When you decide you want to buy a home for the first time, it might be all you think about for a while: What should it look like? Where do you want to live? Bedrooms? Open plan? Condo? Neighborhood vibe? Walkability score? Schools? Pool? (Fingers crossed for pool.)
Good questions, all. But there are a few other questions you need to be asking, too. For example, is your debt-to-income ratio and credit score ready? That can take a little bit of time. But once you’re ready to hit “go” on your search, you’ll want to start the process with a good understanding of what comes next.
In this article, we’ll talk about four things you need to know as a first-time homebuyer:
Types of mortgages and how they work
Loans, programs, and mortgages you might consider
How to apply for a mortgage
What goes into home-buying costs
The basics of how mortgages work
A mortgage is a loan you take out to buy a home. You will be paying back two things. First, there’s the “principal” — aka the cost of the house plus any other costs you want and are able to add to the loan, such as renovations and closing costs. The second thing you’ll pay back is interest.
There are three mortgage decisions you’ll typically need to make: Do you want fixed-rate or adjustable-rate? How long do you want to take to pay off the mortgage — 15 years, 30 years, or a different length of time? And how much can you afford to put down as a down payment?
Let’s talk about those things.
Fixed-rate vs adjustable-rate mortgages
A fixed-rate mortgage charges you a set interest rate that doesn’t change for the entire loan. An adjustable-rate mortgage (ARM), aka a variable-rate mortgage, starts out with an interest rate that’s below what a similar fixed-rate loan would have. That rate holds for a set time (typically three, five, seven, or ten years), but then could possibly (and often does) go up later on.
We generally recommend fixed-rate mortgages because they’re easy to plan around. ARMs can be tempting because that initial rate is so low — but they’re much more complex, and the sticker shock when the rate goes up can be a lot for most people.
15-year vs 30-year mortgages
The two most common timeframe terms for mortgages are 15 years and 30 years. A 15-year fixed payment mortgage comes with higher monthly payments, but typically also with a lower interest rate and a larger loan (so you can buy more house). That means you’ll end up saving money over the course of the loan … but only if you can afford the monthly payment. That’s why 90% of buyers opt for a 30-year fixed payment instead — it comes with lower monthly payments than the 15-year fixed payment mortgage, and it’s more predictable than an adjustable-rate mortgage.
I sometimes still recommend taking a 30-year mortgage even if you think you want to pay it off in 15 years. You can plan to make the same-size payments you’d have made with a 15-year mortgage, but this way, your required minimum payment could be lower if you need it to be. You might end up paying a little bit more in interest, depending on how it shakes out, but you’d also have so much more flexibility to help you handle life’s curveballs.
The amount of down payment you can afford
We usually recommend making a 20% down payment, if possible. The less money you put down initially, the easier it is to get “underwater” (aka “upside-down”) if the value of your house drops — you’d owe more in mortgage payments than your house is worth. Housing prices have been going up for a while, and the trend is expected to continue in 2021 as so many people delayed buying in 2020. When the inevitable price correction happens, you don’t want to be caught; I’ve seen that really trap people financially.
If you’re thinking of putting less than 20% down on a home, know that you’ll also need to pay for private mortgage insurance (or, for certain loans, a federal mortgage insurance premium). That’s extra money that you’re “giving away” since it’s not going to either principal or interest, and the terms can be hard to change or get out of. You have to pay a portion of it up front, too, so it’s going to hit your closing costs.
That said, I want to note two things. First, I always suggest you run a “rent vs buy” calculator. In some cases, the math works out so that it’s really worth it to buy a home even if you don’t have a full 20% down payment. Your calculator should automatically factor in PMI costs for down payments under 20%.
And second, homeownership is a tool to build wealth that’s been less available to BIPOC people, especially Black people, due to systemic racism, and saving for a down payment is one of the biggest blockers to owning a home. The good news is there are loans and programs that can help, and a new focus on making the home-buying process fairer and easier.
Loans and programs for first-time homebuyers
There are lots of different ways you can get help as a first-time buyer. Some of the below are actual loans, some are insurance programs working with lenders, and some are payment assistance programs. The best program is the one you’re eligible for and can afford; for most people, a Federal Housing Administration (FHA) or a conventional loan that can be backed by Fannie Mae or Freddie Mac will be their best bet for a good rate and good terms.
Don’t worry about choosing a lender right now; that can come later when you’re totally ready to buy. What you want to do early on is get familiar with your options.
Government-insured (or partly insured) loans
The US government doesn’t lend directly, but it does have several programs that can help — either by backing the loan (to give incentives to lenders like banks) or by providing you aid. There are often restrictions: Common ones include income limits and restriction of use to buying a primary residence (aka the house where you’ll actually live), and you generally can’t combine the special government-insured loans with Fannie Mae or Freddie Mac programs (more on those in a sec).
The Federal Housing Administration is the world’s largest insurer of residential mortgages. It guarantees a portion of the loan, and then your lender does the rest. That means you might be able to go forward with a lower credit score or a smaller down payment (though again, by doing so, you’d run a higher risk of going underwater if the home’s value drops).
FHA loan requirements are much less strict than conventional mortgage loans — you can get one with a credit score in the 500s — the higher your score, the less you’ll be required to put as a down payment — and a debt-to-income ratio that’s a bit higher than elsewhere, up to 43%. You’ll also need to pay a mortgage insurance premium (no matter how much you put down — even if it’s more than 20%) and prove that you have steady income. You can also borrow money for home improvement and combine it with your mortgage into one loan.
If you’re an eligible service member, veteran, or surviving spouse, a VA loan can be a really great benefit. You’ll need to pay a funding fee for the loan — but there’s no minimum credit score, no mortgage insurance, better terms and interest rates, fewer closing costs … and possibly even no down payment. If you are a vet and you or your spouse is Native American, you can also apply for a Native American Direct Loan for a home on federal trust land.
With an Energy Efficient loan, you can borrow the money you need for energy-efficient upgrades to your new home and combine it with your mortgage into one FHA or VA loan. It may help you qualify for a larger loan, too.
The HomePath Ready Buyer program gives 3% in closing cost assistance to first-time buyers. You have to take a class, and you have to buy a “Fannie Mae-owned home,” aka a home Fannie Mae has foreclosed on (see below for more on Fannie Mae). That means the property may not be exactly where you want to live, and may not be in the best shape — but they’re very affordable.
USDA loans might make you think they’re for farms, but they’re really for houses in rural areas. This program guarantees 100% of your loan, possibly with no down payment. There are income limits, and your home must be in a qualified rural area.
The Good Neighbor Next Door buyer aid program gives housing aid (aka money) to first responders and teachers buying from a list of properties in “revitalization areas.” Downside: Those areas are limited. Upside: The program can help with up to 50% of the listed price (whoa).
Fannie Mae and Freddie Mac
If you aren’t going through any of the programs above, your mortgage loan is called a “conventional” loan.
Fannie Mae and Freddie Mac are government entities that work with local mortgage lenders to insure conventional loans. Lenders tend to prefer loans backed by either of these two, which are called “conforming loans” since they conform to Fannie and Freddie’s requirements. Conforming loans must fall below a limit, which is set based on housing prices in the county. (PS: In case you were wondering, “Fannie” and “Freddie” evolved out of acronyms, but they’re the official names now.)
If the mortgage you want exceeds these limits, it’s called a “jumbo mortgage” and can’t be backed by a federal agency. Those mortgages require you to show you’re in a really good financial state to apply successfully because they’re bigger, not backed, and not insured.
First-time buyer loan programs in your state
Beyond the major federal programs, you can also find a lot of resources within your state. Generally, you have to already be a resident (not moving from another state) and intend to use your first home as a primary residence. Typically, they’ll have credit and income limits. They can also come with an educational requirement which you may have to pay a fee for. But they’re worth it; many of them help pay closing costs and down payments, and they often work with FHA and VA loans. Check the Housing and Urban Development list to find programs in your state.
What you’ll need to successfully apply for a mortgage loan
The first part: A good credit score and debt-to-income ratio. (That’s covered in detail here.) Lenders will want to know about anything that shows up as a debt. If you’ve got student loans, expect to share your typical student loan payment. (You might not be paying right now because of the pandemic, but they’ll still ask what it was.) If you’re on an income-based repayment plan, they might ask you what your “normal” payment would have been otherwise.
They’ll also ask you about your source for a down payment, and they’re pretty picky about where that comes from — basically, they don’t want you to go into debt to take on a much bigger debt. If it’s savings in cash, obviously great. If it’s coming from family members, it needs to be a gift, not a personal loan. Many 401(k) plans allow for taking out loans against your vested balance to buy a house. These loans don’t count against your debt-to-income ratio, but a lender will deduct the available balance of a 401(k) loan by the amount you’ve borrowed. (Just check the fine print of the loan to understand whether you’d have to pay it all back right away if you were to change jobs.)
If you get a jumbo mortgage (remember, that’s one that doesn’t conform to the loan amount limits for Fannie Mae or Freddie Mac backing), lenders will have tighter restrictions — usually they’ll require great credit and at least 15% down (if not 20%), and possibly 6–12 months’ worth of payments in assets. But in my experience, only about 25% of people end up needing this kind of mortgage.
How to find a mortgage lender
Once you’ve decided on your price range and know your mortgage options, you can start searching for a mortgage lender. And shopping around matters: Two-thirds of homebuyers in a study said they did comparison shop, and they got better terms than those who didn’t.
Look at different kinds of lenders — including online lenders, banks, and credit unions. (Online sites like Bankrate can help you with your initial comparison shopping — but they don’t have all of the possible lending programs listed, so do some digging to see what’s available in your local area.) See what kind of initial rates you’re quoted on the type of mortgage you want, then narrow your options down to a handful of contenders.
Next, it’s time to apply for a mortgage preapproval with several different lenders so you can drill down on the terms they’ll offer. A preapproval is not a guarantee of lending, but it is basically a head start — the potential lenders will go through your credit history and other requirements thoroughly in order to offer you terms before you settle on the property itself. (You can expect them to do this again at any time later on in the process, so keep a lid on trying to obtain any other new credit until the house is officially yours.)
Also worth noting: When you’re thinking about making an offer on a home, a preapproval is also usually better than “pre-qualification.” The preapproval makes it much more likely that the lender will actually give you the loan, since they've gotten a head start on the loan application.
Calculating the other costs of buying a home
Once you’ve figured out your mortgage options, it’s time to start calculating the costs. Besides the cost of the mortgage itself, there are two other types of costs: closing costs and moving costs. When you’re budgeting, aim to save up an extra 3–5% of the home price to cover these two things.
Also good to know: The length of time it takes to close on a house might vary — the current average is 42 days, with FHA and VA loans averaging a few days longer … but it can take a lot longer than that.
The various fees you need to pay to seal the deal can typically be rolled into your mortgage loan — though you may want to just pay them up front so you can save on interest. They include:
A portion of your property tax up front (typically 3–6 months)
Title search fees (most of the time)
Attorney’s fees to help make sure the title is clear
Title transfer fees (for the county to record you’re the owner)
Tax on the transfer in most states
Extra money down up front to get a lower interest rate (called “paying points”), which is another amount that can go into the costs
An origination fee for the lender to do the paperwork
Renovation costs, if you want to roll them into the mortgage
Most of the cost of moving can’t be rolled into a mortgage, but you’ll still want to budget for it. Here’s what you should be thinking about:
Renting equipment and boxes and things
Taking time off of work
Hiring movers (the cost of which varies, depending on the level of service and distance)
Furnishing costs — which are optional, but pretty much always happen because rooms need things to sit on and such
Now that you have all the tools to get a clear picture of how mortgages work, you can start putting your plans in (slow but intentional) gear: working on your credit score and debt-to-income ratio, exploring the programs that might work for you, and building up the funds you’ll need to get there.
If you’re an Ellevest Executive member, your investing goals include one for homebuying that uses live Zillow data to make deposit recommendations specific to the area you’re looking at. And then you can spend more time on the hunt for your new home. Good luck, and congrats on this big next step!
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You may or may not have noticed that we linked to a page on nerdwallet.com as the source for info on paying points and jumbo mortgages. FYI, NerdWallet, Inc (“Solicitor”) serves as a solicitor for Ellevest, Inc. (“Ellevest”). Solicitor will receive compensation for referring you to Ellevest. Compensation to the Solicitor will be $20 per membership activated. You will not be charged any fee or incur any additional costs for being referred to Ellevest by the Solicitor. The Solicitor may promote and/or may advertise Ellevest’s investment adviser services. Ellevest and the Solicitor are not under common ownership or otherwise related entities.
You may or may not have noticed that we linked to https://www.investopedia.com/ for the percentage of buyers who opt for a 30-year mortgage. FYI, Investopedia (“Solicitor”) serves as a solicitor for Ellevest, Inc. (“Ellevest”). Solicitor will receive compensation for referring you to Ellevest. Compensation to the Solicitor will be $10 per membership activated. You will not be charged any fee or incur any additional costs for being referred to Ellevest by the Solicitor. The Solicitor may promote and/or may advertise Ellevest’s investment adviser services. Ellevest and the Solicitor are not under common ownership or otherwise related entities.
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