In 2019, first-time buyers made up 33% of all home buyers.
When purchasing your first home, securing a mortgage is a crucial step—and there are several factors for choosing the most suitable one for you.
Financing for a house can seem overwhelming with the myriad of options available to new buyers. It’s essential to take the time to research the basics of home financing to save you precious time and money.
By organizing your finances and then creating a plan for purchasing a new home, you can choose the mortgage that best fits your needs.
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Know What You Can Afford
Buying your first home is exciting, and all of fantasize about new homes with big yards and all the bells and whistles. However, plan to purchase only what you can sensibly afford.
It would help if you aimed to spend no more than 30% of your gross monthly income on home-related expenses. This includes other costs, such as property taxes, maintenance, and mortgage interest.
To determine if you can afford a house, measure your debt-to-income ratio (DTI). Do this by adding up your monthly payments for all debt and dividing that number by your total monthly income.
While some lenders will accept a DTI ratio of up to 45%, if your ratio is above 30%, it might be best to wait to purchase a house until you settle some of your debt.
Remember, you must consider all of your monthly expenses, including medical costs, childcare, transportation, and entertainment expenses—as well as savings goals.
At all costs, you want to avoid a mortgage payment that limits your lifestyle and prevents you from accomplishing your goals.
Start Saving
Now that you know what you can reasonably spend on a home, it’s time to start saving for a house—starting with a down payment.
You will want to put as much money down as possible—at least 20%—to qualify for the best interest rate, reduce your mortgage loan, and avoid having to pay private mortgage insurance.
Even after you reach your savings goal, keep saving until you have the equivalent of six months of mortgage payments in your account.
And don’t forget the fees you’ll pay to close the mortgage, called closing costs. Usually, these are around 2-5% of the loan principal. You’ll also need around 3% of the home’s value for annual maintenance and repair costs.
Even if you can’t save as much or as quickly as you’d like, stay committed to your savings goals. In time, you’ll thank yourself for it.
Loan Types
Now that you know what you can afford and savings in place, it’s time to consider loan options. Begin searching for a lender and comparing interest rates to find the right mortgage for your circumstances.
Conventional Loans
Conventional loans are not guaranteed or insured by the federal government. Typically, they are fixed-rate mortgages. They’re more difficult to qualify for due to strict requirements, including a larger down payment, lower DTI ratios, higher credit score, and private mortgage insurance.
If you can qualify for a conventional loan, they’re typically less costly than those guaranteed by the federal government.
Conventional loans can be conforming or non-conforming loans. Conforming loans comply with guidelines set forth by the government-sponsored enterprises (GSEs) Freddie Mac and Fannie Mae.
In 2020, the limit for a conventional mortgage is $510,400—or more for high-cost areas. Loans over this amount are referred to as jumbo loans, which usually carry a higher interest rate. These are riskier loans that are less attractive to the secondary market.
With non-conforming loans, the lending institution underwriting the loan (typically a portfolio lender) sets its own guidelines. Non-conforming loans can’t be sold on the secondary market.
Federal Housing Administration Loans
The Federal Housing Administration (FHA) provides several mortgage loan programs. FHA loans have lower downpayment requirements, so they’re easier to qualify for than conventional loans.
For first time home buyers, FHA loans are ideal. They have lower upfront costs and less strict credit requirements. Your down payment can be as low as 3.5%. FHA loans are restricted by the statutory limits previously described.
If you decide on an FHA loan, you must pay a mortgage insurance premium (MIP). The MIP is rolled into your mortgage payments. Mortgage insurance protects your lender or title holder if you default on payments.
If you’re interested, check out these frequently asked questions about FHA loans.
VA Loans
VA loans are guaranteed by the U.S. Department of Veterans Affairs (VA). The VA solely guarantees mortgages created by qualified lenders.
Veterans can obtain more favorable mortgage loans without a downpayment with VA loans. Generally, lenders limit the maximum VA loan amount to conventional loan limits.
Before applying for a VA loan to buy a house, you need to request eligibility from the VA. Once accepted, the VA will issue a certificate of eligibility. You’ll use this certificate to apply for a loan.
Submitting Your Loan Application
Once you’ve found your dream home within your budget, you’re ready to apply for a mortgage loan. Most applications can be completed online, but sometimes you may wish to have a loan officer walk you through the process.
You’ll need to submit several documents and information, including:
- Recent pay stubs, tax returns, and proof of income
- Employment history for the past two years
- Financial statements from your bank and other assets (such as CDs or retirement accounts)
The lender will outline their requirements and pull your credit report to confirm your creditworthiness.
It’s Time to Secure Financing for a House
Obtaining a mortgage requires that you complete several steps before filling out an application, including saving and developing a plan to purchase a home.
Do your research so that you’re well informed before securing financing for a house.
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