First Time Home Buyer
Every home owner at some point was a first time home buyer. Whether it’s the first home or the last, everyone remembers their very first time. And that’s to be expected because anything that brings in new experiences will be well-remembered. A lot of effort by industry leaders is put into getting people into their very first home. The real estate industry in general wants to get someone in their first property because that typically means someone who is selling a home is getting ready to buy another. Once someone gets into the first home, at some point the second one will come along.
The single biggest obstacle for most first time buyers is coming up with the cash needed for a down payment and closing costs. But once the property is acquired, equity builds up over time and it’s the increase in equity that pays for the next down payment and closing costs for the second home. Most any homeowner will tell you that it’s easier to buy the second home than the first. Instead of saving and scrimping money each month to come up with down payment money, those funds are secured as the mortgage balance is gradually paid down and property values increase.
One technical trick with a first time home buyer program is that someone can be considered a first time buyer that has previously owned a home. The definition for first time buyers is not having owned a home within the previous three years. That means if someone bought a home and sold it four years ago, first time buyer status is restored. But what type of programs are available for first time buyers?
Let’s first take a look at a popular loan program that isn’t relegated to a first time buyer but is the loan of choice for those in the first timer category- the FHA loan. The FHA loan only requires a down payment of just 3.5% of the sales price making it easier to come up with the needed down payment.
For the closing costs, the FHA loan allows the sellers of the property to contribute up to 6% of the sales price of the home to be credited to your closing costs at the settlement table. That’s quite a bit and if the seller agrees to pay for your costs and the sales price is $200,000, that means the sellers can contribute up to 6% of that amount, or $12,000. However, when sellers do pay the maximum FHA limit of 6%, that can mean an offset in the property’s appraised value. With a $200,000 sales price, closing costs will be closer to $3,000 to $4,000 in most areas.
FHA loans are also a bit more flexible as it relates to someone’s credit history. FHA loans are more lenient if there are credit issues. The minimum credit score for an FHA loan with the minimum 3.5% down payment is 580 whereas the minimum credit score for a conventional loan is 620. With a down payment of 10% on an FHA loan the minimum credit score drops all the way to 500.
Income requirements for FHA loan ask there be at least a two year history of employment. This will be verified by providing the last two years of W2 forms. FHA loans also require the lender to compare monthly credit obligations with gross monthly income and do so by calculating debt-to-income ratios. For FHA loans, there are two such ratios calculated, the housing and the total debt ratio, sometimes referred to as the “front” and “back” ratio. These two ratio guidelines are 31% and 43%.
The key word here is “guideline.” FHA loans do not require that ratios be at or below 31 and 43 but be near there. Debt ratios for FHA loans can be as high as 40 and 50 where there are compensating factors the lender can use to justify the higher debt load. For example, if the new mortgage payment which includes principal and interest, taxes, insurance and mortgage insurance approaches 48, the lender can still approve the loan by highlighting positive factors about the entire loan file such as being with the same employer for 10 years or making a similar rent payment for the past two years that is equal to or near the new mortgage.
Fannie Mae offers a first time buyer program that asks for a down payment of just 3.0% of the sales price. This program, called the HomeReady loan, is used to finance a primary residence. The HomeReady loan is available in a 30 year fixed rate term and also requires the applicants complete an approved homeownership counseling course. If the property is located in an area designated as “low-income” there are no income limits on the borrowers but if the property is not located in a low-income area, borrower income cannot exceed 100% of the Adjusted Median Income for the area.
Freddie Mac also has its own version of Fannie’s program called the Home Possible mortgage. This program is designed for the very low or low income buyer and just needs a down payment of 3.0% of the sales price. As with all low-down payment mortgages, including FHA and HomeReady, mortgage insurance is required and paid in monthly installments.
Other First Time Home Buyer Programs
Other programs for first time buyers include providing loans or grants to be used toward a down payment and closing costs. These programs will provide the necessary funds to close and attach a second lien as security on the property. Outright grants never have to be repaid and no payments are made on the second lien while the borrowers occupy the property and only repaid when the loan is retired via sale or refinance.
Most such down payment assistance programs allow interest to accrue on the outstanding loan balance but if the borrowers own the home and keep the mortgage for a specified period of time, say three years or more, the second lien repayment requirement is dropped.
Grants and down payment assistance programs will vary based upon the location of the property and administered by state, county or local government and administered by the appropriate agency.