4 Great Loans for First-Time Homebuyers
Young people want to become homeowners. While certain conventional wisdom holds that the up-and-coming generation prefers to be renters, numerous studies show that Millennials are just as keen to own their own place as previous generations were.
What's lacking, though, is that many simply don't believe they can qualify for a mortgage, due to credit or down payment concerns. Many also believe they can't afford a mortgage payment, even though rents in many parts of the country equal or exceed the monthly payment for an equivalent-sized home.
Fortunately, there are a number of mortgage options out there that are geared toward first-time homebuyers. Often, they can be easier to qualify for than a potential first-time buyer might think.
Here's a look at the four major ones.
FHA: The traditional mortgage for 1st-time homebuyers
FHA home loans are the classic mortgage type for first-time homebuyers. But don't assume that's just because of their low down-payment requirements - as little as 3.5 percent of the purchase price. They've also got a number of other features that make them an attractive choice for someone buying their first home.
It's not just the down payment requirements that are low on FHA home loans - your credit score can be relatively low as well. The FHA will approve loans for borrowers with FICO credit scores as low as 580 - and that isn't even the absolute minimum. That's as low as you can go with 3.5 percent down - borrowers can be approved with even lower scores if they're willing to put down 10 percent or more.
It should be noted that individual lenders may have credit score requirements that are stricter than the FHA's - some may require a minimum score of 620, for example. So if you have a credit score in that range, you may need to do some shopping around to find an FHA lender who'll approve you.
But that's not the only advantage FHA loans offer for borrowers with less-than-ideal credit. The FHA doesn't use risk-based pricing, so you're not penalized for a lower credit score by having to pay a higher mortgage rate. On conforming loans, those backed by Fannie Mae or Freddie Mac, the mortgage rate you pay increases with lower scores - to the point where so someone with a score in the mid-to-lower 600s can easily pay a rate a full percentage point or higher than someone with a "perfect" credit score of 760 or above.
Again, individual FHA lenders may charge their own rate add-ons for very low scores, particularly those under 620, but you'll still likely end up with a lower rate than you could get on a conforming loan.
Another potential benefit for first-time homebuyers is the FHA 203(k) loan, known as the "fixer-upper" mortgage. This type of mortgage not only provides the money to buy a home, but also allows up to a certain amount toward necessary repairs or improvements that will enhance the value of the property. The amount you can borrow is based on the anticipated increase in the property's value after the improvements. Since first-time buyers are often looking at older homes, this can be a real advantage.
On the downside, mortgage insurance premiums - paid on loans with less than 20 percent down - tend to be higher on FHA mortgages than on conforming loans, particularly if you have good credit. And if you put less than 10 percent down on an FHA mortgage, you have to carry mortgage insurance for the life of the loan, rather than being able to eventually cancel it, as you can with Fannie Mae/Freddie Mac mortgages. Still, with mortgage rates as low as they are, that could still be a pretty good deal over the long term, should mortgage rates return to their historic norms.
Conforming loans: Don't assume you can't
You may not think of conforming loans - mortgages backed by Fannie Mae and Freddie Mac -as loans that are particularly suited for first-time homebuyers. But if you've got decent credit - and most people do, despite the lingering effects of the Great Recession - there's absolutely no reason you shouldn't consider a standard conforming loan.
The majority of home mortgages originated in the United States are conforming loans backed by Fannie Mae or Freddie Mac. Fannie and Freddie don't actually issue mortgages themselves but provide a type of guarantee that makes it easier for these loans to be bundled and sold to investors, which in turn helps keep rates low.
While the FHA has long been known for its low down payments, Fannie and Freddie recently did it a bit better by beginning to approve mortgages with as little as 3 percent down. While not all Fannie/Freddie lenders are offering those loans, other loan programs with as little as 5 and 10 percent down are available to borrowers with good credit.
As a rule of thumb, Fannie/Freddie loans tend to be a better deal than FHA mortgages for borrowers with credit scores above 700; the cost of mortgage insurance tends to be cheaper and you can cancel it once you reach 20 percent equity in the home. Below 700, though, the risk-based pricing starts driving up the mortgage rates and the FHA loans start looking better.
VA loans: For those who've served
If you're a veteran or active-duty member of the military, a VA loan should be your first choice, hands-down. They not only offer very attractive mortgage rates, but for most first-time homebuyers, there's no need for a down payment as well (unless you're buying a fairly expensive home).
There's also no need for mortgage insurance on VA loans, because the VA picks up the tab by guaranteeing a portion of the mortgage. That's also why there's no need for a down payment on most loans.
Once you have the loan, the VA also offers streamlined refinancing, which lets you easily take advantage of lower interest rates should the opportunity arise a few years down the road.
VA loans aren't just for veterans or active-duty military, either. Other borrowers with certain types of military affiliations can qualify as well, including widows/widowers of veterans; members of the National Guard or Reserve with either six years of service or 90 days of active duty; cadets/midshipmen at the service academies, and those serving with certain organizations, such as Public Health Service officers and officers of the National Oceanic and Atmospheric Administration.
USDA loans: Often overlooked
It's amazing how many people have never heard of USDA home loans, considering the incredible value they offer. Officially called USDA Rural Development Loans, these offer a way for persons of modest means to become homeowners.
Like their VA counterpart, USDA loans require no down payment or mortgage insurance - as well as excellent rates. Unlike VA loans, they're available to the civilian population.
While technically limited to buying homes in rural areas, the definition of "rural" is fairly broad - for these loans, it basically means "non-urban," so properties in many small towns and suburbs can qualify as well.
There are income limits for USDA loans - to be eligible, you generally can earn no more than 115 percent of the local median income, adjusted for family size. You also have to be currently without adequate housing, which can refer to either the condition or size of your current home.
Not all lenders offer USDA loans, so you'll want to check with your state or local USDA Rural Development Office to get the names of participating lenders in your area. Funding for the program is limited and there's often a waiting list, so you may not be able to get approved right away. But if you meet the program's criteria, it can be worth the wait.