Obtaining a mortgage is a crucial step in purchasing your first home, and there are several factors for choosing the most appropriate one. While the myriad of financing options available for first-time homebuyers can seem overwhelming, taking the time to research the basics of property financing can save you a significant amount of time and money.
Best Mortgage Lenders for First Time Buyers
Understanding the market where the property is located, and whether it offers incentives to lenders, may mean added financial perks for you. And by taking a close look at your finances, you can ensure you are getting the mortgage that best suits your needs. This article outlines some of the important details first-time homebuyers need to make their big purchase.
Key Takeaways
- Obtaining a mortgage is a crucial step in purchasing your first home and there are several factors for choosing the best one.
- Lenders will evaluate your creditworthiness and your ability to repay based on your income, assets, debts, and credit history.
- As you choose a mortgage, you'll have to decide between a fixed or floating rate, the number of years to pay off your mortgage, and the size of your down payment.
- Conventional loans are mortgages that the government does not insure.
- Depending on your circumstances, you may be eligible for more favorable terms through an FHA, VA, or other government-guaranteed loan.
Loan Types
Conventional Loans
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—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 (GSEs) Fannie Mae and Freddie Mac. These lenders (and various 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 in order to be classified as conforming loans.
The maximum conforming loan limit for a conventional mortgage in 2021 is $548,250, although it can be more for designated high-cost areas.1 A loan made above this amount is called a jumbo loan, which usually carries a slightly higher interest rate. These loans carry more risk (since they involve more money), making them less attractive to the secondary market.2
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 (FHA) Loans
The Federal Housing Administration (FHA), part of the U.S. Department of Housing and Urban Development (HUD), 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 excellent for first-time homebuyers because, in addition to lower upfront loan costs and less stringent credit requirements, you can make a down payment as low as 3.5%.3 FHA loans cannot exceed the statutory limits described above.
However, 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, passes away, or is otherwise unable to meet the contractual obligations of the mortgage.
VA Loans
The U.S. Department of Veterans Affairs (VA) guarantees VA loans. The VA does not make loans itself, but guarantees mortgages made by qualified lenders. These guarantees allow veterans to obtain home loans with favorable terms (usually without a down payment).4
In most cases, VA loans are easier to qualify for than conventional loans. Lenders generally limit the maximum VA loan to conventional mortgage loan limits. Before applying for a loan, you'll need to request your eligibility from the VA. If you are accepted, the VA will issue a certificate of eligibility you can use to apply for a loan.4
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.
Equity and Income Requirements
Home mortgage loan pricing is determined by the lender in two ways—both methods are based on the creditworthiness of the borrower. In addition to checking your FICO score from the three major credit bureaus, lenders will calculate the loan-to-value ratio (LTV) and the debt-service coverage ratio (DSCR) in order to determine the amount they're willing to loan to you, plus the interest rate.5
LTV is the amount of actual or implied equity that is available in the collateral being borrowed against. For home purchases, LTV is determined by dividing the loan amount by the purchase price of the home. Lenders assume that the more money you are putting up (in the form of a down payment), the less likely you are to default on the loan. The higher the LTV, the greater the risk of default, so lenders will charge more.
The DSCR 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 DSCRs 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. The greater the DSCR, the more likely a lender will negotiate the loan rate; even at a lower rate, the lender receives a better risk-adjusted return.
For this reason, you should include any type of qualifying income you can when negotiating with a mortgage lender. Sometimes an extra part-time job or other income-generating business can make the difference between qualifying or not qualifying for a loan, or receiving the best possible rate.
Private Mortgage Insurance (PMI)
LTV also determines whether you will be required to purchase private mortgage insurance (PMI). PMI helps to insulate the lender from default by transferring a portion of the loan risk to a mortgage insurer. Most lenders require PMI for any loan with an LTV greater than 80%. This translates to any loan where you own less than 20% equity in the home.7 The amount being insured and the mortgage program will determine the cost of mortgage insurance and how it's collected.
Most mortgage insurance premiums are collected monthly, along with tax and property insurance escrows. Once LTV is equal to or less than 78%, PMI is supposed to be eliminated automatically.8 You may also be able to cancel PMI once the home has appreciated enough in value to give you 20% equity and a set period has passed, such as two years.
Some lenders, such as the FHA, will assess the mortgage insurance as a lump sum and capitalize it into the loan amount.
There are ways to avoid paying for PMI. One is not to borrow more than 80% of the property value when purchasing a home; the other is to use home equity financing or a second mortgage to put down more than 20%. The most common program is called an 80-10-10 mortgage. The 80 stands for the LTV of the first mortgage, the first 10 stands for the LTV of the second mortgage, while the second 10 represents the equity you have in the home.9
Although the rate on the second mortgage will be higher than the rate on the first, on a blended basis, it should not be much higher than the rate of a 90% LTV loan. An 80-10-10 mortgage can be less expensive than paying for PMI. It also allows you to accelerate the payment of the second mortgage and eliminate that portion of the debt quickly so you can pay off your home early.
Fixed-Rate Mortgages vs. Floating-Rate Mortgages
Another consideration is whether to obtain a fixed-rate or floating-rate (also called a variable-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 (ARM), 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.
How Adjustable-Rate Mortgages (ARMs) Work
The most common types of ARMs are for one-, five-, or seven-year periods.10 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 spread (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 very advantageous 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.
The Bottom Line
If you're looking for a home mortgage for the first time, you may find it difficult to sort through all the financing options. Take time to decide how much home you can actually afford and then finance accordingly. If you can afford to put a substantial amount down or have enough income to create a low LTV, you will have more negotiating power with lenders and the most financing options. If you push for the largest loan, you may be offered a higher risk-adjusted rate and private mortgage insurance.
Weigh the benefit of obtaining a larger loan with the risk. Interest rates typically float during the interest-only period and will often adjust in reaction to changes in market interest rates. Also, consider the risk that your disposable income won't rise along with the possible increase in borrowing costs.
A good mortgage broker or mortgage banker should be able to help steer you through all the different programs and options, but nothing will serve you better than knowing your priorities for a mortgage loan.
First-time homebuyers often face many challenges when it comes to buying a home. Because they don’t have the advantage of equity from a former home sale, their down payments are often smaller than people who have already bought and sold homes.
Also, first-time buyers tend to be younger, so they might not have a long credit history, which can translate into a lower credit score. This means finding loans and lenders that meet their financial needs is important.
Loan products like FHA, VA and USDA loans can be great options as they require lower down payments and minimum credit scores. Be aware, however, that you might have to shop around for a lender that is knowledgeable and can work with you if you have a limited budget or other challenges that might otherwise hinder the approval process.
Forbes Advisor compiled a list of lenders that excel in various areas, such as offering low down-payment mortgages or specialty loans for first-time borrowers.
Tips for Comparing Lenders for First-Time Homebuyers
First-time homebuyers often face two major roadblocks to getting a mortgage: their credit score and their lack of cash to make a large down payment. If this sounds like you, you’ll want to shop around for a lender that has low credit score minimum requirements and low down-payment options.
Before you apply, find out what your credit score is and get an estimate of your down payment based on how much you plan on spending on a home. These are two important factors lenders will look at when deciding:
Whether you qualify for a mortgage
If you do qualify, what your interest rate will be, Most mortgage lenders look for a credit score around 620, so if yours is below that you will have to do some digging. Although some loans, like VA loans, have no minimum credit score requirements, lenders will apply something called a credit overlay to create a credit score minimum that makes sense for their risk tolerance.
Apart from popular mortgage products for first-time buyers like FHA loans, many lenders have specialty loans that cater to first-time buyers. When you’re shopping for lenders, start at your own financial institution. Ask them if they have any loans that meet your needs. They might even offer customer discounts.
If you don’t get approved for a loan right away, loan officers often will work with you to get on track to qualify. It might be as simple as raising your credit score, paying down some debt or squirreling a little more away for a down payment.
Methodology
Forbes Advisor reviewed 12 mortgage lenders that do business both online and in-person throughout the United States. The lenders we reviewed represent some of the largest mortgage lenders by volume, which include banks, credit unions and online lenders.
Our scoring methodology included capturing more than 10 data points, which covered interest rates, lender fees, loan types, discounts, accessibility and borrower requirements.
The best lenders for first-time homebuyers excelled in areas that are historically important for this group including low- to average-credit score requirements, low down payment options and availability of grant programs.
The following is the weighting assigned to each category:
- Loan costs: 30%
- Speed: 20%
- Credit requirements: 20%
- Loan types offered: 20%
- Access and availability: 10%
Specific characteristics taken into consideration within each category include APR, average interest rate, origination fees, minimum credit score requirements, discounts and customer service availability.
Why is my credit score important?
Your credit score is not only important for qualifying for a mortgage, but it’s also the key to getting a lower interest rate. The better your credit score, the lower your interest rate will be, which can save you quite a lot of money.
Consider that a borrower with a $300,000, 30-year mortgage with a 3% interest rate will pay $29,635.90 less over the life of the loan than a borrower who has a 3.5% rate. On a monthly basis (excluding taxes, insurance and other homeownership fees) that’s $82 in savings.
How much house can I afford?
The first step in the homebuying process is to make a budget. First, consider how much you bring in each month and how much you spend (on debt, savings, retirement, college funds, etc.). Most experts recommend spending no more than 30% of your gross monthly income on your mortgage, including taxes, insurance and applicable HOA fees. The Forbes Advisor affordability calculator will help you take the guesswork out of how much you can spend on a house.
What is mortgage insurance?
Private mortgage insurance (PMI) protects the lender in the event that you default on your mortgage. Typically, if you make a down payment of less than 20% of your home’s purchase price, you will incur PMI. How much you’ll pay for this insurance will vary, depending on factors that include the size of your down payment and your credit score.
How do I get preapproved for a mortgage?
Mortgage preapproval represents a lender’s offer to loan the buyer money based on certain financial circumstances and specific terms. Start by gathering documents your lender will need, including a copy of your Social Security card and recent W-2 forms, pay stubs, bank statements and tax returns. The lender you select will then guide you through the preapproval process.
How much money do I need for a down payment?
The larger the down payment you are able to make, the less you’ll have to finance when you purchase a home. On a conventional mortgage, making a down payment of at least 20% will prevent you from having to pay for private mortgage insurance. The minimum down payment required varies based on the type of mortgage you obtain. In 2019, the median down payment for first-time buyers was 6%.
Which loan is best for first time home buyers?
FHA loans
FHA loans are excellent for first-time homebuyers because, in addition to lower upfront loan costs and less stringent credit requirements, you can make a down payment as low as 3.5%. 3 FHA loans cannot exceed the statutory limits described above.
What benefits do first-time home buyers get?
First-time buying assistance can include help with down payments and closing costs, tax credits or education. You might be able to get help from your local, state or federal government if you meet income standards. Charities, nonprofits and employer programs are also available
How do you buy a house with no money down?
There are currently two types of government-sponsored loans that allow you to buy a home without a down payment: USDA loans and VA loans. Each loan has a very specific set of criteria you need to meet in order to qualify for a zero-down mortgage.
Is it better to get a mortgage from a bank or lender?
There are some specific advantages to using a mortgage company for your loan. First, they probably have access to a wider range of loan products than does a full service bank. ... Because these companies only service mortgage loans, they can streamline their process much better than a bank.
Do first-time home buyers get a discount?
Though it's not strictly limited to first-time homebuyers, the Good Neighbor Next Door program from the Department of Housing and Urban Development (HUD) can help you save up to 50% off the list price of a home.
Which bank is best for mortgage?
Banks with the best mortgage rates
Big names you might find in best buy tables if you want a fixed-rate mortgage include Barclays, Nationwide, NatWest, Royal Bank of Scotland and Virgin Money, and for variable rates they might include Clydesdale and Yorkshire Banks.
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