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First time home buyers guide

Gina Pogol
Gina PogolThe Mortgage Reports Contributor

First time home buyers: Start here

So, you’re buying a house. Or, at least, you’re thinking about buying a house. First time home buyers can find the process intimidating, but it doesn’t have to be.

Homeownership is a terrific way to create stability in your life and to start building wealth for your future.

The home purchase also an emotional event which may be fraught with stress. There’s so much money involved when you buy a home. Every decision can be analyzed then analyzed again.

So, how do six million people manage to buy new homes each year? With preparation and attention to detail.

You can’t know everything there is to know about buying a home — especially when you’re a first time home buyer. However, you can do a little research and put yourself in position to succeed.

The more you know, the better off and less stressed you’ll be. You may even get a better deal on your home loan.

Explaining the mortgage

According to the National Association of REALTORS®, only about 10 percent of buyers purchased homes with all cash. Everyone else had to borrow at least s0me of their purchase price with a mortgage. That percentage drops even lower when you only look at first time home buyers.

You can finance 100 percent of the purchase if you qualify. But most people put some of their own money toward the purchase — a figure known as a “down payment.”  You finance the amount that’s left over.

For example, if you bring $25,000 of your own money to a $250,000 home purchase, you have made a 10 percent down payment and your remaining 90 percent mortgage balance is $225,000.

Contact at least two mortgage lenders

You can get a mortgage loan from just about anywhere.

If you have a favorite local bank or credit union, you can apply for a mortgage loan there. You can also find lenders online that may offer special products or lower pricing. It pays to compare.

Mortgages are everywhere. You can even apply for a mortgage from members of your family if they’re so inclined to make you a loan.

As a home buyer with choices, then, what’s important to remember is that every mortgage lender will offer slightly different terms and require you to meet slightly different standards.

Just because you achieve mortgage approval with Bank 1, for example, doesn’t mean Bank 2 will want your business. And mortgage approvals from different lenders don’t necessarily come with the same interest rate and fees, either.

This is one of the main reasons why you should plan to speak with at least two lenders when buying a home. In fact, one study from Stanford University found that obtaining three or four quotes dramatically lowered mortgage costs for homebuyers.

It not only helps to have a Plan B, but it’s nice to know that you’re getting the lowest mortgage rate possible.

What mortgage is best for me?

Home buyers today can choose among dozens of loan types, but more than 90 percent of buyers will end up using one of four government-backed programs.

It’s likely that you will, too.

These four programs are the conforming home loan, the FHA home loan, the VA home loan, and the USDA home loan.

These programs are popular because of their accessibility, low rates, and friendly terms. You can apply for each with your favorite mortgage lender — online or in-person.

The conforming loan

Conforming mortgage loans are what most home buyers think of when they think of “home loans”. The term “conforming” means that these loans “conform” to guidelines established by two quasi-government entities – Fannie Mae and Freddie Mac.

Conforming mortgages are often the best choice for home buyers with good credit scores and a down payment of at least 10 percent.

However, two conforming mortgage options exist for buyers making a down payment of just three percent. They are the HomeReady™ home loan and the Conventional 97 option.

HomeReady™ mortgages offer discounted mortgage rates to buyers in lower-income neighborhoods, minority-heavy neighborhoods, and in areas which have been declared a federal disaster zone.

Conventional 97 mortgages offer no such discount but can be the most economical way to purchase a home with little money down — especially for buyers with extra-good credit.

The FHA loan

FHA loans are popular with borrowers who have smaller down payments and/or credit issues, which require extra underwriting flexibility. The biggest appeal of the FHA loan is that buyers with below-average credit can get mortgage-approved.

FHA loans allow buyers with credit scores as low as 580 (for 96.5 percent loans) and 500 (for 90 percent loans). However, low credit scores must not be the result of recent bad credit history.

FHA mortgage rates are often lower than conforming mortgage rates, but because all FHA loans require mortgage insurance premiums (MIP), the overall cost of an FHA loan is sometimes higher.

The VA loan

The VA loan is a great program, with benefits offered by no other loan. But you need to be associated with the military to be eligible.

Available to veterans and active members of the U.S. military, VA loans offer 100 percent financing, simplified loan approval standards, and access to the lowest mortgage rates available.

For the last two years, VA mortgage rates have consistently beat rates for all other common loan types. VA mortgage rates can be as much as 40 basis points (0.40 percent) lower than rates for a comparable conventional loan.

The USDA loan

Available in rural areas and low-density suburbs, the USDA loan is another no-money-down mortgage you can use to finance a home.

The USDA loan is meant for home buyers with low-to-moderate income through its Guaranty program. The USDA allows credit scores as low as 640. It offers below-market mortgage rates to borrowers with very low incomes through its Direct program.

Surprisingly, the vast majority of the US land mass is considered “rural” by the USDA.

What happens after I choose my loan program?

Once you’ve uncovered the mortgage loan type which works best for you, you’ll want to begin thinking about your monthly budget and how much home you can afford.

It’s up to you to figure this out. A bank can’t do it for you. So, first, determine your monthly budget and write that number down.

For this example, let’s say it’s $1,500 per month.

We’ll now work backward to determine your maximum home purchase price.

Find your PITI

Your mortgage payment is made up of four parts, collectively known as PITI — Principal + Interest, Taxes, and Insurance.

Principal + Interest is your basic mortgage payment. It’s based on your loan amount, interest rate, and your loan term (the number of years you have to repay it).

You’ll also need to budget for real estate taxes. As a homeowner, you’re responsible for paying an annual real estate tax to the local taxing authority. Annual taxes typically range from 1-2 percent of your home’s value annually.

Then, there’s homeowners insurance. Mortgage lenders require that you carry insurance for your home, which typically costs 0.25-0.50 percent of your home’s value annually.

So, assuming a home purchase price of $250,000 and a ten percent down payment, plan on setting aside $400 for taxes and insurance each month.

This leaves $1,100 to spend on principal + interest.

Find your mortgage rate and price range

Determining whether a home is “in budget” depends on your principal + interest payment. Your principal + interest payment depends on current mortgage rates.

Be aware that mortgage rates move up and down all day, every day. Over the course of weeks and months, rates can change by 50 basis points (0.50 percent) or more.

When you’re shopping for a home, especially over an extended time period, it’s important to observe mortgage rates and how they are trending.

Consider the above example, when you have budgeted $1,100 to spend on principal + interest each month.

  • With mortgage rates at 3.75 percent, the payment is $1,043. The home is in-budget.
  • With mortgage rates at 4.25 percent, the payment is $1,107. The home is out-of-budget.

This example shows why you should never shop for homes by “price range.” The same home is affordable when rates are low, and unaffordable when rates increase.

Adjust your target price range based on current mortgage rates. It’s the only true way to keep on budget.

Shop for homes with confidence

There are many stressful stages of buying a home, but getting your mortgage shouldn’t be one of them. A little bit of knowledge can go a long way toward keeping you calm.

Access to good tools can help, too. Use a mortgage calculator to see how today’s mortgage rates might fit your household budget, and what your mortgage PITI could be.

Homebuyer FAQs

How much of a down payment do I need to buy a home?

To buy a home, you may not need a down payment at all. There are various mortgage programs, such as the VA Home Loan Guaranty program and the USDA Rural Housing Loan, which allow 100 percent financing.

Additionally, U.S. municipalities often offer down payment “grants” to first-time home buyers, which can make it possible to purchase a home with no money down. Absent these programs, buyers should expect to make a minimum three percent down payment for a conventional loan; and 3.5 percent for an FHA-backed loan.

Can I use gift funds for my down payment on a mortgage?

Yes, you can use gift funds for a down payment on a mortgage. To use a cash gift for down payment, however, you’ll have to prove that they come from an acceptable source.

Provide a paper trailing showing the gift funds leaving the giver’s account, and being deposited into your account or into escrow. You’ll need a “gift letter” from the giver, indicating his or her relationship to you, the amount of the cash gift, and a statement that giver does not require repayment. There is no limit to the number of monies that can be gifted to a home buyer.

Are there any fees when a home buyer works with a real estate agent?

No, real estate agents are “free” for home buyers; the seller typically pays their commission. Furthermore, because of conflicts of interest. there are almost no situations in which it makes sense for a home buyer to employ the same real estate agent as the home seller.

What is Private Mortgage Insurance or PMI?

Private Mortgage Insurance (PMI) is an insurance policy which makes homeownership possible for home buyers who don’t want to make a twenty percent down payment. You, the borrower, pay PMI premiums to protect your mortgage lender from default and foreclosure.

Should you fail to repay your mortgage, the lender can “cash in” the homeowner’s PMI policy to recover its lost monies. Conforming mortgage lenders require PMI when the home buyer makes a down payment of less than 20 percent.

PMI later self-cancels when the balance drops to 78 percent of the initial sales price. You can also apply with your servicer to remove it (once the loan balance drops to 80 percent (you may have to pay for an appraisal or refinance altogether to get this benefit).

What are points? How do I know if I should buy them or not?

A point is simply 1 percent of the loan amount. If you choose to “buy your rate down,” or pay “discount points,” you will get a lower interest rate.

All else being equal, the more you pay upfront, the lower your interest rate and monthly payment will be. But paying points may not pay off unless you keep your mortgage long enough to recoup your upfront costs with your monthly savings.

Deciding whether to pay points is a personal decision. Home buyers with plans to sell or refinance within a few years should usually not pay discount points. In for a 30-year fixed-rate mortgage, one discount point should reduce the rate by .125 to .25 percent.

For many home buyers, discount points are 100 percent tax-deductible in the year in which they are paid.

Credit score range breakdown: fair, good, excellent

Mortgage credit scores (FICO scores) come in many types, depending on the industry (mortgage vs auto financing, for example), version, and which of the three major credit bureaus you ask – Experian, Equifax, or TransUnion. FICO scores range from 300 to 850.  Lenders use the middle score if your reports contain three scores.

If your report only contains two scores, it’s the lower one that counts when you apply for a mortgage. Credit scores range as follows:

  • 720+ = Excellent
  • 680 to 719 = Good
  • 620 to 679 = Fair
  • < 620 = Poor

You can generally secure a mortgage approval with credit scores of 500 or higher, depending on the overall strength of your application.