If you've been finding it hard to choose a mortgage, you're not alone. Home loans…
Looking for a mortgage for the first time is very challenging. With so many home loans and financing options in the market, most first-time homebuyers get overwhelmed during this period of searching for their new home. The 30 years fixed rate is 3.125%, with an APR of 3.193%.
We understand how crucial it is to find the right mortgage that fits your needs. That’s why in this article, we will take you through the different requirements that can affect your monthly payments, as well as some home loans and programs a first-time homebuyer like you may take advantage of.
Before we dive deep into the types of loans you can choose from, we will run through requirements and factors you need to consider when applying for a home loan.
Equity and Income Requirements
The first thing that a home buyer will notice when looking to finance a home is that home mortgage loan pricing will differ per person. To determine how much a lender is willing to loan to a borrower (plus interest rate), lenders look at several factors that determine the borrower’s creditworthiness. Aside from your FICO score, lenders also compute for the loan-to-value ratio and the debt-service coverage ratio.
Let us go through them one by one:
FICO (Fair, Isaac, and Company) score
The FICO score is a type of credit score that lenders use to assess credit risk. FICO scores consider five different areas to determine creditworthiness:
- Payment history
- The current level of indebtedness
- Types of credit used.
- Length of credit history
- New credit accounts
Loan-to-Value Ratio (LTV)
Aside from the FICO score, lenders also look at the loan-to-value ratio. Lenders use this to determine how much risk they are facing when approving a loan. If the LTV ratio is high, it is typically considered as a high risk, resulting in a loan with a higher interest rate. To determine the LTV, divide the loan amount by the purchase price of the home.
The LTV also determines if you should be required to purchase private mortgage insurance (PMI) to offset the risk to the lender. Most lenders require PMI for an LTV greater than 80%. Try to avoid getting a PMI, as these costs have no benefit to you.
Debt-Service Coverage Ratio (DSCR)
The DSCR determines the buyer’s ability to pay. Lenders use it to qualify a borrower for a home loan because it determines the buyer’s income coverage.
To assess the buyer’s probability of default on the mortgage, lenders divide the buyer’s monthly net income by the mortgage costs. If the ratio is high, then the greater the probability that the buyer will pay the costs, thus lowering the risk the lender takes on.
To receive the best possible mortgage rate, try to include any qualifying income you have. Especially if you have an income-generating business or an extra job, these could help you qualify for a loan or even receive a better rate.
Types of Home Loans
Now that we know what factors affect your mortgage and interest rates let us look at some of the types of mortgages first-time homebuyers may take advantage of.
As a first-time buyer, you are entitled to special benefits where some loans and programs offer a lower – or even no – down payment.
A conventional loan is a type of loan that is not insured or guaranteed by the government. Private lenders usually back the loan, and the borrower usually pays its insurance. Conventional loans are usually fixed-rate mortgages. If you qualify for a conventional mortgage, you are entitled to lower costs than federal government loans. However, this type of mortgage is the most difficult type to qualify for due to its strict requirements, such as a bigger down payment, higher credit score, lower income-to-debt ratio, and even a private mortgage insurance requirement.
There are 2 different types of conventional loans- conforming loans and non-conforming loans. A conforming loan is a mortgage whose terms and conditions comply and meet the government-sponsored enterprises’ criteria, Fannie Mae and Freddie Mac. It is essentially a home loan that does not exceed the dollar amount determined by the Federal Housing Finance Agency (FHFA). Keep in mind that if the home that you are looking to purchase exceeds the dollar amount determined by FHFA, you will be required to get a jumbo loan for that home.
Nonconforming loans, on the other hand, are high-value mortgage loans. They are usually made by private lenders that set their own guidelines that borrowers must meet for approval. These loans are usually made for borrowers who would not qualify for a loan backed by Fannie Mae or Freddie Mac. These loans cannot be sold in the secondary market due to restrictions.
Federal Housing Administration (FHA) Loans
An FHA loan is a mortgage loan backed by the FHA mortgage insurance that an FHA-approved lender provides. An FHA loan provides lower down payment requirements, which can go as low as 3.5%. In addition to a low down payment, the loan also has less stringent credit requirements. Therefore, this is a loan that first-time homebuyers can definitely take advantage of.
However, this mortgage loan differs from conventional loans because the buyer must occupy the house being purchased for at least a year. All FHA borrowers must pay a mortgage insurance premium, which is rolled into the borrower’s monthly mortgage payment.
Are you a Veteran and first-time homebuyer? You may be qualified for a VA loan guaranteed by the U.S. Department of Veterans Affairs (VA) Affairs. The VA does not originate loans, but it guarantees mortgages for those who may qualify.
This loan option is provided for American veterans, military members currently serving the U.S. military, reservists, and select surviving spouses. A VA loan’s main purpose is to supply home financing to help veterans obtain a home loan with favourable terms, such as no down payment.
State and local governments also provide other assistance programs for veterans to help increase homeownership in some areas.
Yes, your eyes do not deceive you. The U.S. Department of Agriculture does indeed offer home buyers assistance. The program allows lenders 100% financing by offering them mortgage guarantees. This loan targets rural areas, but there are also income limitations. So it is better to check with a USDA lender to see if you qualify for this type of loan.
Another important consideration when looking at home loans is choosing between a fixed-rate or floating-rate mortgage.
A fixed-rate mortgage refers to a home loan with a fixed interest rate for the entire loan period.
The main advantage of a fixed-rate loan is that the payment is the same each month. The buyer is then protected from any sudden changes or increases in the interest rate. This predictability makes it easier to budget.
Another advantage of a fixed-rate loan is if you think interest rates will go up in the next several years, you may keep your rate locked-into a fixed-rate period.
Lastly, you may also choose the duration of the fixed-rate mortgage terms, the most common of 30, 20, and 15 years. 30 years is the most popular choice amongst buyers since it offers the lowest monthly payment.
A fixed-rate loan may be more expensive if the interest rates fall in the future.
Another disadvantage is that you’re paying off the principal slower with a fixed-rate than a floating-rate mortgage. In most cases, the monthly payments over the first few years go towards the interest alone.
Floating Rate Mortgages
A floating-rate mortgage, such as an adjustable-rate mortgage (ARM) or an interest-only mortgage, is subject to daily market fluctuations. Meaning, the buyer’s repayments may go up or down as interest rates on the wider market change.
The buyer has the flexibility to make lump sum repayments of any size at any time without penalties. This means that the buyer can pay off the home loan faster, especially if the interest rates go down.
On the contrary, the clear disadvantage of the floating-rate is also its flexibility. Interest rates may float upward, thus increasing the borrower’s monthly payments.
Get the home loan that is best for you.
Ready to go out and look for the right loan for you? Looking for ways to finance your first home may be the most critical step of your home buying experience. Now that you know what loans and types of mortgages are out there, you better understand how to find and finance the perfect home for you. Always remember that what is important is that the type of financing you get is what fits your needs, so prioritize the things that mean most to you and look for the deal that speaks to you.
You are now much closer to purchasing that new home! Good luck!