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8 min read

The First-Time Homebuyer's Guide to Mortgages

Our handbook for securing a place to call your own

Introduction
  • Buying a home is a big step for anyone. But it’s especially touch-and-go for first-time buyers. Breaking down closing costs, the various mortgage programs, the pre-approval and pre-qualification processes, and everything else that goes into applying for a mortgage can be very intimidating.

  • Worry not, however, as our step-by-step guide for first-time homebuyers is here to help — follow along.
11 Things to Consider Before Getting a Mortgage
Get everything in order before leaping into the big decision
  • If you can’t make the 20% down payment, you will pay more in interest over time. Your interest rate may be higher than if you can make a sizeable down payment, and you’ll likely have to pay mortgage insurance.
  • You will have to pay closing costs — usually between 2% and 5% of the amount borrowed for your mortgage — at the time of closing on your home.
  • Other fees you will need to pay include commission to your broker, application fees, title search fees, appraisal fees, and insurance fees. Pay off your mortgage early, and you may also pay a prepayment penalty.
  • Get pre-qualified. Lenders will be more willing to lend you the money you need for your new home if you’re pre-qualified. It also gives you an idea of how much you can borrow.
  • If you have good credit, you can expect a better interest rate on your mortgage loan than if your credit is poor. Boost your credit before applying by paying off high-interest debt and making all of your payments on time.
  • Your credit score and debt-to-income ratio are the main factors that lenders look at when deciding whether to lend you the money on your mortgage. However, a stable income is also highly favored. So, if you’re considering changing jobs, wait until after you’ve applied for your mortgage.
  • Choose the best mortgage program for your long-term goals. Each program has pros and cons, so take a look at each program to see if you meet its qualifications.
  • Make sure you can meet the mortgage payments. If you fail to pay back your loan, you may lose your house, and your credit score will suffer. Understanding the total costs of your monthly payments is imperative when taking out a mortgage.
  • Make sure all other paperwork necessary to get your loan is in place and up-to-date.
  • Shop around for your mortgage. Banks and credit unions typically lend to first-time homebuyers with good credit, a stable job, and a low DTI. However, as the loan process is lengthy and complicated, online lenders and other financial institutions may have fewer restrictions and shorter approval times.
  • Don’t make large purchases before securing your loan. While you may be tempted to buy furniture for your new home, you should wait until your loan is signed. Lenders look at your recent credit as well as your credit history. You don’t want to give them leverage to say no.
Step 1: Find out if You Qualify for a Mortgage
Do you meet the minimum requirements of the loan you’re applying for?
  • The minimum requirements to qualify for a mortgage can be very different, whether you’re applying for an FHA, VA, Conventional, USDA, or another loan.


  • Conventional
  • The Debt-To-Income Ratio (DTI) required for most conventional loans is 43%, but some lenders will accept DTIs up to 50%. Your DTI is the percentage of your gross monthly income that makes the monthly payments on your debt

  • FHA
  • The higher your credit score, the lower your down payment on FHA loans. So, if your credit score is 580 or higher, you can qualify for a 3.5% down payment. But if your credit score is 500-579, you may need to put down 10%.
  • You’ll likely need to show at least two years of employment history, but there are no set income limits with an FHA loan. However, FHA loans do require mortgage insurance — annual and upfront. The yearly percentage is 0.85%, and the upfront fee is 1.75% of the loan amount.

  • VA
  • The minimum credit score to qualify for a VA loan varies from one lender to the next, but most lenders require a score between 580 to 620 or higher.
  • While you will also need two years of employment history, there are no income limits, and VA loans do not require mortgage insurance. Your DTI can be 50%, and you must use your home as your primary residence.

  • USDA
  • To qualify for a USDA loan, you must have at least two years of employment history and a minimum credit score of 620. Your mortgage must be for your primary residence.
  • Although USDA loans do not require a down payment, some lenders will require mortgage insurance. That said, these loans have the lowest mortgage insurance of any type of mortgage, at just 0.35%.
Step 2: Get Pre-Qualified and Pre-Approved for a Loan
A handy process to determine your capacity to borrow
  • Although not mandatory for getting a loan, getting pre-qualified and pre-approved can make securing a mortgage loan much easier.

  • Pre-qualification gives borrowers an idea of how much they can borrow. Lenders will look at your finances, employment history, and credit to provide you with an estimate of how much you can borrow and still make your monthly payments. It also shows lenders you are serious about your loan.

  • Pre-approval also means your lender has performed a thorough credit check and approved you, via a pre-approval letter, for your mortgage.
Step 3: Check Your Credit Score
Time to keep tabs on that all-important score
  • Does your credit score matter? In a word, yes. A good credit score, or FICO score, can mean the difference between getting a loan and not getting a loan. It can also mean you’ll qualify for a much better interest rate on your loan than if you have poor credit.

  • Lenders will pull your credit score from the big three credit unions — TransUnion, Equifax, and Experian — to determine if you will qualify for a loan. Although mortgage interest rates are low, you can get an even better rate if your credit score is above 720.

  • Let’s say your credit score is 760+ — you will qualify for an interest rate of 2.5%. On the other hand, if your credit score is between 620 and 639 (or poor), your interest rate may be 3.5%.

  • That extra 1% may not sound like a lot, but on a $350,000, 30-year mortgage (with a 20% down payment), it can mean the difference between a monthly payment of $1,389.67 (at 2.5% interest) and a payment of $1,540.66 (3.5% interest) per month.
Step 4: Select a Mortgage Program That’s Right for You
Hunt for a plan that closely aligns with your financial goals
  • There are dozens of mortgage programs, each with its own set of requirements to qualify. For first-time homebuyers, you have several options. Some require a solid credit score. Others do not. Some require mortgage insurance (which adds to your monthly payment), while others do not.

  • Conventional Loan
  • Conventional loans are offered by private lenders, banks, credit unions, and other lenders. To qualify, you will need a minimum credit score of about 640, a DTI ratio of less than 43%, no major credit problems, and a total loan amount of about $510,000 or less in most areas of the country ($765,000 in areas with higher-cost homes).
  • You will also need a down payment of 3% or more. If you don’t want mortgage insurance, you’ll need to put down 20% (more on that later).

  • VA Loan
  • VA loans are geared towards veterans, service members, and military families. These federally-backed loans have some distinct benefits over traditional or conventional loans.
  • If you can’t, or if you simply don’t want to put down a down payment, you don’t have to. If you qualify, you can finance 100% of the home's value. That’s $70,000 of savings over a 20% down payment on a $350,000 home.
  • Even with no down payment, you don’t need mortgage insurance. VA loans offer competitive interest rates, and if you pay off your mortgage early, there is no prepayment penalty.

  • FHA Loan
  • If you’re a first-time homebuyer with less than perfect credit — such as little or no credit history, a bankruptcy, or some other financial slip-up — you may qualify more quickly for an FHA mortgage loan than with other types of mortgages.
  • Plus, you don’t need a large down payment, and FHA loans typically have much lower interest rates than conventional loans.
  • However, there is a glaring downside — you will need to purchase mortgage insurance for the life of the loan. That can add to your monthly payments.

  • USDA Loan
  • A USDA (United States Department of Agriculture) loan is a type of mortgage for homebuyers thinking about buying a house in suburban or rural areas. Although most borrowers need mortgage insurance, eligible borrowers don’t need a down payment, and you get 100% financing and below-market mortgage interest rates.
  • There are several loans under the USDA program:
    • The single-family direct homeownership loan
    • The single-family guaranteed homeownership loan
    • The mutual self-help loan
    • The rural repair and rehabilitation loan or grant
  • You will need good credit to qualify, and not all homes are eligible.

  • Good Neighbor Next Door Program
  • The U.S. Department of Housing and Urban Development (HUD) has a program for homebuyers who can commit to living in their property for 36 months. Homes under this program are located in a he upside is that HUD offers an incentive — a discount of up to 50% off the list price of the home — to first-time homebuyers. Properties are only available for sale for seven days, and you revitalization area and are only for sale under the Good Neighbor Next Door program.
  • The upside is that HUD offers an incentive — a discount of up to 50% off the list price of the home — to first-time homebuyers. Properties are only available for sale for seven days, and you must meet the qualifications as a teacher, law enforcement officer, firefighter, or emergency medical technician and meet HUD's regulations for the program.

  • Energy Efficient Mortgage (EEM)
  • An EEM (Energy Efficient Mortgage) is a type of mortgage that first-time homebuyers can use to purchase a home that has been rated as energy efficient. Lenders can offer lower interest rates because they take into consideration the likelihood of lower utility bills. It is also sometimes easier to qualify for an EEM.
  • There are several EEM programs:
    • FHA Energy Efficient Mortgage Program
    • Conventional Energy Efficient Mortgage
    • VA Energy Efficient Mortgage
  • Each EEM program has different requirements to qualify, and not all homes or borrowers will meet all of the conditions.
  • Finding the best mortgages for first-time homebuyers has less to do with the mortgage and more to do with your credit, down payment, DTI, and other financial objectives.
  • How much can you afford in monthly payments? Do you have a substantial down payment? Do you have enough money in the bank to cover all the closing costs? Do you plan to stay in the home for a long time or less than five years?
  • Your short-term and long-term financial goals and how much you can afford in monthly payments are probably the two most important factors to consider when choosing a mortgage program.
Step 5: Find a Lender
Take your time to shop around for a lender that’s right for you
  • There are several great ways to find a reputable lender for your mortgage:
  • Online: One of the easiest ways to find a lender is online, where it’s possible to see real-time quotes from multiple lenders and even get pre-qualified online.
    Websites with reliable mortgage lender comparison tools to get you started:
  • Bank or credit union: If you have a relationship with a bank, you may qualify for your mortgage more easily. The process can take longer, but you can speak with a lender face-to-face, which many people prefer, especially if you’re buying your first home and have questions.
  • Real estate agent: Brokers and agents deal with financial institutions all the time, so they may know lenders who will work with you.
  • Financial planner: These experts maintain strong relationships with lenders. They may agree to recommending you to a lender, making the whole process much more manageable.
Step 6: Find Help for Your Down Payment
Make the most of being a first-time homebuyer by applying for down payment assistance programs
  • Coming up with a down payment can be challenging. Lucky for you, there are programs to help. Down payment assistance programs, in the form of grants, deferred-payment loans, zero-interest forgivable loans, and other types of assistance exist in most areas of the country.

  • As most of these programs only cover part of your down payment or closing costs, you will still need to come up with some of the money for your down payment.

  • Although there are exceptions, most of these programs are only available for first-time homebuyers.

  • Eligibility requirements depend on the program and may include:
    • Income and credit limits: You may need to have a low- to moderate-income and a credit score of at least 640.
    • Employment: Many programs, like the Good Neighbor Next Door program, are only available to first-time homebuyers in certain occupations, like teachers, first responders, and government or military employees.
    • Type of home: Most programs require that the home you purchase be your primary residence. Sometimes there will also be limits on the price of the house and where the home is located.
    • Continuing education: A few of these programs also require that homebuyers attend education programs that teach about financial responsibility or the mortgage process.
Step 7: Select the Right Mortgage Insurance for You
Remember, this type of insurance protects the lender — not your home
  • It’s not uncommon that first-time homebuyers with less than a 20% down payment will need mortgage insurance to qualify for a loan.

  • Mortgage insurance gives your lender the confidence to write you a loan. It also protects your lender if you default on your loan, and qualifies you for loans you may not otherwise qualify for. It only protects the lender. It is not insurance to cover your home. The downside is that it increases your monthly payments.

  • There are several mortgage insurance programs:

  • Conventional mortgages: If you put down less than 20% on a conventional loan, you will likely be required to purchase private mortgage insurance (PMI).

  • The cost of the insurance may be added to your monthly payment, or your lender will increase your interest rate to offset the risk of the loan.

  • You will have to continue paying your PMI until the balance of your mortgage reaches 80% or less of the value of your home.

  • You can pay your private mortgage insurance in several ways:
    • Pay the entire amount upfront
    • Pay half the amount upfront and half the amount added to your monthly payments
    • Add the insurance into monthly payments

  • FHA loan: If you decide on an FHA loan, you will pay mortgage insurance as an upfront mortgage premium and an annual mortgage premium. Your down payment amount doesn't matter. In some circumstances, you can cancel your mortgage insurance when your mortgage reaches 80% or less of the value of your home.

  • If you put less than 10% down, you will pay mortgage insurance for the entire term of your loan. If you put down more than 10%, your mortgage insurance can be removed after 11 years.

  • USDA loan: If you choose a USDA loan, you will pay mortgage insurance at closing and as part of your monthly payment. You can pay the upfront portion as part of your mortgage instead of paying it out of pocket.
Step 8: Find out if You Need a Second Mortgage
It may sound tempting, but make sure you’re aware of the risks involved
  • A second mortgage is just that — a second mortgage on your house. People take out second mortgages for several reasons: to fund a substantial purchase, make home improvements, or pay off a high-interest loan or other debt.

  • Like your first mortgage, the second mortgage is also secured by your home. If you fail to make payments on your loan, the bank (or lender) can foreclose on your home.

  • If that happens, your first mortgage will be paid off by the sale of your property. Any money left over from the sale will then go towards your second mortgage.

  • Home equity loans and home equity lines of credit are the two types of second mortgage loans. Home equity loans are paid as one lump sum, which you repay over a set period of time, and interest rates are fixed. Home equity lines of credit work like a credit card. You only pay interest on the amount you use and spend the money as you need it. Interest rates are adjustable.

  • The biggest downside to second mortgages is that they are secured by your home. Fail to repay your loan, and you risk losing your house. You’ll also pay closing costs and fees — between 3% and 6% — on your second mortgage, just like on your first mortgage.

  • Your credit score plays a part when securing a low interest rate. Most lenders won’t lend any more than between 75% to 85% of the loan-to-value ratio (the percentage of the property that is mortgaged) of both of your mortgages combined.
FAQs
  • How Much Home Can You Afford?
    This is where the pre-qualification and pre-approval process comes in. Although it may be tedious finding out what you can afford, doing this before contacting a real estate agent will keep you from looking at properties that may be far beyond your budget.

  • During the process, your lender will look at your salary, how much debt you currently have, your credit history, assets you own, your investments, and other factors to give you an estimate to ensure you don’t dive in blindly.

  • What Does Your Monthly Mortgage Payment Cover?
    Many first-time homebuyers don’t know what their monthly payment covers and what it doesn’t. Most monthly payments cover the principal amount of your loan and interest, homeowners insurance, property taxes (unless paid separately), and private mortgage insurance (if applicable). Your monthly payment doesn’t cover things like utilities, internet, cable, homeowners association (HOA) fees, and other items.

  • What Happens During the Closing Process?
    Once you and the seller agree on a price for a home, you enter the closing process. Closing can take from 30 to 60 days, sometimes longer depending on the home inspection and underwriting process.

  • During this time, the real estate agent, broker, or your lender will write up a purchase agreement, which you and the seller will sign when you meet.

  • Appraisals, inspections, and review of all other financial documents are also finalized, and any problems that come up during the inspection are addressed.

  • How Much Money Do You Need for a Down Payment?
    While some mortgage programs (like a VA loan) don’t require a down payment, most programs do.

  • The amount you need to put down usually depends on the price of the home and mortgage terms. Lenders typically offer options based on your finances, and sometimes you’ll only need 3% to 5% as a down payment.

  • However, many mortgages will require the standard 20% down payment. If you’re unable to come up with that payment, you will likely be asked to add private mortgage insurance, which will add to your monthly payment.

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