically designed for first-time homebuyers. So it could also be a great idea to research the options offered by some of the best mortgage lenders as well as your local and regional financial institutions.
How do I qualify as a first-time home buyer?
There aren’t any specific requirements that only apply to first-time buyers (unless a particular loan product has a separate credit or down payment requirement for first-timers). For the most part, first-time buyers are subject to the same general requirements that all mortgage applicants face.
Having said that, first-time buyers are less likely to know what to expect than seasoned homeowners. So here are the general categories of information your mortgage lender will consider when you apply for a mortgage for your first home.
- Credit: Before verifying any of your other qualifications, lenders will typically run a credit check. Virtually all mortgage lenders use the FICO credit scoring model, and most will pull your scores from all three major credit bureaus and use the middle number for qualification purposes. FHA loans require a minimum 580 FICO® Score for a 3.5% down payment, while conventional loans have a minimum of 620.
- Down payment: Unless you’re using a VA or USDA loan to finance your home, you’ll need a down payment. FHA and conventional loans have low down payment requirements, and funds can usually come from a gift. But you’ll need to document what funds you have for your down payment and where they came from, as well as how you plan to pay for any closing costs.
- Debt-to-income ratio: Simply put, lenders want to make sure you’ll be able to afford your mortgage payments, so they’ll look at your debt obligations as a percentage of your income, a metric known as your debt-to-income ratio, or DTI ratio. Methods of calculating DTI and lending standards can vary, but a good rule of thumb is that your total monthly debt obligations (including your new mortgage payment) should be no more than 45% of your pre-tax income.
- Employment: Lenders want to know that not only can you afford your mortgage payments for now, but that you’ll also be able to keep paying your mortgage year after year. Most mortgage lenders want to see at least two years of steady employment in the same field (but not necessarily with the same employer). There are exceptions, however — such as if you graduated from college less than two years ago.
- Assets/reserves: Depending on the mortgage loan you select, as well as your other qualifications, your lender is likely to require a certain amount of money in reserves. This can be as little as two months’ worth of mortgage payments. The point is that you typically can’t end up with a zero balance in your bank account after closing on your home.
Before you apply for a mortgage, it makes sense to ensure each of these are as good as possible. For example, taking some time to raise your credit score and save a higher down payment could help you snag a better interest rate which will save you money in the long run.
Choosing the best lender for first-time home buyers
The first step in choosing the best mortgage lender for your first home purchase is to get a good understanding of how home loans work. Then you’ll need to narrow down a short list of a few (say, three or four) lenders with products and resources that meet your needs. Our best first-time mortgage lender list on this page is a good place to start, but it could also be a smart idea to check out your local and regional banks or credit unions so that you can compare mortgage rates.
Once you have a short list, apply for a mortgage with all of them to compare the specific loan terms and fees that you get offered. It won’t hurt your credit score to do this, as all mortgage-based credit inquiries that take place within a typical shopping period are counted as just a single inquiry. You’ll see a range of interest rates, fees, and APRs from different lenders, and you’d be surprised at how much this can save or cost you over the life of a 30-year mortgage loan.
View more information: https://www.fool.com/the-ascent/mortgages/best-mortgage-lenders-first-time-homebuyers/