Securing a mortgage is a crucial step for first-time homebuyers. However, choosing a suitable home loan option depends on a variety of factors. Choosing from the wide range of financing options can be difficult for first-time buyers, so learning mortgage basics is essential for saving time and money.
Mortgage Basics: Loan Types
There are three main types of home loans available to first-time homebuyers.
Conventional Home Loans
Conventional home loans are mortgages that are not guaranteed or insured by the federal government. The most popular conventional loans are fixed-rate mortgages.
These loans are harder to qualify for because they have strict criteria, such as:
- Higher down payments.
- Higher credit scores.
- Lower debt-to-income ratio.
The advantage of these mortgages is that they have lower costs when compared to federally guaranteed loans.
There are two types of conventional loans: conforming and non-conforming.
Conforming Home Loans
Conforming home loans comply with loan limit guidelines set by Fannie Mae and Freddie Mac. Conforming loan lenders often package and sell the loans as securities on the secondary market. However, to qualify for this use, these mortgages must meet tight regulations.
Non-Conforming Home Loans
With non-conforming home loans, the lender can set the guidelines. However, these loans cannot be sold on the secondary market to Fannie Mae or Freddie Mac.
FHA Home Loans
Federal Housing Administration (FHA) loans offer a wide range of loan options for first-time homebuyers. In addition, FHA loans are easier to qualify for and require lower down payments. Lower upfront costs, lower credit score requirements, and down payments of 3.5% make FHA loans attractive for first-time homebuyers.
FHA loan terms require borrowers to pay for mortgage insurance, which protects the lender in case of default, death, or inability to meet the mortgage’s contractual obligations.
VA Home Loans
VA home loans are guaranteed by the U.S. Department of Veterans Affairs (VA). While the VA does not make loans, they guarantee mortgages made by qualified lenders.
VA loans are generally easier to qualify for than conventional home loans. Additionally, they often do not require a down payment. In general, lenders limit the maximum VA loan to conventional mortgage loan limits.
Mortgage Basics: Income Requirements
Lenders price home mortgages in different ways, based on the evaluations of the borrower’s creditworthiness.
Lenders check first-time buyers eligibility against their:
- FICO score.
- Loan-to-value ratio (LTV).
- Debt-to-income ratio (DTI).
A FICO score is a credit score.
LTV is calculated by dividing the loan amount by the purchase amount of the home. A higher down payment means a lower LTV ratio. Lenders prefer a lower LTV ratio and will charge less for these loans.
DTI is one of the determining factors when qualifying for a mortgage. In general, lenders like the debt-to-income ratio lower than 36%, with no more than 28% of debt for a mortgage or rent. However, some borrowers may qualify for a mortgage with a DTI ratio as high as 43%.
Mortgage Basics: Mortgage Insurance
The LTV ratio dictates whether first-time buyers need to buy mortgage insurance, which mitigates the risk of default for lenders.
Typically, lenders require mortgage insurance for loans with an LTV ratio greater than 80%. For most borrowers, this means paying a 20% down payment to avoid mortgage insurance.
If you get a mortgage that requires you to have mortgage insurance, be sure to understand the circumstances under which the insurance is removed. For example, mortgage insurance with some loans automatically drops off at a specified level; however, other mortgages require you to refinance to remove mortgage insurance.
Mortgage Basics: Mortgage Rates
First-time homebuyers should also consider whether to get a fixed-rate or floating-rate mortgage.
With fixed-rate mortgages, the interest rate and mortgage payments stay the same for the entire term of the loan. Additionally, it can be beneficial to lock in a reasonable rate while mortgage rates are low.
Floating-rate mortgages, such as an adjustable-rate mortgage (ARM), are designed to help homebuyers in certain circumstances take advantage of rates that periodically change.
These loans allow borrowers to access low introductory rates during the early years of the loan. Additionally, this can enable borrowers to qualify for a larger loan compared to a fixed-rate mortgage.
The downside occurs when interest rates rise, resulting in higher monthly payments.
All of the available mortgage financing options can often be overwhelming for first-time homebuyers. However, understanding your current financial situation can help you choose the best mortgage.
While it is tempting to take the largest loan offered, it can lead to some lenders requiring higher rates and private mortgage insurance. In addition, it is essential to remember that floating interest rates can increase at any time.
Marimark Mortgage is based in Tampa, Florida, and serves the mortgage needs of homebuyers, homeowners, and investors in Florida, Virginia, and Pennsylvania.
We specialize in mortgages for first-time homebuyers, conventional home mortgages, refinance loans, reverse mortgages, and FHA, VA, and USDA mortgage options. In addition, we’ve worked extensively with cash-out refinancing and help clients to lower their monthly mortgage payments.