What Are Your Home Financing Options as a First-Time Buyer?

Buying your first home can be a thrilling experience. Like riding a rollercoaster or going bungee jumping, it’s exciting and terrifying all at the same time. Fortunately, even if you’re new to the homebuying process, there are plenty of home financing options available to you that can help make navigating the housing market feel a little less stressful.

By understanding your options, you can find the mortgage that best fits your needs and goals.

FHA Loans

FHA loans are a favorite among first-time homebuyers because they’re backed by the Federal Housing Administration, which usually makes them easier to qualify for.

With an FHA loan, you can put down just 3.5 percent of the home’s value if your credit score is 580 or higher. If your score falls between 500 and 579, you’ll need to put 10 percent down.

Because FHA loans have more flexible requirements, they help first-time buyers who may not qualify for a conventional loan. Plus, the low down payment requirement makes them a great option if you don’t have a lot of savings to put toward your new home.

Credit and income requirements

While FHA loans don’t typically have strict credit rules, most lenders prefer a score in the mid-600s. Keep in mind, however, that you may still qualify even if you have a lower score—as long as you have a larger down payment or extra savings.

Your debt-to-income ratio (DTI) is another factor used to determine your eligibility for a mortgage. This number shows how much of your income goes toward debt payments. FHA loans allow a DTI of up to 50 percent (depending on your financial situation), which is higher than the limit for most conventional loans.

For example, if you make $5,000 a month and have $2,000 in debt payments (such as car loans or credit cards), your DTI is 40 percent. With this DTI, you'd likely qualify.

Mortgage insurance and loan limits

FHA loans require mortgage insurance to protect the lender in case you stop making payments. This includes an upfront mortgage insurance premium (UFMIP) of 1.75 percent of the loan amount, which is usually paid at closing. You’ll also pay an annual mortgage insurance premium (MIP), which typically ranges from 0.15 percent to 0.75 percent of your loan balance, depending on your loan amount and term. Depending on your loan terms, you’ll pay MIP for either 11 years or the entire loan duration. FHA loans also come with loan limits: $524,225 for most areas and up to $1,209,750 in more expensive markets.

FHA Loans

Pros:

• Low down payment (as little as 3.5%)
• Flexible credit history and debt-to-income ratio requirements

Cons:

• Mortgage insurance adds to borrowing costs
• Lower loan limits

VA Loans

If you're a veteran or the surviving spouse of one, you may qualify for a VA loan through the Department of Veterans Affairs.

Credit and income requirements

Unlike FHA loans, VA loans don’t set a minimum credit score. However, most VA lenders prefer a FICO score of 620 or higher to qualify.

VA loans also typically allow a higher DTI ratio than many other loans, which can make them a flexible option for new buyers. While you’ll usually need a DTI below 41 percent to qualify, having a higher DTI doesn’t mean you’re out of luck. Whether or not you get approved ultimately depends on your overall financial picture.

Funding fees

One of the big perks of VA loans is that you don’t need a down payment or mortgage insurance. However, there is a one-time funding fee. For most buyers, this fee is typically 2.15 percent of the loan amount, but it can range from 0.5 percent to 3.3 percent, depending on the type of loan and your military service history.

For example, if you get a $300,000 mortgage, your funding fee could range from $1,500 to $9,900.

VA Loans

Pros:

• No down payment requirement
• No mortgage insurance
• Flexible credit and income requirements

Cons:

• One-time funding fee
• Restricted to veterans or surviving spouses

USDA Loans

If you're a first-time homebuyer living in a USDA-eligible rural area, a USDA loan may be a good fit. This program is backed by the US Department of Agriculture (USDA) and helps low- to moderate-income buyers afford homes.

Credit and eligibility requirements

Like other government-backed loans, USDA loans have flexible lending requirements. But most USDA lenders look for a credit score in the low- to mid-600s and a DTI not exceeding 41 percent. There are also income limits based on where you live. If you earn too much, you might not qualify for this type of loan.

Guarantee fees

Similar to a VA loan, one of the biggest benefits of a USDA loan is that you don’t need a down payment. This means you can finance 100 percent of the home’s cost without tapping into your savings. However, if you have savings and want to put money down, you still have that option.

Since there isn’t a down payment requirement, USDA loans require two types of fees:

• Guarantee fee: A one-time fee equal to about 1 percent of the loan amount, usually paid at closing.
• Annual fee: A 0.35 percent fee applied annually to the remaining loan balance, paid as part of your monthly mortgage payment.

USDA Loans

Pros:

• Flexible lending requirements
• No down payment

Cons:

• Income limits
• Guarantee fees

Conventional Loans

Unlike government-backed loans, conventional loans aren’t backed by the government. Instead, many are designed to meet guidelines set by the Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Corporation (Freddie Mac), two major companies that buy mortgages from lenders. They also have programs that can make it easier to qualify with a lower down payment.

For example, Freddie Mac’s Home Possible program helps low- to moderate-income borrowers by allowing lenders to offer loans with just a 3 percent down payment, making it an affordable option for new buyers.

Private mortgage insurance (PMI)

You might think you need a 20 percent down payment to get a conventional loan, but that’s not always the case. Many lenders will accept less. The catch? If you put down less than 20 percent, you’ll usually have to pay private mortgage insurance (PMI), which typically costs between 0.5 percent and 2 percent of your loan amount each year.

The good news is that once you’ve built up 20 percent equity in your home, you can ask your lender to cancel the PMI. And if you don’t, lenders are required to remove it automatically once you hit 22 percent equity.

Credit and eligibility requirements

Every lender has a slightly different set of rules for qualifying, but in general, you’ll need a credit score of at least 620 and a DTI ratio less than 43 percent to get a conventional loan.

Borrowers with a score above 740 typically secure the best rates. While lenders can allow a DTI up to 43 percent (or sometimes higher), keeping it below 36 percent can help you qualify more easily and score better loan terms.

Conventional loans also tend to have higher loan limits than most government-backed loan options—up to $766,550 in most counties, and as much as $1,149,825 in high-cost areas.

Conventional Loans

Pros:

• Lots of flexible loan options
• Competitive interest rates for borrowers with good to excellent credit

Cons:

• Stricter eligibility requirements compared with government-backed loans
• Private mortgage insurance (PMI) required if you put down less than 20%

Finding the right mortgage for your new home

Buying your first home can feel overwhelming, but taking the time to explore your home financing options can make all the difference. Be sure to explore your options, and choose the one that best fits your needs—because a well-informed decision is always the best decision.