If you've been thinking about buying your first home, you probably have a lot of questions. With that in mind, we've created a guide covering everything you need to know before taking out a home loan. Keep reading to learn what factors will play a role in determining your monthly payment, what first time home buyer loan options are available to you, and how you can get some help covering the upfront costs of buying a home.
Important factors to consider when applying for a mortgage loan
Before we get into more specifics about any particular first-time homebuyer program, it's important to take some time to cover the different factors you need to consider when applying for a mortgage. With that in mind, we've outlined them for you below.
The principal loan amount
To start, the purchase price of the home that you end up buying will likely have a big impact on your real estate financing. Often, the home's purchase price minus your down payment ends up being your principal loan amount, or the total amount you borrow. In most cases, the principal loan amount makes up the majority of your monthly mortgage payment.
As you shop for a home, you should try to limit yourself to looking at homes with purchase prices that you feel you can afford. If you're not sure what will fit within your budget, take some time to play around with a mortgage calculator. A mortgage calculator can help you estimate what your monthly payment will be at a variety of sale prices.
The interest rate
Next, it's time to think about mortgage rates since they will also impact your mortgage payment. At a high level, mortgage rates are closely tied to the strength of the economy. However, the specific interest rate you receive will also depend on the strength of your financial profile and, in particular, your credit score.
Since each lender will provide you with a unique interest rate and fee structure, it's a good idea to shop around before applying for a loan. As a rule of thumb, it's best to get at least three estimates before choosing a mortgage lender. Doing so may save you hundreds, if not thousands, of dollars over the life of the loan.
The down payment
Lastly, you will want to think about how much money you intend to put toward your down payment. While the days of needing a 20% down payment are over, typically, you need to be able to put at least 3% to 5% of the home's purchase price down to qualify for a loan.
That said, it's also important to note that if you put less than 20% down, you will likely have to pay mortgage insurance. Mortgage Insurance protects the lender from a loss in the event that you default on the loan. Most lenders require it for borrowers with smaller down payments, and it is especially common with first time home buyer loans.
Most often, borrowers with a mortgage insurance requirement end up having the fee for this protection included in their monthly mortgage payment. While the fee is typically nominal, you can skip it altogether if you have the funds to put down more money upfront.
4 common first-time homebuyer mortgage options
Now that you have a better idea of what to consider when applying for a mortgage loan, it's time to look at your mortgage options. While there are quite a few first-time homebuyer loan programs out there, we've covered the most popular ones. Keep reading to see whether one of these is a good fit for you.
As you might guess, an FHA loan is a mortgage loan backed by the Federal Housing Administration (FHA). In particular, an FHA mortgage aims to help make the homebuying process easier on first-timers by offering more flexible qualifying requirements than a conventional mortgage.
Specifically, FHA loans offer borrowers the opportunity to put as little as 3.5% down. In addition, they have more relaxed credit score requirements. If you want to put as little as 3.5% down, you need to have a credit score of at least 580, compared to the score of 620 that you would need for a conventional loan. However, if you can afford to put 10% down, you can have a credit score as low as 500.
In exchange for that flexibility, the FHA does have a few unique requirements. For one, you can only use an FHA loan for a primary residence, which means it isn't an option for investors (unless you intend on house hacking.) An FHA loan also comes with a mortgage insurance premium (MIP), which is both an upfront and a monthly fee for mortgage insurance.
Meanwhile, a VA loan is a loan option backed by the U.S. Department of Veterans Affairs (VA), which means that if you or your spouse has served in the military, it might be a good fit for you.
VA loans are unique in that they have fewer qualifying requirements than conventional or FHA loans. For eligible borrowers, there are no down-payment or formal credit score requirements either.
Still, these loans also come with their own set of red tape. You'll need to pay a funding fee for your loan to go through, and you may be subject to some overlays from your participating lender. In this case, an "overlay" is just an additional qualifying requirement that is unique to the bank or financial institution funding the loan.
Those who are looking for homes in rural areas may want to consider getting a USDA loan. These loans are a good choice for first-time homebuyers because they allow for up to 100% financing on the price of the home. Plus, while the credit score requirement for a streamlined loan is 640, it can be lower as long as you're willing to provide additional documentation.
These loans are meant for low- to moderate-income Americans, which means you will have to meet a certain income threshold to qualify. You'll also be required to buy a home that is located in a USDA-eligible area.
If none of the above loan programs is a fit for you, there are some conventional mortgages that are meant for first-time homebuyers. The Fannie Mae HomeReady program and the Freddie Mac Home Possible program are both suitable options.
While you will have to take a homebuyer education class and have a credit score of at least 620 to qualify for either of these programs, they allow you to put as little as 3% down. Though, if you put less than 20% down, you will have to pay private mortgage insurance, which can add to your monthly payment.
What to know about closing cost and down payment assistance programs
Often, first-time homebuyers struggle to come up with the funds needed to cover the upfront costs of buying a home. However, it's important to point out that there are down payment assistance programs that can help.
Down payment assistance programs give homebuyers access to the funds they need to cover their down payment and closing costs. Typically, these funds come in the form of a grant or a low- to no-interest loan that can be paid back over time.
The availability of these programs varies by state. With that in mind, if you think you might need help with your down payment and closing costs, it's a good idea to reach out to a mortgage loan officer in your area. They can help you get a sense of the options that are available to you and let you know what you need to do to qualify.
The Millionacres bottom line
At the end of the day, making the leap to homeownership can feel scary. However, it doesn't have to be that way. Truthfully, there are tons of resources available to first-time homebuyers.
While we have created a quick guide to those options, it's important to do your own research to get a sense of what programs and assistance could be available to you.
When you're ready to make a move, don't hesitate to reach out to a loan officer who can help you take the next step.