Looking to buy your first house? You’re not alone. Thousands of Americans buy a home for the first time each year. But what do you need to know to make your dream a reality? Start by working with a realtor so that you can identify a house you want to buy. After you’ve identified a house to buy, contact a mortgage professional. Why? Unless you have enough money saved up to pay for the home in cash, you’re going to need a loan. And given there are many different loan products available, a mortgage professional will help you find the loan product that is right for you and that you can qualify for. Qualifying for a loan comes down to several factors. How good is your credit? How much of a down payment can you make? Can you afford the monthly mortgage payment for the loan you’re qualifying for? In other words, what is the percentage of your monthly debt obligations (inclusive of the proposed mortgage loan) divided by your monthly income? This is called a Debt-to-Income ratio (DTI). Let’s look at a few examples.
- Conventional Loans: These loans typically require a down payment as little as 5% of the purchase price of the home. However, understand that if you make a down payment that is less than 20% of the purchase price of the home, you’ll be required to make monthly mortgage insurance payments in addition to your monthly mortgage payment on the loan. As with any loan, you’ll need to consider how much of a down payment you can afford in conjunction with how much of a monthly mortgage payment you can afford. For example, the larger the down payment you make, the smaller your monthly mortgage payment will be. And if you make at least a 20% down payment, your mortgage payment will be even smaller given you will not be required to make a monthly mortgage insurance payment. Do note that for a 1-unit primary residence, 100% of whatever down payment you make can come in the form of a gift from a family member. Conventional loans typically require a maximum DTI of 50% so your monthly income will have to be at least twice as much as your monthly debt obligations in order to qualify. Lastly, you’ll also need at least a 620 credit score to qualify.
- FHA Loans: These loans are great for borrowers who may not have excellent credit, who can’t make a larger down payment and/or who may have a greater percentage of debts in relation to their income. FHA loans require a down payment as little as 3.5% of the purchase price of the home. Like Conventional loans, 100% of that down payment can come in the form of a gift from a family member. FHA loans will often allow a DTI that is slightly higher than Conventional loans (e.g. 55% vs. 50%). However, do understand that regardless of the size of your down payment, all FHA require monthly mortgage insurance payments in addition to your monthly mortgage payment. Lastly, most lenders allow a credit score as low as 580 on FHA loans.
- VA Loans: Are you or your spouse a Veteran? If so, this is likely a great option as the Department of Veterans Affairs offers home loans to Veterans with no down payment requirement. In today’s world where home prices are higher than ever, not having to make a down payment is huge. Further, VA loans will typically allow a DTI that is higher than Conventional loans (and even FHA loans in some cases). Lastly, there is no monthly mortgage insurance required on a VA loan regardless of how much of a down payment you make and most lenders allow credit scores as low as 580. If you or your spouse is a Veteran, ask your mortgage professional about a VA loan.
- NQM Loans: What if you can’t qualify for a Conventional, FHA or VA loan? A Non-Qualified Mortgage (NQM) may be an option. As with most any loan, a borrower must document that they earn enough income to afford the loan (as well as their other debt obligations) through traditional income sources (paystubs, W2s, tax returns, etc.). In some cases, a borrower simply cannot document sufficient income using traditional sources. For example, a self-employed borrower must qualify for a Conventional, FHA or VA loan by providing tax returns. In many cases, a self-employed borrower cannot qualify because the tax returns do not show sufficient income. That’s where a NQM loan can come into play as they require alternative income documentation. NQM loans allow for alternative income documentation. A common income documentation type that is tailored for self-employed borrowers is a Bank Statement loan. These loans qualify a self-employed borrower’s income using personal or business bank statements as opposed to tax returns. In many cases, bank statements render much more income than tax returns and thus allow a self-employed borrower to qualify for a loan that they wouldn’t have otherwise qualified for. NQM loans generally require at least a 10% down payment for a borrower with good credit. And like Conventional loans, they typically allow a maximum DTI of 50%. As far as credit scores are concerned, NQM loans generally allow credit scores similar to that of FHA or VA. However, a lesser credit score generally equates to a higher down payment.
The moral of the story is that you’re not in this alone. There are multiple loan products out there for you to take advantage of. Contact a mortgage professional and let them help guide you through what may very well be the largest purchase you make in your life.