First Time Buyer - What Is The Best Mortgage?

If you are a first time home buyer who has never investigated their mortgage options before, you have plenty to learn and understand about how mortgages work before you can choose the best mortgage for your situation.

Mortgage Requirements

Before exploring different mortgage options, you will need to know about how lenders review your application and decide whether or not to approve your request for a mortgage. Two main criteria apply. The first is your ability to pay back a mortgage. This is evaluated on the basis of your total monthly income and total monthly debt. In general, a monthly income to debt ratio of 36-40% (where your total monthly expenses do not exceed 36-40% of your monthly income) is desirable. The second factor is your willingness to pay, and is represented by your credit rating.

As a rule, the lower your credit score or the higher your income to debt ratio, the lower your chances of being approved for a conventional mortgage. For the lender, the risk is higher when either of these two situations applies, and the borrower pays for this higher risk with less attractive mortgage terms and conditions, such as a higher interest rate.

Conventional Fixed Rate Mortgages

For many first time buyers, the simplest loan is often the best, and it doesn't get much simpler than a fixed rate 30 year mortgage. This is a standard home loan that the average person who meets the above two criteria will find affordable.

Adjustable Rate Mortgages have their Uses

First time home buyers may prefer to steer clear of mortgages with a variable interest rate, however they are beneficial in certain situations. The advantage is that borrowers can obtain a much more affordable interest rate for the first few years of the mortgage. However, after the initial fixed rate interest period expires, the interest rate becomes adjustable according to an economic index that fluctuates with the market.

The advantage for first time buyers is that the majority of such people do not live in their first home for more than a few years. This means a first time buyer with an adjustable rate mortgage can enjoy the lower interest rate during the fixed rate period, and may be ready to purchase a new home by the time the adjustable rate period begins.

This should be approached cautiously, however. If you are not ready to move when the adjustable rate period begins, you may end up having trouble making payments if interest rates have climbed sharply during the fixed rate period. It is also important to note that moving to a new home will require paying another round of closing costs.

More complicated variations on the adjustable rate mortgage, such as the pay-option version, should be avoided. The pay-option offers a very low initial interest rate, and also allows the borrower to several different payment options. They can choose to make a fully amortized (interest plus principal) payment, an interest-only payment, or a minimum payment that does not even cover the interest for the month. The danger is the temptation to make only minimum payments. When this happens negative amortization occurs, where the unpaid interest is added to the principal balance of the loan. This is particularly risky because an unwary home owner can end up owing more than their home is worth if the real estate market takes a dive.

Getting a Mortgage with a Small Down Payment

A conventional mortgage with an affordable interest rate usually requires a down payment of anywhere between 10% and 20% of the value of the property. In general, it is best to use the largest down payment you can afford, both to reduce the size of your mortgage and so that you don't have to pay private mortgage insurance.

First time buyers with small down payments do have some options-it is even possible to obtain a 100% mortgage that requires no down payment at all. The disadvantage to buyers is that these loans are considered highly risky by mortgage lenders. The buyer pays for the higher risk with private mortgage insurance or higher interest rates. It also means that the buyer builds up home equity much more slowly.

FHA-Backed Mortgages

The Federal Housing Association provides would-be home owners with another means of obtaining an affordable loan, by providing insurance for mortgage loans so that they minimize the risk to lenders. This allows buyers with smaller down payments to obtain affordable mortgages with more favorable interest rates. This is perhaps the best option for a first time buyer, as they can obtain a conventional fixed rate mortgage even if they have a down payment of less than the standard 20%. These mortgages can also be a good option for buyers with lower credit ratings, as FICO scores are not an eligibility criteria for applicants of FHA-backed mortgages.