There’s plenty of good news about financing for first-time home buyers. A variety of mortgages is available and some loans require little or no down payment. Depending upon your qualifications, loans are available through banks, credit unions, federal or veteran’s assistance program, even through your own municipality.
To find the best deal, put on your shopping shoes.
Here’s a rundown of the steps needed to secure a loan and a sampling of those available.
How much can I spend?
Before looking for a real estate agent and a home, determine how much house you’re qualified to buy. The amount of mortgage you can afford is based on your debt-to-income ratio, which takes into account the percentage of your income that will be spent on housing, as well as on such consumer debt as credit card bills, car payments and other loans.
The traditional debt-to-income ratio is 28 and 36 percent: In other words, your total monthly housing payment ? including mortgage principal and interest, insurance, real estate taxes and any condo monthly assessments ? should not exceed 28 percent of your before-tax monthly income. Then, when adding in all other consumer debt payments, the total figure should not exceed 36 percent of your monthly income. Those parameters may still be used by some lenders, especially for low-down or no-down mortgages.
Re/Max agent Tim Baker of Naperville says, however, that banks generally target a 33 and 38 percent ratio.
“The 33 percent figure is … your monthly payment, insurance and taxes, divided by your gross monthly income,” Baker said. “The 38 percent is the ratio of your total debt, including your house, credit cards, and car payments,” to your income. “Buyers have to qualify under both ratios.”
If, for example, your monthly gross income is $4,166 (or an annual income of $50,000), your mortgage payment and related expenses must not exceed $1,375 (or 33 percent of $4,166) and your total debt must not exceed $1,583 (or 38 percent of $4,166).
Marc Falk, vice president and regional manager of the mortgage lending division for National City Bank of Illinois, says that, before seeking a mortgage, eliminate as much of your debt as possible.
“Too often, we see people buying cars or building up their charge accounts with furniture or something just before buying a house,” Falk said. “People (who) spend forward wind up having it affect them afterwards. You’re driving up that 38 percent ratio and end up not qualifying.”
The down payment
Not long ago, lenders required 10 to 25 percent down before making a mortgage loan. But today, first-time buyers are securing loans for far less.
Leony Tavas-Scott, community liaison officer for Bank One in Illinois, said community home buyers programs, for instance, offer a wide range of options.
“Besides traditional lenders like banks, there are community home buyers programs and others through FNMA (Fannie Mae), the Federal National Mortgage Association,” Tavas-Scott said. “Basic community home buyers programs offer loans for as little as 3 to 5 percent down, provided you qualify.”
To be eligible for community assistance loans in the City of Chicago, your income must not exceed the current median family income level of $63,800, said Tavas-Scott.
Some lenders have also come up with a number of creative financing plans, including some that require no down payment at all.
“There are plans where a bank will actually lend 103 percent of the value of the house, which includes no money down or closing costs,” he said. “However, there are always other issues when other standards are relaxed. In this case, the debt ratio is very stiff; you have to be squeaky clean as far as your credit rating is concerned. And because your mortgage is for more than your house is worth, you’d better plan to stay awhile.”
Falk says buyers can acquire their down payment in a number of ways, including gifts from family members, grants, community assistance programs, or, in the case of existing construction, seller contributions.
“In terms of gift money from family members, make sure you have something in writing that states the money is a gift and is not to be paid back,” Falk cautions. “Otherwise, that will affect your debt ratio as well.”
Shopping for a loan
Once you make an offer on a house, you’ll have a certain period, often about a week, to secure a loan. Have an idea which mortgage product you want, and see if you can get a number of lenders to crunch some numbers for comparisons.
Check out banks, mortgage finance companies, credit unions, mortgage brokers and savings and loans.
Real estate agent Baker says to look for a reputable lender that will be accessible through the entire process. “Some lenders are difficult to work with, or require a lot of nit-picky documentation before they’ll process an application,” he said. “Today, you should be able to get a quick approval for a loan — three to five business days.”
“You also want to watch out for someone quoting an outrageously low rate,” Falk said. “Often, you’ll find lenders unable to honor it at closing, or tacking on a lot of extra fees at the end.”
In the present environment of rising interest rates, it might pay to try to lock in the rate you are quoted. For a fee, lenders often will guarantee an interest rate, for up to 60 days, the time it usually takes days to close on the loan.
You can shop for options on line at a variety of sites, including quickenmortgage.com, iown.com, eloan.com, and getsmart.com. Individual lenders also have their own Web sites.
Loan application
You’ll need some documentation in order to complete the loan application. Be sure to have the following:
- W-2 forms, to verify your income and employment.
- Pay stubs, which, like W-2 forms, can be used to determine gross and net income and the monthly payment you can afford. Those who are self-employed need profit and loss statements. The lender will most likely ask for several pay stubs.
- Bank statements from the past few months to show resources, along with statements about other investments, including stocks, mutual funds and bonds.
- Federal income tax returns, often for the last two years.
- Information such as balances and payments regarding current debt, including car payments and credit cards.
Types of loans
Though the number of mortgage programs and options has grown in the last decade, it’s still a matter of how much you can afford: How much will it cost you now and for the life of the loan?
Some options, like a balloon mortgage, work better for folks who expect to move in three to five years. That’s because under a balloon mortgage, normal payments are made for a set number of years, say seven, and then the mortgage must be paid off all at once, or refinanced.
A fixed-rate loan, the most popular option today, works best for those planning to put down roots. You’ve locked in your rate for the term of the loan, whether it’s for 30 or 15 years.
Because its initial interest rate is lower than a fixed-rate loan’s, some buyers may opt for an ARM, or adjustable-rate loan. But, the interest rate floats, meaning it may go up or down over the life of the loan. And, you’ll have to qualify as if you are taking out a fixed-rate loan.
These common mortgage loans sometimes can be had for nothing down, but more likely you will be asked to put down from 5 to 20 percent of the loan amount.
Here are some other mortgage options.
- Sellers assistance programs, available at various lenders. For example, the not-for-profit Nehemiah Foundation offers a loan for first-time buyers of existing homes, with an incentive for both buyer and seller. The buyer agrees to pay the full purchase price of the house with no money down. In exchange, the seller puts up 4.25 percent of the sale price as a down payment.
- Department of Veteran Affairs, or VA, loans, available only to eligible veterans. They offer a significant advantage: No out-of-pocket expenses may be required. Interest rates and points are negotiated and paid up-front, although buyer and seller decide who pays the points, which are a fee collected by the lender. One point equals one percent of the loan amount. The veteran will also have to decide whether to make a down payment.
- FHA programs usually require 3 percent down and are available as both fixed- and variable-rate loans. Gifts from relatives can be used as a down payment. There are restrictions on the price of the house you can buy, however.
- Conventional loans guaranteed by private insurers are usually less expensive than FHA or VA loans. Baker says the private mortgage insurance (PMI) required if your down payment is less than 20 percent is cheaper than the mortgage insurance premiums required for an FHA mortgage.
- Community Home Buyer Programs. Available through Fannie Mae, they require first-time home buyers to contribute as little as 5 percent down. Gift or grant money from an employer may be used as part of that down payment.
- Assist Bond Programs. Falk says these programs offer an option where loans are actually canceled.
“After a period of time, usually about seven years, the debt is canceled and you don’t have to pay the loan back,” he said.
- Low-doc or no-doc loans require minimal paperwork, but again, when standards are relaxed, there’s always a catch: Expect to pay 25 percent down for having less paperwork, and a higher interest rate throughout the life of the loan.
