Real Estate Buying & Investing
First Time Homeownership
Every homeowner was a first-time buyer at some point. It can seem impossible that a huge asset like a home is possible to purchase when you’re just getting started, but there are plenty of good loan programs out there to help you succeed. When you’re ready to buy, knowing what is available to you before you begin could mean access to more with better benefits.
Lenders recognize that first-time buyers are often just getting on their feet financially, so these loans are designed to make your purchase possible. These programs vary depending on where you live and what’s available to you, but the general idea is to provide financial help to qualified buyers who have a strong enough credit score and fall within income restrictions. These loans often come with safeguards to protect your first investment and often have features like easier approval and down payment assistance.
It is a good idea to be familiar with what each program offers, including rebates, tax benefits, ways to fund your down payment, and the minimum amount required upfront. Knowing the pros and cons of, let’s say, fix or floating interest rates, can help you keep more money for making your new house feel like home. Knowing what a traditional loan offers compared to other alternatives can empower you to feel confident in your first home purchase.
Understanding Fixed-Rate vs. Floating-Rate Mortgages
Another consideration is whether to obtain a fixed-rate or floating-rate mortgage. In a fixed-rate mortgage, the rate does not change for the entire period of the loan. The obvious benefit of getting a fixed-rate loan is that you know what the monthly loan costs will be for the entire loan period. And, if prevailing interest rates are low, you’ve locked in a good rate for a substantial time.
A floating-rate mortgage, such as an interest-only mortgage or an adjustable-rate mortgage, is designed to assist first-time homebuyers or people who expect their incomes to rise substantially over the loan period. Floating-rate loans usually allow you to obtain lower introductory rates during the initial few years of the loan, and this allows you to qualify for more money than if you had tried to get a more expensive fixed-rate loan. Of course, this option can be risky if your income does not grow in step with the increase in interest rate. The other downside is that the path of market interest rates is uncertain: If they dramatically rise, your loan’s terms will skyrocket with them.
The most common types of adjustable-rate mortgage (ARM) are for one-, five-, or seven-year periods. The initial interest rate is normally fixed for a period of time and then resets periodically, often every month. Once an ARM resets, it adjusts to the market rate, usually by adding some predetermined percentage to the prevailing U.S. Treasury rate. Although the increase is typically capped, an ARM adjustment can be more expensive than the prevailing fixed-rate mortgage loan to compensate the lender for offering a lower rate during the introductory period.
Interest-only loans are a type of ARM in which you only pay mortgage interest and not principal during the introductory period until the loan reverts to a fixed, principal-paying loan. Such loans can be helpful for first-time borrowers because only paying interest significantly decreases the monthly cost of borrowing and will allow you to qualify for a much larger loan. However, because you pay no principal during the initial period, the balance due on the loan does not change until you begin to repay the principal.
Equity and Income Requirements
When getting a first-time homeownership loan, it is important to understand mortgage loan pricing is determined by the lender and is based on the creditworthiness of the borrower. This can be tricky if you’ve never owned property before. In addition to checking your credit score, lenders will calculate the loan-to-value ratio and the debt-service coverage ratio to determine the amount, they’re willing to loan to you, plus the interest rate.
Your loan-to-value ratio is the amount of actual or implied equity that is available in the collateral being borrowed against. For home purchases, this is determined by dividing the loan amount by the purchase price of the home. Lenders assume that the more money you put in the form of a down payment, the less likely you are to default on the loan. The higher the loan-to-value ratio, the greater the risk of default, so lenders will charge more.
Your debt-service coverage ratio determines your ability to pay the mortgage. Lenders divide your monthly net income by the mortgage costs to assess the probability that you will default on the mortgage. Most lenders will require a debt-service coverage ratio of greater than one. The greater the ratio, the greater the probability that you will be able to cover borrowing costs and the less risk the lender assumes.
Private Mortgage Insurance
Your loan-to-value ratio also determines whether you will be required to purchase private mortgage insurance. This insurance helps to protect the lender from default by transferring a portion of the loan risk to a mortgage insurer. Most lenders require private mortgage insurance for any loan with a low down payment. The amount being insured, and the mortgage program, will determine the cost of mortgage insurance and how it is collected.
Most mortgage insurance premiums are collected monthly, along with tax and property insurance escrows. Once you loan-to-value ratio is equal to or less than seventy-eight percent, your private mortgage insurance is supposed to be eliminated automatically. As a rule of thumb, try to avoid private mortgage insurance because it is a cost that has no benefit to you.
Conventional loans are mortgages that are not insured or guaranteed by the federal government. They are typically fixed-rate mortgages. They are some of the most difficult types of mortgages to qualify for because of their stricter requirements. These include a bigger down payment, higher credit score, lower income-to-debt ratios and the potential for a private mortgage insurance requirement. However, if you can qualify for a conventional mortgage, they are usually less costly than loans that are guaranteed by the federal government.
Conventional loans are defined as either conforming loans or nonconforming loans. Conforming loans comply with guidelines, such as the loan limits set forth by government-sponsored enterprises Fannie Mae and Freddie Mac. These lenders, and others, often buy and package these loans, then sell them as securities on the secondary market. However, loans that are sold on the secondary market must meet specific guidelines to be classified as conforming loans. For nonconforming loans, the lending institution underwriting the loan, usually a portfolio lender, sets its own guidelines. Due to regulations, nonconforming loans cannot be sold on the secondary market.
Federal Housing Administration Loans
The Federal Housing Administration (FHA), part of the U.S. Department of Housing and Urban Development, provides various mortgage loan programs for Americans. An FHA loan has lower down payment requirements and is easier to qualify for than a conventional loan. FHA loans are great for first-time homebuyers because, in addition to lower upfront loan costs and less rigid credit requirements, you can come with a low down payment.
All FHA borrowers must pay a mortgage insurance premium, rolled into their mortgage payments. Mortgage insurance is an insurance policy that protects a mortgage lender or titleholder if the borrower defaults on payments or is otherwise unable to meet the contractual obligations of the mortgage.
Veterans Affairs Loans
The U.S. Department of Veterans Affairs guarantees Veterans Affairs loans. Veterans Affairs does not make loans itself, but guarantees mortgages made by qualified lenders. These guarantees allow veterans to obtain home loans with favorable terms and usually without a down payment.
Veterans Affairs loans are normally easier to qualify for than conventional loans. Lenders generally limit the maximum Veterans Affairs loan to conventional mortgage loan limits. Before applying for a loan, you’ll need to request your eligibility from Veterans Affairs. If you are accepted, they will issue a certificate of eligibility you can use to apply for a loan. In addition to these federal loan types and programs, state and local governments and agencies sponsor assistance programs to increase investment or homeownership in certain areas.