Securing a mortgage is a crucial step for first-time homebuyers. However, choosing a suitable home loan option depends on various factors. Choosing from a wide range of financing options can be difficult for first-time buyers, so learning mortgage basics is essential for saving time and money.
What is a Mortgage?
A mortgage, or mortgage loan, is an agreement between borrowers and a mortgage lender to purchase or refinance a home with money the lender provides, given the borrower will pay the money back over some time.
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 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:
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 Fannie Mae and Freddie Mac set. Conforming loan lenders often package and sell the loans as securities on the secondary market. However, these mortgages must meet tight regulations to qualify for this use.
Non-Conforming Home Loans
With non-conforming home loans, the lender can set the guidelines. However, these loans cannot be sold to Fannie Mae or Freddie Mac on the secondary market.
FHA Home Loans
Federal Housing Administration (FHA) loans offer many 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. Lenders generally 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 buyer’s 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 home’s purchase amount. 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. Lenders generally like a 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 requiring mortgage insurance, 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 loan term. 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 take advantage of rates that periodically change in certain circumstances.
These loans allow borrowers to access low introductory rates during the loan’s early years. Additionally, this can enable borrowers to qualify for a larger loan than a fixed-rate mortgage.
The downside occurs when interest rates rise, resulting in higher monthly payments.
The available mortgage financing options can often be overwhelming for first-time homebuyers. However, understanding your financial situation can help you choose the best mortgage.
While taking the most significant loan offered is tempting, 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 anytime.
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.
Updated on January 26, 2023