Best First-Time Homebuyer Loans

Many first-time homebuyers struggle to come up with the cash for a down payment and closing costs. The right first-time homebuyer program can help you become a homeowner without perfect credit or a traditional 20% down payment.

If you’re in the market for your first home, here’s what you need to know to help you find the best first-time homebuyer loan.

What you’ll learn here:

There are different definitions of what it means to be a first-time homebuyer, says Tammy Andrews, vice president and branch manager for Motto Mortgage United in Fulton, Maryland. “From a lender’s perspective, it can be not ever owning a home, period. But for different grant programs, it might mean not having owned a home in the last three years,” she says.

A low down payment is usually the main characteristic of a first-time homebuyer loan. Genworth Mortgage Insurance’s First-Time Homebuyer Market Report indicates more than 80% of first-time homebuyers have used some form of low down payment mortgages, including conventional, Federal Housing Administration, U.S. Department of Veterans Affairs and U.S. Department of Agriculture loans.

“FHA and VA have been the classic first-time homebuyer programs mostly because of the low down payment,” says Anna DeSimone, author of “Housing Finance 2020,” a comprehensive guide to the mortgage process. However, she points out, Fannie Mae and Freddie Mac both have conventional loan programs that only require 3% down.

The main difference between the loan types is the credit score requirements. “FHA will accept a lower credit score,” she says.

As far as which loan program is best, there isn’t a one-size-fits-all answer. It really depends on your financial situation and the cost and location of the home you are looking to buy.

For example, while you might assume an FHA loan is the best entry point for those with less-than-stellar credit, Andrews says that program is also the strictest when it comes to student loan debt. The FHA’s formula counts student loans in a way that typically raises a borrower’s debt-to-income ratio.

Whichever loan you go with, don’t forget to ask about state programs for down payment and closing cost assistance for first-time homebuyers. They can come in the form of grants or forgivable second mortgages.

There are a couple of ways to begin your research. DeSimone recommends starting with your state’s housing financing agency, which offers affordable mortgages based on housing characteristics and prices for its areas. “They are subsidized by their state and they work with FHA, VA, and Freddie and Fannie loans,” she says. When buyers contact their agency, she says, they’ll get an unbiased, independent opinion and will be referred to approved lenders.

In addition to affordable mortgage programs, state agencies can give first-time homebuyers advice, and some states also help with home energy improvements and payment protection in case a borrower loses his or her job, says DeSimone.

Another route to try is to work with a local lender or mortgage broker in your area who knows about grant programs and what the requirements are for particular areas, says Andrews. “It’s absolutely a great idea to shop around and ask a lot of questions,” she says, adding that a mortgage broker can do that shopping for you.

Whether you’re a first-time or repeat homebuyer, getting approved for a loan will depend on your ability to repay the loan. “You have to build a picture to the mortgage lender that you have the strengths and responsibility to successfully finance the home mortgage,” says DeSimone. That will include a number of factors including your income, your assets, your existing debt and your credit score.

If you’re debt free, have a steady income and have an excellent credit score, that will, of course, be a big plus. Lenders can also look at compensating factors in order to extend your borrowing power even further, says DeSimone, like if you have large cash reserves, additional recurring income, or a long history of paying rent on time. A key number that lenders look at is debt-to-income ratio, or how much of a borrower’s income is going toward paying off existing debts and housing costs.

You should aim to have a debt-to-income ratio of less than 43% – that’s the highest ratio a borrower can have and still get a qualified mortgage. Don’t worry if you’re above that threshold as a first-time homebuyer, though. “Some programs are allowed to loosen ratios up to 50% for people who have compensating factors,” says DeSimone.

Start thinking like a lender to ensure you can get approved for the amount you need. Build a picture that shows you can responsibly finance the loan, and gather documents to prove it.

From there, you should reach out to a mortgage professional and do a buyer consultation, says Andrews.

“The old-school way of thinking is to go to a real estate agent first, but the key component is the money piece,” she says. Speaking with a mortgage professional is grounding and can help you get a ballpark of the budget you’ll be working with and the credit score you will need.

>Your interest rate will depend on your credit whether or not you’re a first-time homebuyer. Interest rates are higher for people who have lower credit scores, says DeSimone. “The riskier it is to take on this debt, the more they are going to charge.”

That said, it’s important to look at the entire loan package and not just the interest rate when choosing your best option. Many first-time homebuyers believe that the loan with the lowest interest rate is the only way to go, but there are other factors to consider.

“If you’re getting a mortgage and have plenty of money to pay closing costs, and the house is in perfect condition, you can afford to shop around to try to get the best rate,” says DeSimone. But if you’re strapped for cash or buying a house that needs a little work, it might be worth paying a higher rate if it means you can keep more cash on hand.

“If it makes a difference between being a homeowner now or waiting, it might make more sense to spend a little bit more now,” says DeSimone.

Crunch the numbers to figure out what a higher rate will really cost you. For example, if one loan option comes out to $18 more per month because of a higher interest rate, how does that compare with putting off homeownership and paying rent for another year or two so you can save for a bigger down payment loan with a lower rate? If housing prices rise, you could end up paying just as much anyway.

In addition to shopping interest rates, you’ll also want to compare the amount of mortgage insurance and upfront costs you’ll have to pay with various types of loans. If you’re paying less than 20% of the loan for a down payment, you’ll likely need to get mortgage insurance.

For FHA loans, the upfront cost is 1.75% of the loan, which will be added to the total borrowed. Then, you’ll also pay monthly premiums that vary based on the loan amount for the life of the loan. The exception is if your down payment is 10% or more, then monthly premiums can end after 11 years.

VA loans don’t require borrowers to carry insurance, but they do have an upfront cost of 1.4% to 2.3% for first-time homebuyers, depending on the size of the down payment. USDA loans do have recurring payments, but they are considerably cheaper than FHA loans – 1% upfront, and then 0.35% of the remaining loan principal each year.

With a conventional loan, you may have to pay mortgage insurance as well, at a higher rate than the federal programs. Private mortgage insurance rates generally range from 0.55% to 2.25% of your original loan amount. PMI can be removed once your mortgage balance hits 78% of the original purchase price.

First-time homebuyers have a lot to think about before they make what is likely the biggest purchase of their lives. Don’t wait until you find the house of your dreams to start doing your mortgage research. Work with a professional who can guide you to the right first-time homebuyer loan for your needs.