First-Time Home Buyers Guide

Buying your first home is a major milestone, but there's a lot to consider before calling your real estate agent. As a first time home buyer, you need to be able to qualify for a mortgage based on your credit score, income, down payment, and level of debt. You also need to make sure you're truly ready for homeownership and the costs that go along with it, including closing costs, property taxes, and ongoing maintenance and repair expenses.

If you're buying a house for the first time, this first-time home buyers guide will help you make sure you're making the right decision. You'll learn about how you get approved for a mortgage and key factors to consider before making your purchase. You'll also learn about first-time home buyer programs you can take advantage of and home loans ideal for first-time buyers. Let's dive in.

Your ability to qualify for a home loan depends on on these factors:

• Your credit score
• Your debt-to-income ratio
• Your employment history
• The amount of your down payment

Government-backed loans, including loans guaranteed by the Veterans Administration (VA), Federal Housing Administration (FHA), and U.S. Department of Agriculture (USDA) tend to have easier qualifying requirements than conventional loans, which are not guaranteed by any government agency.

Credit score

Minimum credit score requirements vary by lender for conventional loans. Most popular credit scoring models, including the FICO? Score, work on a scale of 300 to 850, and scores of 740 or above are considered to be very good or excellent.

Generally, most mortgage lenders like to see a score of at least 620, which is considered a fair credit score. To qualify for loans at the most competitive rates, you'd need a score of about 740 or higher.

Credit score requirements are lower for FHA, VA, and USDA Loans.

• The minimum score you'd need with an FHA loan is 500 if you make a 10% down payment or 580 with a 3.5% down payment. Check out our list of the best FHA lenders.
• VA loans do not have a minimum credit score, but many lenders like to see a score of 620 or higher. Read our list of the best VA loans.
• The USDA doesn't set a minimum credit score, but lenders often prefer a score of 640 or higher. We've also ranked the best USDA loan lenders.

Debt-to-income ratio

Mortgage lenders want to make sure you have enough money to pay your mortgage loan. To determine this, they look at both your income and your level of debt. There are actually two different debt-to-income ratios they consider:

• Your front-end ratio: This is calculated by comparing your income to your mortgage costs (including principal, interest, taxes, and insurance, or PITI). If your mortgage costs total $900 per month and your pre-tax income totals $5,000, your front-end ratio would be 18% ($900 divided by $5,000). Most conventional lenders prefer a front-end ratio of no more than 28%, although some lenders are flexible and VA, FHA, and USDA loans allow for a higher ratio.
• Your back-end ratio: This ratio is calculated by comparing total debt costs to income. Some debt payments that are factored in include your mortgage payment, car loans, other loan payments, and credit card debt. Utility payments, car insurance, and certain other monthly bills not reported to major credit reporting agencies aren't considered. Typically, lenders prefer this ratio to be below 43%, although some have stricter ratios. You may be able to qualify for VA, FHA, and USDA loans with more debt relative to your income.

Employment history

Lenders want to know your source of income is stable. As a result, for both conventional and FHA loans, you'll need to show your income has been steady over the past two years. Tax returns, pay stubs, W-2s, and 1099s can all be used to demonstrate that you've had a consistent income. While there's more flexibility with VA and USDA loans, most lenders will still require that you show you've worked regularly.

If you have large gaps in your employment history, have changed jobs often, or have had wild fluctuations in your earnings, lenders may not be willing to count all your income when determining your debt-to-income ratio. Self-employed borrowers may also be subject to additional scrutiny when it comes to verifying income sources. This is because a salary from an outside employer is often seen as a more reliable source of income.

But as with other qualifying requirements, some lenders are more flexible than others in approving a loan without two years of steady earnings.

Down payment

Ideally, a first-time home buyer would have enough money to make a 20% down payment on their home. This would mean you would need $40,000 if you were purchasing a $200,000 house. However, many borrowers fall short of this goal.

It is possible to get a conventional mortgage with as little as 3% down, although you may need a higher credit score or lower debt-to-income ratio. You can also qualify for a USDA or VA loan with no down payment or an FHA loan with just 3.5% down if your credit score is at least 580.

However, while VA loans don't require mortgage insurance, the FHA and USDA do. And conventional lenders require private mortgage insurance (also known as PMI) if you put down less than 20%. This insurance is an added cost to you and it protects lenders from losses if they must foreclose, but provides you with no protection if you can't pay your bill.

Many mortgage types allow you to use a down payment gift from close relatives or friends as part of your down payment. And some mortgage types, such as FHA, VA, and USDA loans, let you cover your entire down payment using a financial gift from someone else.

Homeownership is considered part of the American dream, so there are lots of government programs that aim to help you with buying a home for the first time. USDA loans, VA loans, and FHA loans referenced above are all ideal options for first-time home buyers due to their more relaxed qualifications. But there are others as well, including the HomePath Ready Buyer Program and others through Fannie Mae, Freddie Mac, or local authorities.

Fannie Mae HomeReady Mortgage

This program caters to first-time buyers or repeat buyers with low incomes and limited money available for down payments. It requires a minimum credit score of 620, and your earnings can't exceed 80% of the median income in your local area. First-time buyers must take a homeownership education course. If you complete the course and qualify, you can get a mortgage with as little as 3% down.

Fannie Mae 97% loan-to-value mortgage

First-time home buyers can qualify for a 30-year fixed-rate mortgage or an adjustable-rate mortgage with as low as a 3% down payment. A homeownership education course is required if all co-borrowers are first-time borrowers, and all borrowers must have a minimum credit score of 620 or higher. Income requirements don't apply to this program.

The HomePath Ready Buyer? Program

This program is for first-time buyers who complete an educational course and buy a foreclosed property from HomePath owned by Fannie Mae. It pays for closing costs valued at up to 3% of the purchase price of the home. Buyers must plan to make the home their primary residence and begin living in it within 60 days of the time of closing.

Freddie Mac HomeOne? Loan

This loan is open to first time home buyers who have a minimum credit score of 620. It allows you to get a loan with a down payment as low as 3%, but you must complete a homeownership education course if all borrowers are first-time homeowners. There are no income limits for this program.

Freddie Mac Home Possible?

This program also allows you to qualify for a loan with a down payment of just 3% of the home's price. It's not limited only to first-time borrowers but there is a maximum income limit of 80% of area median income.

State-specific programs

Many states also offer programs designed for first-time home buyers. You can check with your state's Housing Finance Authority to find out about low-interest loans, loans with easy qualifying requirements, grants, and other forms of assistance in your area. You can also enroll in a local first-time home buyer class to find out about programs and considerations specific to your region.

Before buying a home for the first time, you need to make sure you're financially and personally prepared for the home-buying process. To make this decision, ask yourself these 10 questions.

1. Do you plan to remain in your home for at least five years?

There are many costs associated with buying and selling a home. Because of that, most experts agree it isn't a good idea to buy unless you plan to remain in the home for at least five years. Over that period, the home will ideally appreciate enough in value that you can recoup the expenses associated with its purchase and sale.

2. Will you qualify for a loan based on your financial credentials?

As mentioned above, lenders consider your credit score, debt relative to income, and employment history when determining if you are eligible for a loan. If you don't qualify for a mortgage, or if you qualify only for a loan with a very high interest rate, you may want to wait until you're in a better financial position before becoming a first time home buyer.

3. How much money do you have for a down payment?

You can qualify for some types of home mortgages with as little as 3% down or with no down payment at all. But this usually isn't a good idea. There are added costs associated with taking out a mortgage loan that doesn't require a down payment, even with government-guaranteed mortgages such as FHA or VA loans. And not having a down payment puts you at risk of owing more money than your home is worth.

If you borrow enough to cover almost the entire price of the home, when you want to sell, it could be difficult to make enough money to pay off your full mortgage -- especially after accounting for real estate agent expenses and other closing costs. This could trap you in your home, even if you need to move because your financial or job situation changes.

A large down payment protects you from ending up underwater, which is what it's called when your mortgage is more than the value of your house. You ideally want a large enough down payment that your home is still worth more than you owe on it, even if the real estate market declines.

If you can save a 20% down payment, you'll be in a good position since you likely won't end up underwater and you can also avoid paying for private mortgage insurance or other fees.

4. How stable is your job?

Lenders want to see stable employment history, but it's also a good idea for you personally to make sure your income is reliable. You don't want to buy a home and become unable to make payments because you lost your job.

5. How is the real estate market in your area?

It can be difficult to predict what will happen with the real estate market. Still, you can look at factors such as how long homes are on the market and whether they're selling at asking price, or above it or below it, to assess whether it's a buyer's or seller's market. If it's the right time for you to buy and you plan to stay put for a long time, it may not matter much. But ideally, you want to try to avoid buying when home prices are at their peak.

6. Can you afford a home in your area?

Most experts recommend you keep your housing costs below 30% of your income. If homes are very expensive in your area, it may not be feasible to buy without borrowing too much and becoming house poor. If you tie up too much of your money in your home, it could be difficult for you to save for retirement or accomplish other financial goals.

One way to save money on a home is to buy a starter home. These are generally smaller, less expensive homes. You may be able to afford the mortgage on a starter home, then upgrade to a larger home when your income is higher.

7. What mortgage terms can you qualify for?

For most Americans, their mortgage is the largest debt they take on. Qualifying for favorable mortgage rates is important to avoid paying more than necessary.

When you borrow so much and pay it off over such a long time, even a small difference in interest rates can make a big impact. A $300,000 loan at 6.75% and 20% down would come at a total cost of $560,043 with monthly payments of $1,556 over 30 years, while the same loan at 7.25% would cost $589,281 with monthly payments of $1,637.

8. Do you have enough money for closing costs?

Closing costs are an inescapable expense when buying a home and they can total around 2% to 5% of the purchase price. Make sure you're prepared for all expenses of owning a home, including:

• Loan origination fees
• Home inspection fees
• Appraisal fees
• A credit check
• Homeowners insurance
• Homeowners association fees
• Prorated property taxes
• Title insurance (this protects you in case there is an unexpected ownership claim on your property)
• Recording fees
• Transfer taxes
• An escrow deposit (this could include depositing several months of mortgage and insurance payments in an escrow account)
• Mortgage insurance upfront premiums (for some type of loans such as FHA Loans)
• Other closing fees
• Loan discount points if you want to buy down the interest rate

While some lenders allow you to borrow to cover some of these closing costs, if you do, you'd be paying interest on them over many years. It's often best to pay upfront if you can afford to do so.

9. Do you have an emergency fund?

Many experts recommend setting aside 1% of your home's value every year to cover repair costs. Others suggest budgeting $1 per square foot for maintenance and repair.

Whatever metric you choose, you need to be prepared to pay when things break. You also want to be sure you don't miss a mortgage payment due to a drop in income or an increase in your expenses.

An emergency fund helps you be ready for the responsibility of homeownership. Ideally, this fund will cover three to six months of living expenses (including your new mortgage payment). That will help ensure you're able to cover costs that arise after you've purchased your home. You can use our emergency fund calculator to determine how much you can expect to save.

10. Do you have money for moving expenses?

Moving can be very expensive, especially if you're making a long-distance move. Make sure you have money to cover the cost of getting your possessions into your new home.

The right home loan for a first-time buyer will depend on many factors, including your financial credentials and the size of your down payment. Many first-time buyers will find it easier to qualify for a loan that's guaranteed by the government, such as an FHA loan, VA loan, or USDA loan.

However, if you have good credit, low debt relative to your income, and a reasonable down payment, a conventional loan may come with lower fees and a better interest rate than these government-backed loans.

When you are shopping for a home loan, you should get mortgage quotes from at least three lenders. Look for lenders that provide pre-qualification without a hard credit check, as too many hard credit inquiries can adversely impact your credit score. When comparing quotes, the key factors to consider include the following:

• Interest rate: Lower rates -- which are reserved for the most qualified borrowers -- can reduce the cost of your monthly payments and total cost of your loan.
• Fixed vs. adjustable-rate mortgages: Fixed-rate mortgages often start at a higher rate, but the rate and payment amount won't change over time. This provides you with more certainty as you don't have to worry about costs rising. Adjustable-rate mortgages (ARMs) generally start at a lower rate, but the rate is tied to a financial index, so it can change. This means your mortgage payments can change over time. Typically, an ARM will have a fixed rate for a period of time before adjusting. A 5/1 ARM, for example, would have a fixed rate for the first five years, and the rate could then change once each year.
• Loan term: A 30-year repayment term is very popular, but you also have the option to choose other repayment terms, such as a 15-year mortgage. The longer the loan term, the higher the total repayment costs but the lower your monthly payment.
• Points: Homeowners have the option to pay points, or buy down the rate by prepaying a portion of interest. If one mortgage offer has points and the other doesn't, you aren’t comparing apples with apples. Each point costs 1% of the amount of your mortgage and reduces your rate by 0.25%.
• Upfront fees: Consider loan application costs and origination fees, the cost of an appraisal and credit check, and other expenses associated with the loan.
• Qualifying requirements: Some lenders have more lenient requirements than others.

For most borrowers, a fixed-rate mortgage is the best option because there is no risk of payments rising. Borrowers who will likely move or refinance within a short time may prefer an adjustable-rate mortgage to get lower upfront costs. And while there are other mortgage options, such as interest-only loans or loans with a balloon payment, these are high-risk loans that should usually be avoided.

If you're looking for even more information, check out our Home Buyer Checklist for everything you'll need to know about buying a home.

Still have questions?

Here are some other questions we've answered:

• How to Create a First-Time Homeowners’ Budget
• Beginner's Guide to Mortgages
• Starter Homes: What Are They and Is One Right for You?