Details for Applying a Mortgage for First-Time Home Buyers

Introduction

Buying a home is undeniably one of the most significant and extensive purchases for any
American, whether working for the federal government, private employers, or self-employed.
Buying a home is often considered by most investment experts as a worthwhile project because
housing property appreciates every year. Although planning to purchase a home is an exciting
experience, it can be overwhelming if proper preparations are not made. Successfully applying
for a mortgage requires applicants to consider multiple things before starting the process. This
includes where one desires to live, the style of housing, price ranges, and how inflation and other
economic factors affect the housing market (Rawson, 2022). This paper explores all the
necessary details and requirements for applying for a mortgage for first-time home buyers,
including a checklist for first-time applicants, the types of mortgage loans available, income and
equity requirements, and “special plans” for first-time homebuyers.
A Checklist for First-Time Home Buyers
a. Step 1 – Make an Estimate of the Price You Can Afford
The first thing for any home buyer is to figure out how much they can afford to splash on
a home. This information is crucial because it assists one in narrowing down their search.
Lenders often examine an applicant’s DTI (debt-to-income) ratio. DTI is a person’s income
percentage that is spent monthly to offset debts like credit cards, student loans, and car loans.
Most lenders prefer a DTI of between 43-45 percent (Rawson, 2022).
b. Step 2 – Start Saving to Make a Down payment.
After getting a rough estimate of the home one wishes to buy and estimating the DTI, the
next most critical step is to consider how much the individual is willing to commit as a down

3
payment. It is important to note that a PMI (Private Mortgage Insurance) is needed if the
applicant does not make a 20 percent down payment. Additionally, one might be required to set
aside funds to cover property taxes, closing costs, homeowner insurance, and, occasionally, a
homeowner’s association fee. Mortgage applicants must add up all these costs to determine how
much home they can afford.
c. Step 3 – Improve the Credit Score
Creating an excellent credit score presents a significant upper hand for any home buyer
applying for a mortgage. A good credit score can help the applicant meet the requirements or be
eligible for a better interest rate, which could save thousands or hundreds of thousands of dollars
over the loan’s lifespan. Therefore, interested home buyers are often advised to monitor their
credit scores regularly and seek tips from experts on how to improve their scores through
methods like paying off debts and bills on time (Rawson, 2022).
d. Step 4 – Compiling the Paperwork
After reviewing the costs linked with purchasing a new home and determining the
budget, the applicant is ready to compile all the financial documents and paperwork to apply for
the loan with lenders. Besides the financial documents, it is essential to note that lenders often
consider the applicant’s job stability, preferably two years above. People working part-time must
have been employed for at least two years to leverage overtime, commission, and bonus, among
other things. One must produce a few standard requirements when applying for a mortgage,
including credit history, bank statements, tax returns, pay stubs (previous 2-3 years), and the W2
forms (last two years). A pay stub, also known as a paycheck stub or pay slip, outlines the
payment details for each period, for example, every month. The W2 form displays critical details

4
about an employee’s income, benefits provided, taxes withheld, and other payment information
in a financial year.
e. Step 5 – Getting Prequalification
Prequalification for a mortgage means an applicant can confirm their eligibility as a
credible home buyer to the potential seller. This is paramount in a competitive market because it
can help the applicant stand out as a more legitimate client. Therefore, homebuyers are often
recommended to consult mortgage experts and representatives to assist in getting prequalified for
a loan based on which one fits their budgets, financial benefits, and preferences.
f. Step 6 – Selecting the Appropriate Mortgage
Choosing the correct or appropriate mortgage (loan) option is the final step for any
homebuyer, who often has a myriad options to choose from. Without proper due diligence, it can
be challenging for newbies to settle on the loan plans that best fit their budgets and needs. When
borrowing money from lenders to finance a home, one makes a legally-binding commitment to
repay it over a specified period (albeit with interest). Therefore, like any other loan, the mortgage
borrower must consider factors like the principal, interest rates, and the repayment period. The
section below discusses some common types of mortgage loans new applicants can consider
(Rawson, 2022).

Types of Mortgage Loans

i. Conventional Loans
Conventional loans refer to uninsured mortgages or those loans guaranteed by the
national government. These loans are fixed-rate mortgages and the most difficult to obtain
because they have stricter qualifications than other plans. They often require significantly lower
DTI ratios, higher credit scores, more significant down payments, and potential for PMI (private

5
mortgage insurance). Despite being the most difficult to qualify for, conventional mortgages are
cheaper than guaranteed loans guaranteed by the government (Green, 2013).
Conventional loans are classified as either conforming or nonconforming. Conforming
mortgages are loans that comply with guidelines like loan limits defined by the Freddie Mac and
GSEs (government-sponsored enterprises). These lenders usually purchase and package
conforming loans before reselling them as securities in secondary markets. The optimum
conforming mortgage limit in 2022 is roughly $647,200. Any loan above this limit is referred to
as a jumbo loan, and they come with slightly more interest rates and risk, making them
unattractive. In conforming mortgage loans, the lenders underwriting them often set their “own”
policies and guidelines. Nonconforming loans are not retailed in secondary markets because
lender set their own guidelines.
ii. Federal Housing Administration or FHA Loans
FHA loans are an integral component of the US Department of Housing, offering a wide
range of mortgage loan programs for US citizens. The advantage of an FHA is that they offer
lower down payment conditions, and they are easier to qualify for than conventional loans. FHAs
are an excellent option for first-time home buyers since they incur less up-front costs and have
less strict credit conditions. Applicants can deposit a down payment of as little as 3.5 percent.
The only undoing with FHAs is that borrowers must pay mortgage insurance premiums.
However, a mortgage insurance shields titleholders or lenders from risks if the borrower dies,
defaults on payments, or is incapable of meeting the legal or contractual obligations (Green,
2013).
iii. US Department of Veteran Affairs or VA Loans

6
The VA (Department of Veterans Affairs) does not provide loans but guarantees
mortgages created by approved or accredited lenders. The guarantees issued by the VA permit
veterans to access mortgage loans at favorable terms, often without having to deposit down
payment. In most instances, VA loans have less strict requirements than conventional loans.
However, lenders tend to restrict the max VA loans to levels matching conventional loans.
However, before applying for a VA loan, an applicant must request an eligibility report from the
VA. If one qualifies, the VA usually issues an eligibility certificate that is used to apply for a
mortgage loan (Green, 2013).

Income and Equity Requirements

House mortgage loan prices are often calculated or implemented by lenders in two
different ways, with the two approaches relying on the borrower’s creditworthiness. Besides
scrutinizing the borrower’s FICO score, lenders usually compute the DSCR (debt-service
coverage) and LTV (loan-to-value) to establish the amount they can be ready to offer applicants,
plus interest rates (Chandy & Ding, 2021).
Loan-to-value refers to implied or actual equity available in the collateral the borrower is
placing to borrow the loan. LTV is calculated by subdividing the loan amount by the home’s
buying price. Lenders usually presume that putting more money in terms of a down payment
significantly lowers the risk of defaulting the loan. A higher LTV translates to a greater default
risk; thus, lenders tend to charge more. This is why borrowers must list any qualifying income
during negotiations with lenders.
Private Mortgage Insurance or PMI
Lenders also used loan-to-value to gauge whether a borrower must purchase a PMI.
Private mortgage insurance is important to lenders because it protects them from the risk of

7
defaulting by transferring a section of the loan risk to the insurers. A more significant proportion
of lenders often demand that borrowers provide a PMI for loans with loan-to-value amounts
exceeding 80 percent. Typically, this refers to all loans whereby the borrower owns below 20
percent equity in the purchased house. The mortgage program and the money being insured
establish the price of the insurance, including how it will be collected (Webber, 2022).
Many insurance premiums are taxed monthly, alongside property insurance and tax
escrows. When the loan-to-value level is below 78 percent, the PMI is erased automatically. A
borrower can also nullify a PMI once the house being acquired has risen in value to award them
a 20 percent home equity and the specified time limit has elapsed, for example, after two years.

Special Plans for First-Time Homebuyers

a. Individual Retirement Accounts or IRAs
Each first-time house buyer qualifies for a mortgage loan of up to roughly $10,000 based
on IRA (individual retirement account) plans without being charged a 10 percent levy for
withdrawing early. The limit applies to an individual, meaning that a couple can withdraw close
to $20,000 from a Roth individual retirement account for home acquisition. The couple can
withdraw these funds without being penalized, as long as they both have Roth accounts five
years or older. However, this applies only to early withdrawal. If one withdraws from traditional
individual retirement accounts, one must pay income tax for all funds withdrawn (Michel, 2005).
b. Ready Buyer Program
The FNMA (the Federal National Mortgage Association) HomePath Ready Buyer
Program, or Fannie Mae, is a package created for first-time home buyers in the US. This
program gives up to nearly 3 percent of financing toward closing costs on the acquisition of

8
foreclosed houses owned by Fannie Mae. For eligibility, buyers are required to under a
compulsory home-purchasing education course before placing their offers (Michel, 2005).
c. Down Payment Assistance Programs
Most states have down payment aid arrangements for first-time home purchasers. Buyer
eligibility or qualification varies from state to state, although most of these programs are
generally steered toward lower-income public servants and individuals (Michel, 2005).

Conclusion

Buying a home in the US for first-time buyers can pose a significant challenge if
applicants fail to follow the proper procedures and protocols. The six critical steps that all first-
time home buyers must consider are: (1) making an estimate of the price of the home one can
afford, (2) saving for a down payment, (3) improving the credit score, (4) compiling the
paperwork, (5) getting prequalification, and (6) selecting an appropriate mortgage plan. The
three significant mortgage loans to consider are conventional, federal housing administration,
and VA loans. DSCR and LTV are the two integral income and equity requirements to consider.

9

References

Chandy, S., & Ding, W. (2021). Bank investing: A practitioner’s field guide. John Wiley & Sons.
Green, R, K, (2013). Introduction to mortgages and mortgage-backed securities. Academic
Press.
Rawson, C. (2022, May 12). 11 tips for first-time homebuyers. The Balance.
https://www.thebalance.com/tips-for-buying-your-first-home-1798337\
Webber, M. (2022, Mar 17). Why private mortgage insurance can be a good thing. Lansing State
Journal. https://www.lansingstatejournal.com/story/marketplace/real-
estate/2022/03/17/why-private-mortgage-insurance-can-good-thing/7073751001/