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First-Time Home Buyers: How to Qualify for Loans, Programs and Grants

Only 37% of first-time homebuyers can afford the standard 20% down payment, according to a report by Zillow. While that might sound shocking, it's no wonder when you consider that Americans have record-breaking credit card debt and oppressive student loan balances.

Fortunately, some mortgage loans are designed to help people who can't afford a big down payment. What's more, first-time homebuyer programs and grants can help you get the cash you need to close on your loan. To improve your chances of getting into a home, know what's available and which steps you need to take to get help.

What Are the Different Loans, Programs and Grants?

State and federal governments and nonprofit organizations offer several types of programs to help first-time homebuyers secure a mortgage. Here are just a few examples:

  • Conventional mortgages. Conventional loans are mortgages not backed by a government agency. Some loans backed by Fannie Mae and Freddie Mac require a minimum down payment of just 3%.
  • Government agency—insured loans. These are loans insured by the Federal Housing Administration (FHA) and require a minimum down payment starting at 3.5%. Loans insured by the Department of Veterans Affairs and the Department of Agriculture have no minimum down payment requirement.
  • Secondary loan programs. Some states offer homebuyers a secondary loan to help with a small down payment and closing costs. Some examples include the California MyHome Assistance program and Tennessee's Great Choice Plus program.
  • Down payment grants. Some programs make outright grants, rather than loans, for down payments, meaning this money does not need to be paid back. For example, the National Homebuyers Fund offers a down payment assistance grant worth up to 5% of the loan amount to low- and moderate-income homebuyers, whether or not it's their first home purchase.

Who Is Eligible for a First-Time Buyer Program?

Specific rules vary according to the state, county or city program. Some common guidelines:

  • Past owners can be first-time buyers. Typically, anyone who has not owned a home in the past three years is considered to be a first-time buyer.
  • Some programs are for all buyers. Down Payment Resource maintains a national database of around 2,400 programs that offer mortgage assistance. According to DPR, about 40% of the programs aren't solely earmarked for first-time buyers.
  • You don't need sparkling credit scores. FICO® Scores* of at least 640 or so are typically all that are needed to qualify for first-time homebuyer assistance. FICO® Scores range from 300 to 850. But chances are you may need higher credit scores of around 680 or so to qualify for a conventional mortgage. For more, see "What is a Good Credit Score?"
  • Help is targeted to public service workers. Some programs are specifically focused on helping teachers and public safety workers. The Good Neighbor Next Door program is open to law enforcement, primary school teachers, firefighters and emergency medical technicians. The deal: 50% off the list price of a home that is in the program's database, as long as you agree to stay in the home for at least three years.
  • Income limits apply. These programs are designed to help low- and moderate-income households afford a home. Eligibility is often linked to the local median income; the limit is typically more for households with multiple occupants.
  • There's an eligible home price cap. Both conventional mortgages and FHA-insured loans have specific borrowing limits in the continental U.S. State and local agencies may have different limit requirements to be eligible for first-time buyer assistance.
  • Class required. Many programs require borrowers to complete a class (it can be online) that walks through the financial responsibilities of homeownership. There may be a fee for this class.

How to Find Programs You May Be Eligible For

  • Fire up your browser. Make a few different passes at an online search. First, type in the name of your state with the phrase "first-time homebuyer program" and then again with "homebuyer program." You should get results that send you to specific pages at your state's Housing Finance Agency. Then repeat the exercise, plugging in your county to see if there are local programs available.
  • Sit down with a lender who specializes in first-time buyer programs. Not all lenders are authorized to offer FHA-insured loans. (You can search online for FHA-approved lenders.) And not all lenders are up to speed on how the 3% down payment for conventional mortgages work. Ask friends, family and real estate agents for recommendations of lenders that close a lot of mortgage deals for first-timers and that have experience adding state or local grants or loans to help get the deal done.

How to Qualify for a Mortgage Loan

Whether or not you use a first-time homebuyer program to get into your new home, you'll still need to qualify for a mortgage. Here are some steps you can take to be proactive:

  • Check your credit reports and scores. Do this at least three months in advance to give yourself time to address any issues. You can get a free credit report from Experian.
  • Check your debt-to-income ratio.debt-to-income ratio (DTI), calculated by dividing your monthly debt payments by your monthly gross income, tells lenders whether adding a new loan would stretch you too thin. Mortgage lenders use two rules of thumb with your DTI: The first is to keep your monthly housing costs below 28% of your gross income, and the second is to keep your total monthly debt payments below 36% of your gross income.
  • Consider your options. If your credit score is below 620, which is typically what lenders require for conventional mortgage loans, don't fret. It is possible to get a mortgage with bad credit (you can go as low as 500 with 10% down payment on an FHA loan). Just keep in mind that you'll have fewer options and may need to pay a higher interest rate. If you want a better selection of lenders and a lower interest rate, try improving your credit scores before applying for a mortgage.
  • Address potential issues. If your DTI is on the high end or you found something troubling on your credit report, address the concerns immediately. For example, pay down your credit card balances, get caught up on late payments and dispute any errors you find. These actions can take a while to reflect in your credit score, so it's critical that you start working on them as soon as possible. Also, avoid applying for credit cards and other loans leading up to your mortgage application and throughout the mortgage process.

Getting Preapproved for a Mortgage

Before you start house hunting, it's wise to get preapproved. Not only does this show sellers that you're serious but also that there's a good chance the sale will go through if they accept your offer. Take these steps before seeking preapproval.

  • Don't confuse a preapproval with a prequalification. A mortgage prequalification gives you an estimate of how much you can borrow, but it doesn't require a credit pull or in-depth information. A preapproval, on the other hand, requires a full mortgage application along with supporting documents and a hard credit pull. A prequalification can help you determine your budget but isn't as convincing as a preapproval.
  • Gather your documents. A mortgage is a major financial commitment, both for you and the lender. So expect to share a lot more documentation than you would if you were applying for other loan types. Requirements can vary by lender, but expect to at least share your pay stubs, W-2s and tax returns for the past couple of years, bank statements for the past few months, other applicable income documents, information on your other debts and copies of your government-issued ID.
  • Shop around. If you're planning on buying a home soon, consider getting preapproved by more than one lender. This won't necessarily make a difference to sellers, but it can give you a chance to compare interest rates and terms with several lenders, as well as their customer service. That way, when you find the house you want, you'll be ready to go with the lender that offers the best terms.

Additional Costs to Consider

There are programs that can help you with your down payment and closing costs, but there are some other costs to consider as you determine your budget.

  • Mortgage insurance. If you're applying for a conventional mortgage or FHA loan and your down payment is less than 20%, chances are that you'll have to pay some form of mortgage insurance. Private mortgage insurance (PMI) applies to conventional mortgage loans and can cost between 0.5% and 1% of your loan amount. With an FHA loan, you'll pay mortgage insurance premium (MIP), which includes an upfront payment of 1.75% of the base loan amount and an annual charge of 0.45% to 1.05%, depending on your base loan amount and down payment.
  • Homeowners insurance. This covers you against losses and damage caused by various perils, including burglary, fires and storms. Cost can vary depending on where you live, but you can generally expect to pay around $35 per month for every $100,000 of home value. If you live in a flood zone, you may also be required to buy flood insurance.
  • Property taxes. Your county, city or school district may charge property taxes to generate revenue. Property tax rates can vary depending on where you live, so check with your county assessor's office to find out your annual rate.
  • Homeowners association fees: If your new home is within the bounds of a homeowners association (HOA), you'll likely need to pay an investment fee to join and monthly dues. Check with the real estate agent or HOA directly to find out the cost.
  • Repairs and maintenance: Depending on the state of the home, these ongoing costs can be unexpected and regular or infrequent. As a result, it's wise to not use all of your spare cash for the down payment and closing costs. Instead, hold some back in an emergency fund in case you need it.

Grab Your Tax Credit

After you buy a home, you may be eligible for additional financial help. Your main mortgage charges interest. All homeowners, regardless of income, can claim mortgage interest as a deduction on their taxes. A deduction reduces your taxes based on your tax rate. For example, if you have a $1,000 deduction and you are in the 25% tax bracket, your deduction reduces your taxable income by $250 ($1,000 x 0.25%).

An even better deal is a tax credit. A tax credit reduces your taxes dollar for dollar. If you have a $1,000 tax credit, your taxable income is reduced by the full $1,000.

If you meet certain income requirements, you may be eligible for a mortgage tax credit that allows you to claim a credit on up to $2,000 a year in mortgage interest payments. If your mortgage interest is more than $2,000, you can claim the rest as a tax deduction. That means you can reduce your taxable income for the year by $2,000. To claim this credit, you must obtain a Mortgage Credit Certificate (MCC) from your state or local housing agency.

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