For most of us, obtaining a mortgage is a crucial step in purchasing a first home. There are a variety of financing options available to first-time homebuyers—including conventional mortgages and government-backed loans from the Federal Housing Administration (FHA) or the U.S. Department of Veterans Affairs (VA). Understanding how they work can point you in the right direction, help you find the best lender for you, and save you a significant amount of time and money. Here is what you need to know.
Key Takeaways
- When you apply for a mortgage, lenders will evaluate your creditworthiness and ability to repay, based on your income, assets, debts, and credit history.
- Among the decisions you’ll have to make are between a fixed vs. adjustable interest rate, the length of the loan term, and how large a down payment you can afford.
- Depending on your circumstances, you may be eligible for a Federal Housing Administration (FHA) loan, a U.S. Department of Veterans Affairs (VA) loan, or another type of government-guaranteed loan.
- As a first-time homebuyer, you may also be eligible for special programs that allow you to access deeply discounted homes and put low or no money down.
First-Time Homebuyer Requirements
To be approved for a mortgage, you’ll need to meet a number of requirements, which can vary depending on the type of loan you’re applying for and your particular lender. Lenders will generally require proof of income sufficient to make the monthly mortgage payments, enough cash for a down payment, and a credit score over a certain threshold.
To be approved specifically as a first-time homebuyer for some types of loans, you’ll need to satisfy the definition of a first-time homebuyer, which is broader than you may think. You don’t have to be a homebuyer in your 20s to be considered a first-time buyer.
According to the U.S. Department of Housing and Urban Development, a first-time homebuyer is someone who meets one of the following criteria:
- Has not owned a principal residence for three years
- Is a single parent who has only owned with a former spouse while married
- Is a displaced homemaker and has only owned with a spouse
- Has only owned a residence not permanently affixed to a foundation
- Is an individual who has only owned a property that was not in compliance with building codes
Common Types of Mortgages
Conventional Loans
Conventional loans are mortgages that are not insured or guaranteed by the federal government. They can be more difficult to qualify for than government-backed loans, requiring a larger down payment, higher credit score, and lower debt-to-income (DTI) ratio. However, if you can qualify for a conventional mortgage, it will usually cost less than a government-backed one.
Conventional loans are defined as either conforming or nonconforming. Conforming loans comply with guidelines established by the government-sponsored enterprises (GSEs) Fannie Mae and Freddie Mac. They often buy loans from lenders, then package and sell them as securities on the secondary market.
The maximum conforming loan limit for a conventional mortgage in 2024 is $766,550, though it can be more in designated high-cost areas. A loan made above this amount is called a jumbo loan, which usually carries a slightly higher interest rate. These loans entail more risk (since they involve more money), making them less attractive to the secondary market.
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. The FHA does not make the loans itself but guarantees loans made by approved private lenders, which lessens the lender’s risk.
FHA loans can be a good choice for first-time homebuyers because, in addition to their less stringent credit requirements, you can make a down payment as low as 3.5% in some cases or 10% in others. FHA loans are also subject to limits. In 2024, for example, the limit on a single-family home loan ranges from $498,257 to $1,149,825 depending on housing prices in the area.
U.S. Department of Veterans Affairs (VA) Loans
The U.S. Department of Veterans Affairs (VA) guarantees VA loans. As with FHA loans, the VA does not make loans itself but guarantees mortgages made by qualified lenders. These guarantees allow veterans and service members to obtain home loans with favorable terms and usually without a down payment.
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 obtain a certificate of eligibility from the VA.
In addition to these federal loan types and programs, some state and local governments and their agencies sponsor assistance programs intended to increase homeownership in certain areas.
How Lenders Decide What to Charge You
Lenders look at a number of factors in deciding how much money they might be willing to lend you and on what terms. Your creditworthiness plays a major role, so you can expect that they will review your credit reports and check your credit score.
They will also calculate a loan-to-value (LTV) ratio, comparing the amount you want to borrow against the value of the home. 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’ll be to default on the loan. The higher the LTV, the greater the risk of default, so lenders will charge more.
For this reason, you should include any type of qualifying income that you can when applying. Sometimes, an extra part-time job or income-generating side business can make the difference between qualifying or not qualifying for a loan, or in receiving the best possible rate. A mortgage calculator can show you the impact of different rates on your monthly payment.
Private Mortgage Insurance (PMI)
If you aren’t planning to make a down payment of 20% or more on a conventional mortgage, the lender is likely to require that you purchase private mortgage insurance, or PMI. PMI helps insulate the lender from the possibility of your defaulting on the debt by transferring a portion of the loan risk to a mortgage insurer. The cost of PMI will vary based on the loan amount and the type of mortgage.
Once your equity in the home reaches the 78% level, the lender or loan servicer is supposed to stop charging you for PMI. If that doesn’t happen automatically, you can request that they drop it.
As a general rule try to avoid PMI if you can because it is a cost that has no benefit to you.
Fixed-Rate Mortgages vs. Variable-Rate Mortgages
Another consideration is whether you want a fixed-rate or adjustable-rate (also called a variable-rate or floating-rate) mortgage. In a fixed-rate mortgage, the rate does not change for the entire length of the loan. The obvious benefit of a fixed-rate loan is its predictability. And, if prevailing interest rates are low when it’s issued, you can lock in a good rate for a substantial period of time.
An adjustable-rate mortgage (ARM), while less predictable, often comes with a low introductory rate that can mean more affordable payments during the early years of the loan. That may also allow you to qualify for a larger loan than you could get with a fixed rate.
Of course, this option can be risky if the rate shoots up after the introductory period ends and your income is no longer adequate to handle the monthly payments. These loans do, however, typically have caps on how far and how fast your rates can rise.
The most common types of ARMs today are for five-, seven-, or 10-year periods, after which they adjust. At that point, the interest rate will reset periodically, often every month. When an ARM resets, its new rate will be determined by the index to which it is tied (such as the rates on Treasury securities) plus an additional margin tacked on by the lender.
Specialty Programs for First-Time Homebuyers
In addition to the traditional sources of funding available to anyone, there are some specialty programs for first-time homebuyers. Among them:
Fannie Mae’s Ready Buyer Program
The Federal National Mortgage Association’s (Fannie Mae’s) HomePath Ready Buyer program is designed for first-time buyers and provides up to 3% assistance toward closing costs on the purchase of a foreclosed property owned by Fannie Mae. To be eligible for the program, applicants must complete a mandatory home-buying education course before making an offer.
Individual Retirement Account (IRA) Withdrawals
Eligible first-time homebuyers can take up to $10,000 out of an individual retirement account (IRA) without paying the usual 10% penalty for early withdrawals. The limit is per individual, so a couple could withdraw up to $10,000 each from their own IRAs for a total of $20,000.
Note that this exemption only applies to the penalty for early withdrawals. If you withdraw money from a traditional IRA, you will still have to pay income taxes on it.
If an eligible first-time homebuyer has a Roth IRA, they can withdraw money for the purchase both tax- and penalty-free as long as they’ve had a Roth account for at least five years. They can also withdraw their contributions to the Roth account (but not the earnings) whenever they wish.
State Down Payment Assistance Programs
Many states have down payment assistance programs for first-time buyers. Eligibility varies from state to state, but generally, these programs are geared toward lower-income individuals and public servants. HUD maintains a list of programs for each state on its website.
What Credit Score Is Needed to Buy a House?
Most conventional mortgages require a credit score of 620 or higher; however, Federal Housing Administration (FHA) loans can accept a credit score as low as 500 with a 10% down payment or as low as 580 with a 3.5% down payment.
What Is the Average Interest Rate for a First-Time Homebuyer?
Interest rates depend on various factors, including credit scores, down payment amount, type of loan, and market conditions. There is no data to indicate that first-time homebuyers pay higher or lower interest rates than experienced homebuyers with similar financial qualifications.
Are There Any State Tax Credits for First-Time Homebuyers?
While the first-time homebuyer tax credit was eliminated at the federal level in 2010, several states still offer their own tax credits. Additionally, some municipalities and counties offer property tax reductions for first-time homebuyers in their first year. You can check the websites of your state and local tax departments to see what you may be eligible for.
How Do Rent-to-Own Agreements Work With Homes?
In rent-to-own agreements, a person can rent a home for a period of time, with the option to buy it before the agreement expires. In some cases, a portion of their rent will be applied to the down payment.
What Happens if Your Mortgage Application Is Denied?
If a lender turns down your mortgage application it is required by law to tell you why. The reason may be something you can address before applying again, such as improving your credit score or lowering your debt-to-income ratio. And just because one lender denies your application, that doesn’t mean another lender won’t approve you.
The Bottom Line
First-time homebuyers have a number of financing options, including some that aren’t available to other people. A good mortgage broker or mortgage banker may be of help here, but nothing will serve you better than knowing your priorities and the trade-offs you’ll need to weigh in finding the best mortgage lender for you.
