Buying your first home can seem like the financial equivalent of climbing a mountain or embarking on some other type of intimidating journey. To be successful, you will need to prepare and understand the lay of the land. It won’t be easy and you may have to weather a few storms along the way. But once you reach the top, all your hard work will have paid off and you will have reached an impressive milestone.
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In this article, we’ll focus on one of the most important parts of your planning: understanding the types of mortgages available to first-time homebuyers. You should familiarize yourself with these options so that you can choose which one is best for you. There are two main contenders that tend to be a better fit, but we’ll also look at some additional options.
Conventional Mortgage
Basic Summary: This is a standard loan offered through private (non-governmental) entities. These loans are sometimes called Fannie and Freddie loans because they are usually backed by Freddie Mac and Fannie Mae. That will not affect you on a day-to-day basis, but it is good to keep it in mind. for example, the forbearance measure in the CARES Act applied to loans backed by Fannie and Freddie, among other types of loans.
Conventional mortgages include “conforming” loans, which adhere to Fannie Mae and Freddie Mac guidelines. As a general rule, a conforming loan cannot exceed $510,400. However, a nonconforming loan that exceeds this limit, called a jumbo loan, is still considered “conventional.” First-time homebuyers shouldn’t look for a jumbo loan in most cases.
Best Features: Conventional loan can provide the lowest interest rate available to borrowers with good credit. These loans also do not require Private Mortgage Insurance (PMI) premiums, except when a borrower makes a down payment of less than 20 percent. Even then, you can dump PMI when you hit 20 percent equity.
Qualifying first-time homebuyers can get a conventional loan with a relatively small down payment, as low as three percent (this is called an “LTV 97 loan”).
Also, some sellers may look more favorably on buyers with conventional loans. Sellers may think these loans are more likely to close on time.
Biggest drawbacks: Good credit is required to get a conventional loan and excellent credit is required to get the best interest rates. Debt-to-income requirements are also stricter than other loans. Borrowers must make a 20 percent down payment, otherwise they will be subject to private mortgage insurance, which is an additional monthly cost. Please note that some state programs may provide relief for PMI.
Best for you if: This type of loan is best if you have a very strong credit score. If your score is not in the 700s, you may be better off with an FHA loan. Even with unavoidable mortgage insurance, the FHA loan may be cheaper. But with strong credit, the conventional mortgage is probably the best. It’s a solid option with any down payment amount of three percent or more.
FHA loan
Basic Summary: FHA loans get their name because they are insured by the Federal Housing Administration (FHA). These mortgages are incredibly popular with first-time homebuyers and offer more leeway than conventional mortgages.
An FHA loan requires a minimum credit score of 500. However, if your score is between 500 and 579, you will need to make a 10 percent down payment. If it’s 580 or higher, you can make a down payment of as little as 3.5 percent of the purchase price.
All FHA loans require you to pay Mortgage Insurance Premiums (MIP). It will pay for insurance for a period of 11 years or the life of the loan, depending on the loan-to-value ratio and the loan period. This includes an annual mortgage payment (actually paid monthly) and an advance mortgage payment, although the advance payment may be included in the loan.
There are five types of FHA loans that can be useful for various situations. We are focusing primarily on the traditional mortgage, which makes it easy to compare with a conventional mortgage. However, you may want to familiarize yourself with the other options, including the FHA 203(k) loan, also called a renovation loan or construction loan. This type of loan can help you finance major repairs or renovations in the same loan as your home purchase.
Best features: FHA loans are affordable for borrowers with less than stellar credit. You can make a down payment as low as 3.5 percent. There are several types of FHA loans that could be even more helpful, depending on your circumstances.
Biggest drawbacks: The terms of FHA loans may not be as good as those of a conventional mortgage, so if you qualify for a conventional mortgage, you’ll want to consider your decision very carefully. You can’t avoid mortgage insurance and you may have to pay for it over the life of the loan.
Best for you if: The FHA loan may be a good option for you if you have a credit score that doesn’t qualify you for the best conventional loan rates, or if you have significant debt but still want to buy a home now ( the FHA loan has a more relaxed DTI ratio). requirements).
Honorable Mentions: VA and USDA Loans
Conventional mortgages and FHA loans are the two top contenders when it comes to financing options for your first home. However, there are a couple of other options that you should at least consider should you qualify:
1) USDA loans
This US Department of Agriculture program helps homebuyers buy in approved rural areas. No down payment required. However, there are restrictions. First, you can only buy under this program in a USDA-approved area. Second, there are also income restrictions, which means that if you make too much money, you won’t qualify. Credit score requirements are not stringent, making this a potentially solid option for homebuyers looking for homes in rural areas.
2) VA Loans
These loans are backed by the Department of Veterans Affairs and are available to active duty military, veterans, and some military spouses. No down payment required. Borrowers must pay a financing fee, although it may be included in the mortgage.
Also consider other programs
We’ve discussed some of the most popular types of mortgages that may be available to you as a first-time homebuyer. In addition to deciding which loan to apply for, you may also want to consider homebuyer programs that offer help to first-time buyers. Here are a few to consider:
state programs. Your state may have resources for first-time homebuyers. These could include down payment assistance programs, programs for reduced or waived PMI, and others. Check out this database of state programs maintained by NerdWallet.
HUD Next Door Neighbor Program. This special HUD program encourages “law enforcement officers, firefighters, EMTs, and teachers” to buy homes in “revitalization areas” by offering a fifty percent discount on the price. see the neighbor next door
Home Ready and Home Possible. We already mentioned conventional loans that allow a three percent down payment. But you can read about the formal programs that make it possible, along with new programs that may be on the horizon.