First-time Home Buyers Guide to Lending

For a first-time home buyer, finding and buying a house can be a dream come true. For many people, buying a house is one of the biggest experiences we will ever go through! It's a major decision, and it can feel intimidating to wrap your head around all the information out there. But if you are armed with the proper knowledge and resources, it doesn't have to be a confusing or daunting process.

To demystify home buying and help you start the journey with confidence, it helps to understand the different things you need to consider before making a purchase. You might also want to know what to expect from the various stages of the buying process. This First-time Home Buyer's Guide to Lending will help you figure out precisely what kind of home you can afford, what your lending options are, how to shop for the best loans, and more.

What is a First-time Home Buyer?

The term "first-time home buyer" sounds pretty straightforward, right? But it's not as literal as it may seem. A first-time home buyer could be someone who has never bought a home before, but it can also mean other things. A home buyer who doesn't have a substantial down payment can qualify as a first-time home buyer and often be eligible for grants and loan programs, even if they have bought a home before. Usually, to qualify for these grants and loans, home buyers must not have owned a home in at least the last three years.

First-time home buyers can be eligible for several specific programs and discounts to make purchasing a home less expensive. One option is the Federal Housing Administration (or FHA) Loan. It's a loan backed by the FHA that offers appealing loan terms designed to assist first-time home buyers. Many people can qualify for them with a lower credit score than most non-FHA loans require.

Federal and state first-time home buyer programs are available, so it's essential to be aware of your options. Some lenders also offer slightly discounted mortgage rates for first-time home buyers. Some programs have specific requirements, such as maximum income levels, while others are available to everyone.

The First-time Home Buying Process: One Step at A Time

From choosing which neighborhood you want to live in to settling on your mortgage terms to shopping around for a lender, this guide offers you a birds-eye view of the entire process from start to finish. Whether you are just beginning your home search, ready to find a lender, choosing a mortgage, or closing on your loan, read on for help navigating through these various steps.

Step 1: Assess Your Financial Situation

The first step is to review your finances and get them in order to get approved for a mortgage. This has two major aspects: your credit score and your debt-to-income ratio.

Credit

Your credit score is probably the most important factor that lenders consider for home buyers. If you have a high credit score, that usually means you will qualify for more favorable loan terms. This is great because it will save you a lot of money as you pay your mortgage off over the years. Usually, a credit score of 760 or higher is good enough to qualify you for the lowest mortgage rates and best terms. That's why it's smart to pay down high-interest debt before buying a house.

Make sure to do a thorough check of your credit report to make sure there aren't any errors that are lowering your score. Also, make sure that you don't have any outstanding debts that you aren't aware of, fraudulent charges, etc. These things can negatively impact your credit score and make it less likely that lenders will work with you.

However, you can still qualify for many federal and some conventional loans, even with a low credit score. We'll get into more detail on that later on.

Debt-to-income Ratio

The other major factor lenders consider is how much debt you have relative to your income, otherwise known as your debt-to-income (DTI) ratio. Generally, lenders expect housing expenses (including the mortgage payment, property taxes, homeowners insurance, and homeowners association dues) to be no more than 30% of your gross monthly income. Furthermore, your monthly debt payments (credit card bills, student loans, etc.) should be no more than 36% of your monthly income.

Some mortgage lenders look for a DTI ratio of less than 43%. Others will allow as high as 50%. But be aware that the higher your DTI ratio, the higher your interest rates on your mortgage are likely to be. A high DTI makes you a more risky borrower because you don't have as much access to liquid cash that's not tied up in debt repayment.

So, for example, if you and your partner have a combined income of $8,000 per month, your monthly housing payments should ideally be less than $2,400 per month.

Step 2: How Much Down Payment Can You Afford?

The next step is to figure out your down payment. If you can put 20% down, you can probably find a conventional loan. This means you can avoid paying Private Mortgage Insurance, which covers the lender if you cannot pay the loan. However, you don't have to put down 20% in all cases. Sometimes you can pay as little as 3-5% depending on what type of loan you are interested in and if you are willing to pay PMI. (It's also good to note that you can stop paying PMI after you have built up 20% home equity in your new home.)

If you are getting a loan from the VA or USDA, you don't have to make any down payment at all. FHA loans typically require a 3-5% minimum down payment.

Paying a higher down payment can help you get a lower interest rate, lower monthly payments, and make you a more appealing borrower to various lenders. One of the primary benefits of being a first-time home buyer is that you don't need to make a sizable down payment, but if you can, it can make your application much more likely to be approved. That said, it's not recommended to put all your available cash toward your down payment. You want to keep some cash on hand for things like closing costs, home repairs, etc., that will come down the line once you have purchased your home.

Step 3: Lending Options

The best way to prepare yourself as a first-time home buyer is to familiarize yourself with the different types of mortgages available to you so you can shop around for the best possible loan. There are many kinds of mortgages out there, so to begin narrowing down your search, consider the following factors.

Fixed- or Adjustable-Rate

You will need to decide if you want a fixed-rate (FRM) or adjustable-rate mortgage (ARM). Fixed-rate loans usually come with rates that are a little bit higher, but the benefit is that the rate never changes. This means you know what your monthly payments will be for the entire length of your mortgage. An ARM usually begins with a slightly lower rate for an agreed-upon period (such as 5-8 years), and then it will adjust up or down at intervals that you predetermine with your lender.

Loan Terms

In addition to your rates, you will also want to determine the length of the loan. Short-term loans have lower rates, but you usually have to pay a much higher monthly payment. This means that you might be pressed for cash during the life of the loan, but will end up paying much less overall. You have to decide whether it is best for your financial situation to have a lower monthly cost or to pay your loan off more quickly to save money overall.

By far, the most common type of home loan is a 30-year fixed mortgage. This is a traditional private loan from a bank or lender. If you don't plan to live in your first home for that long, however, an ARM can sometimes be a great way to save money.

Here are some of the most popular types of home loans for first-time home buyers:

• USDA Loans: USDA loans are backed by the US Department of Agriculture. They are primarily intended for those wanting to purchase a home in certain rural areas. You need a credit score of 640 or higher to qualify, but they often don't require a down payment. They also offer lower interest rates than other types of loans.
• FHA Loans: FHA loans are backed by the Federal Housing Administration and usually require a credit score of 620 or higher, a down payment of 3.5% or more, and Private Mortgage Insurance.
• VA Loans: VA loans are backed by the US Department of Veterans Affairs and usually require a credit score of only 580 or above. They don't require any down payment, but they are only available to current or former members of the military and their spouses. VA loans tend to have lower interest rates than other loans, as well, which can save you quite a bit of money as you pay off your mortgage.

Step 4: Find a Real Estate Agent

You will want to work with a local real estate agent who is an expert in their field and understands the market where you are looking to buy a home. Find an agent who you communicate well with and who you believe is trustworthy, knowledgeable, and responsible. A good real estate agent can help you find reliable mortgage lenders and vice versa! If you live in an area with a competitive market, things move quickly, so it's always best to get pre-approved before serious house hunting begins.

Step 5: Get Pre-Approved

This step helps you get an estimate of how much you can borrow. It gives sellers and others you are working with the verification that you can afford to make the payments on the home you want to buy. It's a critical step in finding a home in a competitive housing market.

Pre-approval requires you to submit your financials to a lender for them to assess. They will run a credit check and then notify you of how much of a home loan you are approved for.

Step 6: Get Quotes from Lenders

Mortgage rates can change frequently and vary greatly depending on the lender you choose. It's therefore critical to get quotes from at least three mortgage lenders. You can often get a quote for free from the lender's website if you offer some basic information. As a first-time home buyer, you should familiarize yourself with the current state of mortgage rates and how they fluctuate, so you know what to look for.

In general, it's best to look for the lowest interest rate available to you, but this doesn't always give you the full picture. If a lender charges high fees, like underwriting, origination, etc., you could pay more even if they offer a low interest rate. Combine the lender's fees with interest rates to find your Annual Percentage Rate (APR), which offers a better picture of what you will actually be paying.

Many people also work with loan officers or mortgage brokers who help you shop around for the best deals. Beware of brokers who charge a fee for their services, as you can usually find ones that don't.

And remember, quotes are just quotes. The loan terms won't be finalized until you are ready to sign a deal with the lender.

Step 7: Shop for Your Home and Make an Offer!

Work with your real estate agent to narrow your search to a home that meets your needs and fits your budget. Try to arrange for in-person tours while you are looking so you can get a feel for what it will be like to live in the home and neighborhood. If you find a home you love in your desired location, be ready to make an offer fast! The offer should include home appraisal and inspection contingencies so that you can walk away from the deal without losing your deposit if the house turns out to have significant issues.

Talk to your real estate agent about what to expect during this process. In many cases, you have to be ready to negotiate on price, especially if you go into a bidding war with multiple other buyers. If you don't win your first choice of home, don't despair. Your real estate agent can help you find comparable properties, and with a little time and patience, you will eventually find a great first home.

With SD Capital Funding, you have advisors at your disposal from beginning to end to offer tips. They can be your advocates during one of the most significant transactions of your life. We're here to help you through the lending process to find the right mortgage for your situation.

If you need some guidance on the loans available to you, or if you're ready to get pre-approved for a home loan, contact SD Capital Funding for help from our experienced team!