You may have heard about the “renter’s trap.”
That’s a self-perpetuating cycle where you’re renting, and you’d like to save up for a down payment on your first home purchase, but you can’t, because you keep having to pay for rent.
Gathering a down payment may not be the only barrier to owning your first home. You also need a qualifying credit score and an affordable home that fits your needs. That trap is tricky.
Luckily, a first-time homebuyer has several options to help overcome these barriers and escape the renter’s trap. We spoke to Bart Tipton, a top real estate agent based in Bakersfield, California, with over 18 years of experience, to talk about the pitfalls — and perks — of being a first-time homebuyer.
Is it worth the effort to switch from renting to owning?
“Yeah,” he tells us, “over the period of time … the appreciation rate [often] outpaces the rate of inflation. … It’s hard to time the market, but if you’re in it over the long run … you’re most likely always gonna come out ahead.”
So maybe it’s time to start paying your own mortgage (and stop paying your landlord’s).
First thing’s first: Who exactly is a ‘first-time homebuyer’?
The answer isn’t as obvious as you might think. Certainly, someone who has never bought or owned a home before is a first-timer.
But having owned a home doesn’t necessarily disqualify you. Many people may be considered first-time homebuyers according to the definition from the Department of Housing and Urban Development, but not realize it. For example:
Someone who hasn’t owned a home for three years or more
That’s right: Your status resets. If you haven’t owned a home in the last three years, congrats: You are a first-timer again.
A single parent who has only owned with a former spouse
If your home ownership was with someone you were married to, but aren’t anymore, your previous ownership doesn’t count toward your first-timer status.
If your spouse hasn’t owned a home
Maybe you’ve owned a house before. If you marry someone who hasn’t, you may still be considered a first-time homebuyer.
This outdated and cringe-worthy term sounds like the title of a Charlie Chaplin movie, but it refers to someone who provided (unpaid) services tending to their family. They have been out of the traditional workforce, but are no longer supported by the spouse they owned the property with.
Someone who owns property that’s prohibitively not up to code
If you own property not in compliance with local or state building codes, and it can’t be brought into compliance for less than the cost of building a new and permanent structure, that ownership doesn’t count against your status.
If your residence doesn’t have a permanent foundation
You may fall under this category if you’ve only owned a principal residence “not permanently affixed to a permanent foundation in accordance with applicable regulations.” Think mobile home.
As of summer of 2021, it’s still a seller’s market, and Tipton is “seeing a lot of multiple offers,” making it even more intimidating for all types of first-timers to enter the market. But let’s make that less daunting, starting with the down payment.
Down payment assistance programs (DPAs)
There’s a common perception that you have to start with a standard down payment of 20% of your new home’s value. The advantage of a larger down payment is that the more you pay up front, the smaller your loan (and monthly payments).
This 20% also sidesteps the need for private mortgage insurance (PMI), which is protection for the lender in case you can no longer make payments on your loan (note that PMI applies to conventional loans). If your loan requires PMI, you pay for it, usually as a premium added to your monthly mortgage payment.
Unfortunately, 20% can be a lot of money, and a lot of first-timers can’t swing it. Fortunately, you don’t necessarily need a 20% down payment to buy a house.
In practice, most buyers don’t pay anywhere near that much up front (the average is actually closer to 5%), which eases the immediate burden a bit. But in addition to that, first-time homebuyers can apply for down payment assistance programs.
These take many forms, including grants (which don’t have to be repaid), loans that you pay down alongside your mortgage, and even loans that are forgiven if you live at your new residence for a qualifying number of years. Most are specifically for first-time buyers, and they vary by state.
“In California,” Tipton points out, “we have CalHFA,” which he describes as a “low down-payment assistance program.”
Let’s take a look at CalHFA as an example:
CalHFA’s MyHome Assistance Program is a “subordinate loan” of up to 3.5% of the cost or value of your home, and you can use this loan toward your down payment or closing costs. CalHFA’s website refers to these loans as “silent seconds,” meaning that payments are deferred until your home is sold, refinanced, or paid off. So in addition to boosting your down payment, this subordinate loan helps make your monthly mortgage payments more affordable and offers you a break before you have to repay it.
Certain qualifications also need to be met — a minimum credit score, income limits, and a completed course in the basics of homeownership.
Every state has down payment assistance, and each program has its unique details and requirements, so take some time to check out what’s available for you.
The federal government takes an interest in making homeownership more available to its citizens, with the assumption that owning strengthens our communities and economy. So a first-time homebuyer has many potential options to tap into, including government-backed programs like Federal Housing Administration (FHA) mortgages, the USDA Home Buyer Assistance Program, and loans for veterans through the Department of Veterans Affairs.
Federal Housing Administration (FHA) loans
The FHA is part of the U.S. Department of Housing and Urban Development, so the federal government insures these loans. As a result, they can offer low down payments and less stringent credit score requirements, two features that will be particularly attractive to a first-time buyer. (“One of FHA’s highest priorities is to assist homebuyers with the purchase of their first home,” states an online HUD reference guide.) The minimum down payment is 3.5%, which is a little higher than Fannie Mae requires, but the minimum qualifying credit score for that down payment is lower (580).
Why does the United States Department of Agriculture insure home loans? They’re intended to make homeownership more accessible for low-to-moderate income buyers in rural areas. But according to their site, their definition of “rural” isn’t just for agricultural land; it has expanded to include “small towns, suburbs and exurbs of major U.S. cities,” with emphasis on low-income as well as rural areas.
To get buyers into these homes, these government-backed mortgages offer loans at $0 down, which is otherwise almost unheard of (outside of VA loans). However, there are stricter requirements for a USDA loan compared to an FHA loan. The qualifying credit score is higher (640), and your income typically can’t be more than 15% above the median income of the area, in keeping with their goal of encouraging lower-income ownership. But for the right buyer, this can be a great opportunity.
Along with the USDA, the U.S. Department of Veterans Affairs offers the other government-insured loan that doesn’t require any down payment. It’s available exclusively to “servicemembers, veterans, and eligible surviving spouses,” with further eligibility tied to length and character of service. People who have served in the military are further helped into homeownership with the absence of private mortgage insurance.
Conforming loan programs
In addition to these government-backed programs, first-time homebuyer programs designed by the government-sponsored enterprises (GSEs), Fannie Mae and Freddie Mac, also provide a great opportunity for well-qualified first-timers. Fannie Mae, the first GSE, was formed in the wake of the Great Depression in an effort to stabilize the mortgage market and make homeownership more accessible. (TRIVIA: The name comes from pronouncing the acronym FNMA, the Federal National Mortgage Association.). Freddie Mac was created in the 1970s to further expand these efforts. These GSEs were designed to create a secondary market for banks and lenders to sell mortgage loans that meet certain qualifying standards (known as “conforming mortgage loans”), allowing them to free up capital to make more loans.
Both Fannie and Freddie have created strong first-time homebuyer programs that allow for low down payments and competitive rates.
Fannie Mae HomeReady® and HomePath®
FNMA offers a program called HomeReady® that offers mortgages with a down payment of as low as 3%. Homebuyers must have a credit score of 620 or higher.
Fannie Mae HomePath® offers first-time homebuyers an online course on homeownership to become eligible for up to 3% additional toward closing costs on HomePath® properties — properties Fannie Mae owns that have been foreclosed upon.
Foreclosures can happen for a number of reasons, but there is a possibility that these homes have fallen into some state of disrepair, so keep that in mind.
“I would probably not recommend any fixer-uppers for a first-time homeowner,” Tipton tells us. “Unless [the buyers are] very, very handy, and know exactly what they’re doing.”
Freddie Mac’s HomeOne® and HomePossible®
Freddie Mac’s HomeOne® program allows for down payments as low as 3% down for qualified buyers, and Freddie’s HomePossible® program expands that even further by allowing borrowers to utilize friends or family to help with their down payment or to qualify for their mortgage as a non-occupying co-borrower.
The GSEs offer these programs through banks and other mortgage lenders, so talk to a qualified loan originator who can help you figure out which of these programs might best work for you.
Borrowing from your future self
Many of the loans listed above are useful to first-time homebuyers, but not necessarily exclusively for them. But here’s a perk for first-timers only: You can withdraw funds from your IRA without penalty. Usually, any money you withdraw before the age of 59.5 would carry a hefty fee of 10%. But not if you’re using it to buy your first home.
The maximum you can withdraw is $10,000. If it’s two buyers — you and a spouse, for example — you can combine your withdrawals for a total of $20,000, which would make a pretty decent down payment (about 6% of a median 2021 home price of $340,000).
But exercise caution: You’d also be diminishing your savings. Other penalty-free opportunities to borrow from your IRA include things like medical emergencies, so approach this tactic with that level of seriousness.
Great! So, is it easier for a first-time homebuyer to qualify for a loan?
These solutions offer boosts to a first-timer, but they’re not handing you a home on a silver platter. You’ll still need to qualify for a mortgage. First-time buyer programs can make your down payment more accessible, but credit score and DTI requirements are the same whether you’re a first-timer or a repeat buyer.
“Have a price range that you’re comfortable with,” Tipton also advises. “Just because you’re approved for a certain amount doesn’t mean you should spend that much.” So if you’ve received any advice that you should “buy as much house as you can afford,” proceed with caution. It might be wiser to make sure you have some money saved for the unexpected.
And last but not least, Tipton says to “make sure [first-time buyers] find a good real estate agent to help out and lead them down the road.” Contact a top HomeLight buyer’s agent today and take your first step out of that renter’s trap!
Header Image Source: (Joshua Hanks / Unsplash)