Home Loans for First-Time Buyers: A Guide

Home Loans for First-Time Buyers: A Guide
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If you're looking into getting a home loan to buy your first home purchase, you'll find that you can have several options depending on your financial picture, preferences and chosen property. Some first-time homebuyers can access loans with perks like no down payment, while others can choose from low down payment programs and even benefit from down payment and closing cost assistance that makes it easier to prepare for the upfront costs. To get ready for the home financing process, use this guide to learn about the first-time homebuyer loan options as well as better understand what mortgages involve.

Introducing Home Loans

Since many first-time homebuyers don't have a financial situation that allows for paying fully in cash for a new home, taking out a home loan makes achieving this goal much easier. Working with a mortgage lender, you'd look for an appropriate mortgage program and terms, go through the qualification process and usually put some money down and pay closing costs. Once you've become a borrower, you'd pay the loan balance plus interest and other charges through monthly payments for a typical period of ​15 to 30 years​.

A mortgage will come with an important condition that you should know about as a borrower. The loan is secured to your home to protect the lender against delinquency if a foreclosure happens due to your inability to make payments anymore. This means you need to take care in purchasing a property and taking out a loan that you can afford indefinitely into the future since you could end up having the lender take the property from you if you get in a tight spot where you miss several payments. Your lender usually has options if you think you'll miss a payment, so never hesitate to reach out as soon as you can.

Read More​: How Does a Mortgage Work?

Understanding Key Home Loan Terms

Your home loan will have several terms, and your mortgage payment will include multiple items that affect the cost. Understanding these is important for anybody considering taking out a mortgage.

A few important terms for your mortgage include the interest rate and term length. The interest rate determines how costly the loan will be each month and ultimately over time. You can expect your credit score, down payment amount, current market rates, loan type, selected property and location to all play a role in the rate, and it can adjust at certain times or always stay the same. The term length ties in with the interest rate since you can get better rates with ​15-year​ mortgages than ​30-year​ ones, but the longer term means lower monthly payments that may better fit your finances.

Other important items in your mortgage payment include the principal, interest, private mortgage insurance (PMI) or its equivalent and the escrow. While the principal and interest reflect portions of the original loan balance and interest paid, escrow refers to the homeowner's insurance and property taxes the lender usually collects while you're a borrower. PMI or its equivalent is common for mortgages where you make a low down payment that's under ​20 percent​.

What It Takes to Qualify

Since a mortgage lender will want assurance you can afford your mortgage payment and pay it on time, you'll have to meet certain qualifications regardless of the mortgage program you choose. While some programs have more flexibility than others in these areas, expect the lender to consider the following regarding your financial situation:

  • Income​: Your income should show the lender you have enough money coming in to make timely mortgage payments as well as cover your other costs. In some cases, loan programs will have a maximum income to qualify as well. All income will need to be verified so the lender can consider it a predictable cash inflow, and you can come across minimum employment periods, especially for self-employed borrowers.
  • Debt​: Since your other debts like credit cards and student loans take up some of your income, the lender will need to do some calculations for debt-to-income (DTI) ratios and better assess how a mortgage would fit in. They'll usually compare your total mortgage payment to your total income (called the front-end DTI ratio) and your total debt payments to your total income (called the back-end ratio).
  • Credit​: Your credit score is particularly important as it affects the mortgage program approval and interest rate. Actions such as applying for new accounts, having high account balances and missing payments can hurt your credit score and thus your likelihood of mortgage approval. Minimum credit scores for mortgages run from ​500 to 640​ depending on the program; lenders often favor or even require higher scores than such minimums as well.
  • Savings​: Several loan programs require putting some money down, often between ​3 and 20 percent​, plus you'll pay closing costs from anywhere between ​2 and 6 percent​ of the loan taken out. Lenders will want to see that you either have the funds on hand or have another approved method of acquiring them for these expenses. Further, they'll probably want to see extra funds that could cover several months of mortgage payments if needed.
  • Property value​: Any mortgage program will require that a professional appraiser determines your future home's value. The lender uses this number to check the loan amount for which they should offer you. You can run into difficulties where you need to pay a larger down payment to make up for a difference between the property sale price and appraised value.

Exploring Government Home Loan Programs

The income-based U.S. Department of Agriculture (USDA) single-family home loan program makes homeownership accessible to people who can't afford a down payment and who want to purchase an existing rural home for their principal residence in an approved area or even have a new one built. Lenders usually like to see a ​640+​ credit score and a maximum back-end DTI ratio of ​41 percent​ to benefit from this no-down-payment loan. Borrowers of USDA loans agree to a form of mortgage insurance called a guarantee fee where they pay 1 percent upfront and then ​0.35 percent​ annually for the loan's life.

Federal Housing Administration (FHA) mortgages can serve both first-time homebuyers and people with lower credit scores and less cash for a down payment. People with scores of ​500 to 579​ put down ​10 percent​, while those with higher scores only need ​3.5 percent​. The program allows for a typical maximum back-end DTI ratio of ​43 percent​. Borrowers have to pay mortgage insurance of ​1.75 percent​ upfront and then between ​0.45 and 1.05 percent​ annually for the rest of the term, unless they refinance through a different program. Unlike with USDA loans, there aren't income ceilings for FHA loans.

Available only to those with an acceptable military affiliation and minimum service length, U.S. Department of Veterans Affairs (VA) loans stand out from the other government-backed options for only having one upfront funding fee of ​0.5 to 3.6 percent​ versus ongoing guarantee or mortgage insurance fees. VA loans allow for no down payment to improve accessibility, and other common requirements are a ​620+​ credit score and a maximum back-end ratio of ​41 percent​. Unlike with some other government programs, VA loans can allow borrowers to buy more expensive properties and there aren't income limits.

Be sure to also investigate your eligibility for a HUD (Department of Housing and Urban Development) program or any other down payment assistance programs through your local government or nonprofits.

Looking Into Conventional Home Loans

While these mortgages can come with tougher qualifications, conventional home loans stand out as a popular choice for borrowers since they can come with appealing terms and give borrowers flexibility that the government-backed mortgage options may not provide. For example, the mortgage doesn't have to be for a primary residence. These loans get guaranteed through Fannie Mae or Freddie Mac, which are government-sponsored enterprises, and they usually require a ​620+​ credit score along with a DTI ratio of ​45 to 50 percent​ depending on the borrower's other qualifications.

The conventional mortgage option allows for a lower down payment than FHA loans since you usually just need ​3 percent​ of the home's price, so first-time homebuyers can find this an accessible option. Interest rates usually are also lower than for FHA loans, and while there is PMI without a minimum ​20 percent​ down payment, you can eventually have it canceled without needing to refinance your mortgage. PMI for conventional loans usually is tiered based on down payment amount too, so you can save money by putting more down than the minimum, even if you can't afford 20 percent.

Two conventional mortgage programs that target first-time homebuyers include the Fannie Mae HomeReady and Freddie Mac Home Possible options. The programs target individuals who make within the income limits and who only have the minimum funds to put down. While similar, Freddie Mac's program offers more flexibility in down payment funding since it doesn't require a specific minimum borrower contribution, but it does tend to require a higher credit score of ​660 versus 620​ for HomeReady. First-time homebuyers have to complete a homeownership education course for both options.

Considering Jumbo Home Loans

In most counties across the United States, you'll come across a conforming loan limit of ​$548,250​ when you look into getting a conventional mortgage for a home. In certain counties in states such as California, Wyoming, Colorado, New Jersey, New York and Maryland, the loan limit is a higher ​$822,375​, and the limits can change over time. So, if you choose a property where you'd need a higher loan, you'll often need to look into applying for a jumbo loan that has higher limits that also vary by state.

Since you'd borrow a significant amount of money, you can expect more stringent qualifications through the mortgage lender alongside a higher cost of borrowing. For example, your mortgage lender may expect a minimum ​700​ credit score, require you to put ​10 to 20 percent down​ on the property and charge you PMI unless you put down enough money. Jumbo mortgage interest rates also exceed those of conforming conventional loans slightly, and the rate difference means you'll ultimately pay more in the long run for your property financing.

Seeking First-Time Home Buyer Programs

To make it easier to handle upfront expenses like your closing costs and down payment, you can research first-time homebuyer programs available in your locale and determine if your chosen property and financial situation qualify you for help. Down payment and closing cost assistance can come in grant or loan form. The amount given often correlates to the lower end of a minimum down payment amount.

Sometimes, you can borrow the money needed and pay it off after a deferment period. Otherwise, your state may give you the money outright or forgive it based on certain residency requirements. States will usually require that you work with a certain lender, meet income requirements, possibly have a minimum amount of cash to contribute yourself, qualify for a mortgage program and take a homebuyer education course.

Read More:What Is a Home Down Payment?

How to Start With Applying

Before going ahead and shopping for lenders, take some time to check your finances against the requirements for mortgages. This means looking at your savings and credit history, checking your credit report and score and assessing your budget to get an idea of what you can afford. When you're ready, do some research online, speak to local financial institutions or ask for recommendations from others to find a few lenders to meet with regarding a preapproval. This initial step will provide more insight into loan options and your likelihood of approval.

When reaching out to each lender, you'll get asked for some basic details such as the estimated home price, your earnings and the intended loan amount alongside personal basics like your Social Security number and name. You may also get asked to send some income and asset verification documents before you hear about whether you're preapproved. If the lender preapproves you, you can look at the offered terms, compare them to the other options and choose the best mortgage option and lender to proceed with. You'll also receive a letter that helps with the home buying process as it offers some assurance of financing.

You'll continue the official mortgage approval process when you had an offer on a home accepted, and that's when you'll fill out the complete mortgage application and complete several steps the lender requests. For example, you'll probably need to submit tax returns, your photo ID, bank statements, pay stubs and other items as well as follow up with steps like a home appraisal and final credit check. After the lender has checked everything and given you the final approval, you get to have a closing meeting that finalizes your new responsibility for the mortgage.