By, Lisa Roberts
Being a first-time homebuyer is never an easy thing. There are many different aspects to tackle and a copious amount of information you have to learn to make a sound decision. One of the more challenging aspects of being a homebuyer is dealing with financing and understanding all the different options presented to you. So, to make this a bit easier, we will go over the financing basics for first-time homebuyers. With luck, these should banish some confusion.
How to consider house funding
The first thing to understand when considering house funding is that there is a big difference between being able to buy a home and being able to afford one. For example, if you are purchasing a home in California, it is imperative to investigate the real estate market trends in the area. That will include the prices of properties and the features they have. While you should be familiar with current market trends, you need to understand which homes you can afford. Keep in mind that a home is an investment. And that, more often than not, it will require further funding to be viable. You are not only looking at mortgage payments but also furnishing and renovation costs. Add to that various taxes, and you will soon see why there can be a considerable difference between the home value and its actual cost of ownership. So, make sure to develop a reasonable budget before you start looking at homes that you cannot afford to own.
Dealing with mortgage loans for first-time homebuyers
If you are so well off that you can afford to buy a home out of your savings, great! But, if not, you will have to get a loan. Fortunately, there are numerous loan options for you to consider based on your current financial status and the home you are getting. But, unfortunately, these loans can sometimes be hard to understand, especially if you have little experience with financing. So, to make things a bit clearer, here are the most common types of loans that a person would get for mortgage payments.
Standard (conventional) loan
If you can acquire it, the conventional loan is your best option for financing. You will get a good rate with it, but, unfortunately, it can be pretty hard to qualify. This is because the federal government doesn't cover standard loans. Therefore, it is up to the banks to determine whether or not you can actually pay them off. This is why it requires a bigger down payment, lower income-to-debt ratio, and a better credit score. If you qualify for it, we strongly suggest that you go with this option as the conventional loan is usually the best option.
Federal Housing Administration (FHA) loan
FHA loan is a part of the HUD (U.S. Department of Housing and Urban Development). Its main goal is to help people with poorer finances to get homes. As such, it has a lower down payment and is much easier to qualify than the standard loan. And, as a first-time homebuyer, you can even make a down payment of merely 3.5%.
A notable downside of FHA loans is that you must pay a mortgage insurance premium. This insurance serves to protect the lender should you default on your payments, pass away, or are unable to meet contractual obligations. This is one reason why the standard loan is still preferable to FHA, even if it is your first home.
Veteran Affairs (VA) loan
If you are a veteran or a member of your immediate family is, you can apply for a VA loan. In this situation, the U.S. Department of Veteran Affairs (VA) isn't the loan provider but a competent negotiator. Through them, you can get a much better deal for your loan and even avoid down payments. Seeing that the VA loan has the same maximum limit as the conventional, there is little reason not to get one if eligible.
Income and equity requirements
Since mortgages and financial situations are a fairly serious matter, banks can hardly leave their evaluation to home buyers. What they do instead is to evaluate you in different metrics. They will first check your FICO score from three credit bureaus. And then, they will calculate your DSCR score and the LTV score.
DSCR stands for debt-service coverage ratio. It essentially determines your ability to pay off the mortgage. The lenders will take your monthly net income and divide it by the mortgage costs. The higher the number, the less of a burden it is for you to pay your monthly rate.
LTV stands for loan-to-value ratio. It describes the amount of equity that is available in the collateral borrowed against. When it comes to home purchase loans, the lender will evaluate LTV by dividing the loan amount by the purchase price. The higher your LTV is, the greater the risk that you won't be able to pay off your loan.
Private mortgage insurance
Another thing that the LTV determines is your PMI (private mortgage insurance). In most cases, you will need to get a PMI if your LTV is greater than 80%. What determines the insured amount is determined by the cost of the mortgage and how the lender collects it. If the LTV becomes equal to or less than 78%, the PMI should be eliminated. It is also possible to cancel PMI once your home has enough value to give you 20% equity and a predetermined period has passed (usually two years).
Final financing basics for first-time homebuyers
As we have mentioned before, there are numerous aspects to consider when financing your first home purchase. While we've covered the financing basics for first-time homebuyers, we advise you to continue your research and learn as much as you can. You still need to get a hold of fixed-rate vs. floating-rate mortgages and how they correlate with your interest rate. It would be best if you also considered resale factors and how they can influence your future finance. So, don't shy away from educating yourself. Hire a financial consultant, if need be.
By understanding financing basics for first-time homebuyers, you will know how the mortgage works and why it is essential to pick the right one.