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With housing prices being at record levels in many markets across the country, affordability has become a serious problem. But there’s no group for whom this is a bigger issue than first-time homebuyers.
The combination of high house prices and often limited financial resources of first-time buyers can make a home purchase especially difficult. But there is help in the form of first-time homebuyer programs. These programs may enable you to purchase a home even though you wouldn’t qualify under traditional mortgage financing.
But be aware that first-time homebuyer programs are often more complicated and less well understood, even within the lending community. For that reason, you should know which programs are available, and have at least a general understanding of how they can benefit you.
7 First-Time Home Buyer Programs
First-time buyers are critical to the entire housing market, and for that reason, first-time homebuyer programs are available from several different mortgage sources.
In some cases, the basic mortgage program itself serves as an effective first-time homebuyer program. In others, it works in combination with a second mortgage or government grant program that eliminates the down payment requirement.
- VA Mortgages
- NADL (Native American Direct Loans)
- USDA Mortgages
- FHA Mortgages
- FNMA (Fannie Mae) & FHLMC (Freddie Mac) First-time Homebuyer Programs
- Retirement Funding
- Down Payment Assistance & Government Grants
VA mortgages themselves are one of the very best first-time homebuyer programs in existence. Eligible veterans can obtain financing equal to 100% of the property they’re buying.
The veteran will need to qualify based on both income and credit, but guidelines are relaxed when compared to conventional mortgages.
For virtually all first mortgages in this guide, including VA mortgages, the maximum loan limit for single-family homes is $510,400 for 2020, with higher limits for two-to-four unit properties. But in the case of VA loans, there are provisions to make loans that exceed these limits.
NADL (Native American Direct Loan)
The Native American Direct Loan program is offered as part of the VA loan program. It’s available for eligible Native American veterans and their spouses, providing an opportunity to use VA loans to purchase, build, or improve homes on Federal Trust Land.
The loans require no down payment or private mortgage insurance. They also have low closing costs and an interest rate of 3.75% on a fixed-rate 30-year mortgage. The VA funding fee is reduced to 1.25% and is added to the loan amount.
You will need to qualify based on income and credit, but the qualifications are more relaxed than other loan types.
Like VA mortgages, USDA mortgages can cover 100% of the cost of a home. You can even increase the loan amount by 6% to cover closing costs.
You don’t have to be an eligible veteran to qualify either. But since USDA mortgages are designed for lower-income borrowers purchasing properties in generally rural areas, there are income limits.
You can even use a USDA loan to make repairs or renovations to the property you’re purchasing since it’s not unusual for rural properties to be in some state of disrepair. There are certain property limits. For example, the home must generally be no more than 2,000 square feet, have no inground pools, and not be designed to produce income.
The Federal Housing Administration (FHA) doesn’t offer zero down payment mortgages, but they do provide financing for borrowers with impaired credit.
With most FHA mortgages, you’ll need to make a down payment of 3.5%. But those funds can be provided by a gift from a family member, and often from first-time homebuyer grants.
If you’re a law enforcement officer, firefighter, emergency medical technician, or teacher, FHA also has a special program called Good Neighbor Next Door. The program offers a 50% discount off the purchase price of eligible properties and is designed to encourage the renewal of revitalization areas. The program is only available for properties offered for sale by HUD, but it can be a real opportunity for a first-time homebuyer to purchase a home at a deep discount.
FNMA and FHLMC First-time Home Buyer Mortgage Programs
Conventional mortgages are typically issued by either the Federal National Mortgage Association (FNMA, or “Fannie Mae”) or the Federal Home Loan Mortgage Corporation (FHLMC, or “Freddie Mac”).
Conventional mortgages are generally available for borrowers with average or better credit, and normally require a down payment of at least 5% of the purchase price. But if you have less than 20% down on the property, private mortgage insurance, or PMI will be required. The premiums are calculated on an annual basis and will be added to your monthly house payment.
PMI is not to be confused with homeowner’s insurance, which covers damage to the property. PMI protects the mortgage lender if the borrower defaults. This type of insurance acts as an incentive for lenders to make low down payment conventional mortgages to qualified buyers.
Both Fannie Mae and Freddie Mac offer special first-time homebuyer programs.
FNMA HomeReady & Community Seconds
For Fannie Mae, the program is called HomeReady, and it enables first-time homebuyers to purchase a home with as little as 3% down. However, eligible borrowers can obtain secondary financing through a program known as Community Seconds. When a HomeReady first mortgage and a Community Seconds loan are combined, borrowers can receive financing equal to up to 105% of the purchase price of the property.
It’s available in both fixed-rate and adjustable-rate mortgages, with terms of 30 years. Borrowers must qualify based on income and credit, but there are reduced private mortgage insurance requirements. The borrowers’ income cannot exceed 80% of the area median income where they’re purchasing the home
FHLMC Home Possible & Affordable Seconds
Freddie Mac has a similar program for first-time homebuyers called Home Possible. It allows first-time homebuyers to purchase a home with as little as 3% down.
And even the down payments itself can come from different sources, including:
- A gift from a family member
- Employer assistance programs
- Secondary financing
- Even sweat equity
Eligible borrowers can also finance up to 105% of the purchase price of the property using a combination of a Home Possible first mortgage and an Affordable Seconds second mortgage.
Like HomeReady, income is limited to 80% of the area median income. But the program offers both reduced closing costs and private mortgage insurance coverage.
Retirement Funds Can Be Used for Your Down Payment
Maybe you don’t have enough money in savings to make a down payment on a home, but if you have a retirement plan, that could be your source of funds.
Under IRS regulations, you can withdraw up to $10,000 from an IRA account without having to pay the 10% early withdrawal penalty. You’ll still have to pay ordinary income tax on the amount of the withdrawal, but it may be a way to obtain funds for a down payment if you don’t have other savings.
Borrowing from Your Employer-Sponsored Retirement Plan
Still another source is an employer-sponsored retirement plan, like a 401(k) or 403(b) plan. You can’t make withdrawals from these plans to purchase a home, but you can take a loan if it’s permitted by your employer.
Though not all employers allow it, IRS rules allow you to take a loan of up to 50% of the vested balance of your plan, up to a maximum of $50,000.
If you do take a loan for the down payment, you’ll have five years to repay the borrowed funds. And unlike withdrawing funds from an IRA, you won’t have to pay tax on the distribution.
Most mortgage lenders will allow a retirement plan loan for the down payment because it represents funds secured by an asset you own. Other types of financing, such as taking cash advances against credit cards or securing personal loans, are not permitted down payment sources.
Down Payment Assistance Programs & Government Grants
One of the biggest obstacles confronting all first-time homebuyers is the down payment. Even though down payments are available as low as 3% to 5%, that can still be a lot of money in an area with very high house prices.
For example, in Los Angeles County, which is the county with perhaps the single largest housing market in the US, the median price for a home is just over $635,000. A 3% down payment would require coming up with more than $19,000, while a 5% down payment would require nearly $32,000. And neither figure takes into account closing costs and tax and insurance escrows.
That’s a substantial amount of money for a first-time homebuyer, who may have a below-average household income.
Down Payment Assistance
Many states, counties, and cities offer down payment assistance programs. Though they may be initially set up as loans, they ultimately function as first-time homebuyer grants.
In most cases, you’ll need to meet certain income limits, which most typically is when you are below the median household income for your county of residence. There may also be a maximum property purchase price or even a specific geographic requirement. (Local governments often attempt to target homebuying in certain neighborhoods in an effort to revitalize those areas.)
You may also be required to live in the property for a certain minimum number of years for the down payment assistance to convert to a grant. If you sell the property or move out and convert it to a rental in less than the required minimum amount of time, the assistance may be fully due and payable.
Other programs may require you to make a small monthly payment, which will be required for a certain number of years. Once you reach that threshold, the loan is forgiven, converting it to a grant.
First-time Homebuyer Grants
Local government housing assistance and grants usually work in conjunction with other mortgage types, particularly FHA mortgages. For example, an FHA mortgage will provide financing for 96.5% of the purchase price of a home. That will require a 3.5% down payment from the homebuyer. The local government program or grant will provide the funds for that down payment, effectively enabling the buyer to purchase the home with no down payment.
Since they are available in virtually every state, you can check with a mortgage lender to see when they are available.
Typically funded by state or local government bond issues, the availability of funds can change. When a bond issue is approved, the funds are available. But once the issue has been exhausted, the program will cut off participation until the next bond issue.
To learn which first-time homebuyer grants are available in your state, check with the popular mortgage industry website HSH.com.
What Qualifies You as a First-Time Homebuyer?
What qualifies you as a first-time homebuyer may come as a complete surprise to most people. The common interpretation – logically – would be a person who has never owned a home. But while that’s true in an absolute sense, the definition is very different for lending purposes.
The specific definition of a first-time homebuyer varies depending on the first-time homebuyer program you are participating in. But as a general description, many loan programs are based on the definition provided by the US Department of Housing and Urban Development.
Here are the qualifications for a first-time homebuyer:
- An individual who has had no ownership in a principal residence during the 3-year period ending on the date of purchase of the property. This includes a spouse (if either meets the above test, they are considered first-time homebuyers).
- A single parent who has only owned with a former spouse while married.
- An individual who is a displaced homemaker and has only owned with a spouse.
- Individuals who have only owned a principal residence not permanently affixed to a permanent foundation per applicable regulations.
- An individual who has only owned a property that was not in compliance with state, local or model building codes and which cannot be brought into compliance for less than the cost of constructing a permanent structure.
Since HUD is a major player and influencer in the entire US housing industry, their definitions are widely accepted throughout the industry. But be sure to check the specific definition for any and all first-time homebuyer programs you plan to work with. Not only can they vary somewhat from one plan to another, but they may also be modified over time.
Where to Find First-Time Homebuyer Programs
The best way to find first-time homebuyer programs is to contact lenders in your area. Most first-time homebuyer programs are handled through direct mortgage lenders, rather than by the program sponsors themselves.
Since not all mortgage lenders participate in all first-time homebuyer programs, you should visit the websites of the program sponsors. They often provide lists of participating lenders in each market of the country.
Whatever program you hope to take advantage of, interview the lender representative to determine his or her level of expertise. Most of these programs have substantial departures from traditional mortgages and require special training. Only work with those lenders that demonstrate a clear understanding of the specific program you want to participate in.