When Does Underwriting Take Place During the Loan Process?

When does mortgage underwriting take place, within the broader context of the mortgage lending process? This is a common question among first-time home buyers and mortgage applicants.

The short answer is that it takes place somewhere in the middle of the process. It happens after the loan application has been completed, and before the final approval and funding. In fact, mortgage underwriting is a necessary step that paves the way for the final loan approval.

Mortgage Underwriting Defined

Elsewhere on this website, we’ve offered an in-depth explanation of the mortgage underwriting process. That article also provides a basic definition of underwriting. This is a process lenders use to determine a borrower’s ability and willingness to repay a loan. They do this by looking at the borrower’s credit history, income, debts, and other financial components.

It can take anywhere from a few days to a few weeks, depending on several factors.

Getting back to the question at hand: When does the mortgage underwriting process actually take place? It usually happens in the “middle” of the overall lending process. This will be easier to understand if we look at underwriting within a broader context.

When Does It Take Place

First, a disclaimer: The mortgage lending process can vary from one borrower to the next, for a variety of reasons. There are many steps in the process, and a lot of variables along the way. So your experience might differ slightly from the series of steps listed below. With that being said, mortgage underwriting generally takes place somewhere in the middle of the loan process.

For home buyers, the sequence usually goes like this:

  1. The borrower completes a standard loan application to start the process.
  2. The borrower gets pre-approved for a specific loan amount.
  3. The home buyer finds a house and makes an offer to purchase it.
  4. The buyer then goes back to the mortgage company with a signed purchase agreement, to continue the loan process.
  5. The mortgage lender will arrange for a home appraisal to be completed.
  6. A title search will be completed to check for liens or other title issues.
  7. The loan then moves into the underwriting stage, for an in-depth review.
  8. The underwriter approves of the loan and says the borrower is “clear to close.”
  9. The loan gets funded, usually within a few days of the closing date.

So that’s when mortgage underwriting takes place within the broader scope of the lending process. It generally takes place after the application has been completed, and after the home has been appraised. It occurs before final loan approval and funding. It’s a necessary step that paves the way for the final approval.

What Should the Home Buyer Do at This Stage?

We’ve talked about when underwriting occurs. It takes place after the initial loan application, and after the home appraisal (in most cases).

The next logical question is: What should the home buyer be doing at this stage in the mortgage process? The most important thing is to stay in touch with your loan officer, and handle any paperwork requests in a timely fashion. This will help keep things on track for the closing.

Much of the underwriting process happens “behind the scenes,” from the borrower’s perspective. It happens without direct involvement or participation from the home buyer / borrower.

But there are occasions when the underwriter will request items from the borrower. This might be additional documents needed to underwrite the loan, or a letter of explanation relating to a certain financial transaction.

As a borrower, the best thing you can do is handle these requests as quickly as possible. This will help prevent any unwanted delays that might interfere with closing. Aside from that, much of the underwriting process is out of your hands. You just have to wait for the review process to be completed.

Related: What underwriters might ask for

In recent years, technology and streamlining have expedited this process a bit. Today, mortgage companies are able to approve loans in less time, compared to five or ten years ago. There seems to be a big push in the industry right now for delivering faster results to borrowers.

Home Inspection Contingency Clauses for Buyers

This article is part of a series that explains the different kinds of contingencies that can be included within a real estate purchase agreement. Today, we will take an in-depth look at the home inspection contingency in particular. Home inspection clauses are a common element in purchase contracts. So it’s important to understand how they work.

Home Inspection Contingencies Explained

Within the context of a real estate purchase agreement or contract, a “contingency” is a condition that must be met — or an action that must be completed — in order for the sale to move forward. There are several different kinds of contingencies, including one that pertains to the home inspection.

Definition: A home inspection contingency is a clause written into a real estate contract that gives the buyer the right to have the house inspected by a professional inspector within a certain period of time. It also allows the buyer to cancel the contract (or negotiate repairs) if they are not comfortable with the inspector’s findings.

How the Process Works

To understand how a home inspection contingency works, it helps to consider it within the broader context of the buying process.

The process usually goes something like this:

  1. The buyers make an offer to purchase a particular home.
  2. The buyers include an inspection contingency within their purchase agreement.
  3. The seller accepts the offer and the escrow process begins.
  4. Shortly after that, the buyer arranges for a home inspection to be completed.
  5. The inspector evaluates the property’s interior and exterior, electrical system, plumbing, roof, foundation and more.
  6. The inspector writes up a detailed inspection report and gives it to the buyer.
  7. Based on this report, the buyer can do one of three things: (1) accept the home as-is, (2) request that the sellers make certain repairs, or (3) walk away from the deal.

So the home inspection contingency gives the buyers the right to order an inspection, and to back out of the deal if they’re unhappy with the results. Most importantly, it allows the buyer to recover the earnest money deposit they provided when they first made the offer. *

* Important note: In order for the buyer to recover the earnest money deposit, it has to be clearly spelled out in the contract (see example below). Otherwise, the buyer could end up forfeiting the deposit. This is usually how it works, though laws and procedures can vary from state to state. Consult with a local real estate professional to be sure.

Example of a Home Inspection Contingency

Below, you’ll find an example home inspection contingency that might be included within a real estate purchase agreement. This sample uses common language that is often used within such contingencies.

Example home inspection contingency:

The Buyers’ offer is contingent upon a satisfactory inspection within ten (10) days. Upon receipt of the results of such inspection, the Buyers may request in writing at any time within that ten (10) day period that the Sellers make certain repairs or that the Sellers reduce the sales price to compensate for such defect(s). Such a request to repair or reduce the price does not terminate the contract and the Sellers shall have ______ days from receipt of such request to agree to make such repairs or reduce the sales price. If the Sellers do not agree, the Buyers shall have ______ days to waive the contingency and accept the property “as-is” or to declare the contract null and void. Earnest money and accumulated interest will be returned to Buyer within 48 hours upon written notification to Seller or his/her agent that contract has been terminated by Buyer.

Note: This is just a generic sample of a home inspection clause. It might not be applicable in all situations. Real estate documents and procedures vary.

Timeline: How Many Days Should it Cover?

In some states, there is a standard or default number of days for the home inspection contingency. But there may also be a blank line where the buyer can enter an alternate number of days.

For example, the standard purchase agreement might state that the “Buyer has 7 (or _____ ) days to request a home inspection.” In this case, the default number of days for the home inspection contingency is seven. But it can be set for a longer or shorter time period, as long as the buyer and seller agree on it.

The standard, or customary, number of days allowed for a home inspection can vary. In most cases, the buyers will have the property inspected within days of the purchase agreement being signed. So these clauses are usually set for somewhere between five and ten days.

Once the inspection has been completed, the buyers’ agent will typically write up an addendum to the original purchase agreement that removes the home inspection contingency. And the transaction can then move forward unimpeded.

Disclaimer: This article is intended for educational purposes only and does not constitute legal advice. Real estate procedures and documents vary from state to state. Consult a real estate professional in your area if you have specific questions about this subject.

How Mortgage Financing Contingencies Work (With Example Clauses)

The mortgage financing contingency is one of the most common contingencies included within real estate purchase agreements or contracts. Essentially, these clauses give home buyers a way to back out of the deal if they are unable to secure a mortgage loan to complete the purchase. Here’s an overview of how mortgage financing contingencies work, along with an example clause.

What Is a Mortgage Contingency, Exactly?

Within the context of a real estate transaction, a contingency is something that must happen in order for the deal to move forward. The sale of the home can be contingent upon certain conditions or events. These necessary conditions are spelled out within the real estate contract (a.k.a. purchase agreement).

In a previous article, we looked at some of the most common contingencies used by home buyers. The mortgage financing contingency is one of the most commonly used clauses. It basically says that the sale of the home is contingent — or dependent — upon the buyer’s ability to get a loan.

Real estate purchase agreements are binding legal agreements made between the person selling the home, and the person(s) buying it. So it’s important for both parties to understand all of the clauses that are included within the contract. And in some cases, it’s wise for buyers to include certain contingencies within the purchase agreement to protect their interests. The mortgage loan contingency is one such example.

Sample Financing Clause in a Real Estate Contract

As far as the actual wording goes, financing contingencies can vary from state to state. Most states have a standard document known as the residential real estate purchase agreement (or something similar). These documents usually have a fill-in-the-blank section that pertains to the mortgage contingency, if the home buyer chooses to include one.

Here is a sample financing contingency from a purchase agreement:

“This contract is contingent on the ability of purchaser to secure or receive a commitment for the financing described above within 45 calendar days from the date of acceptance of this contract, which commitment or approval purchaser agrees to pursue diligently. If, after making every reasonable effort, the purchaser is unable to obtain the specific financing, and notifies seller of this fact in writing within the term of this contingency, this contract shall become null and void and purchaser’s deposit shall be refunded in full.”

Here are the most important parts of this sample mortgage contingency:

  • Timeframe — In this example, the home buyers have given themselves 45 days to get a loan commitment from their lender. That’s 45 days from contract acceptance to the final loan commitment. After that time, this contingency will expire.
  • Notification — This contract clause also stipulates that the home buyer must notify the seller in writing, if they are unable to secure financing.
  • Refund — If the buyers do not get their loan, the contract becomes “null and void.” This means the buyers can back out of the deal without losing their earnest money deposit. The deposit would then be refunded, as stated in the example contract above.

In the above sample, the buyers gave themselves 45 days to get a loan commitment from their lender. But this is not a standard requirement. The number of days used for mortgage financing contingencies can vary, as explained below.

How Many Days Should You Aim for?

There is no official rule or law that says how long, or how many days, the mortgage contingency should remain active. It can vary from one real estate contract to the next. Usually, it’s up to the home buyer. But the seller must agree to it as well, so the number of days for the financing contingency will have to be acceptable to both parties.

On average, mortgage contingencies included within purchase agreements tend to range from 30 to 60 days. But again, it can vary. And it’s not binding until both parties agree to it in writing, with signatures on the contract. *

Beware of Contingencies in a Hot Housing Market

In most cases, it makes sense for home buyers to include a financing contingency within the real estate purchase agreement or contract. It prevents them from losing the earnest money deposit due to something that’s beyond their control.

But there are some scenarios where buyers should tread carefully. For instance, in a hot housing market where sellers tend to receive multiple competing offers, having too many contingencies could work against the buyer.

Contracts (and the clauses and stipulations that go into them) are an important part of the purchase process. Buyers should carefully consider all of the components that go into the purchase agreement, and that includes any contingencies. When in doubt, ask your real estate agent for advice.

* Disclaimers: This article explains how mortgage contingencies work, and it includes generic language and details that might not apply to your specific situation. Real estate laws and requirements can vary from one state to the next. This article is meant for a general audience and does not constitute legal advice.

Qualifying for a Home Loan as First-Time Buyer: 5 Common Requirements

First-time home buyers tend to have a lot of questions about the mortgage approval process. One of the most common questions we get from our readers is: What are the steps in qualifying for a home loan as a first-time buyer? And what are the minimum qualification requirements for getting a first mortgage loan? Here’s what you need to know.

How to Qualify for a Home Loan as a First-Time Buyer

Mortgage lenders look at a variety of factors when considering loan applications. Income, credit scores, debt ratios, and down payment funds are some of the most important factors for first-time buyers qualifying for a home loan. So let’s talk about each one.

1. Credit Score Requirements

Credit scores are one of the most important qualification requirements for a home loan. This is true for first-time and repeat buyers alike.

Credit scores are three-digit numbers that basically show how you have borrowed and repaid money in the past. They are computed automatically by sophisticated algorithms that use information found within a person’s credit reports. The FIFO credit scoring model is the one most commonly used by mortgage lenders. So it’s generally the one that matters most, when it comes to qualifying for a home loan as a first-time buyer.

Minimum credit-score requirements can vary from one mortgage program to the next. The FHA loan program is one of the most lenient, in terms of credit standards. First-time home buyers who use an FHA loan must have a credit score of at least 580, if they wish to use the 3.5% down payment option.

Conventional home loans (which are not insured or guaranteed by the government) typically have higher credit score requirements. To qualify for a conventional loan, first-time home buyers might need a credit score of 600 or higher. That number is not necessarily written in stone, but it does signify a common cutoff point used by mortgage lenders. Some set the bar even higher at around 620. It can vary.

Related: What’s needed to buy a home?

The bottom line is that a higher credit score will help you when qualifying for a home loan as a first-time buyer. It could also help you secure a lower mortgage rate, which could save you money over time.

2. Basic Income Requirements

Your income level will also affect your ability to qualify for a mortgage loan as a first-time buyer. This is true for repeat buyers as well.

For obvious reasons, mortgage lenders want to ensure that you have sufficient income to repay your home loan obligation.

3. Debt-to-income  Ratios

Household debt is another important qualification requirement for first-time home buyers seeking a mortgage loan. Mortgage lenders will review your current debts to ensure that you are not taking on too much additional debt with the acquisition of home loan.

To do this, they look at something known as the debt-to-income ratio, or DTI. This is basically a comparison between the amount of money you earn and the amount you spend on your recurring debts.

Here again, there is no single threshold that applies across the entire mortgage industry. A lot of lenders today set the bar somewhere around 40% to 43%, in terms of total debt-to-income ratio. Borrowers who have compensating factors might be allowed to have a total DTI as high as 50%. It varies.

The bottom line here is that if your combined monthly debts “soak up” more than 50% of your income, you might have trouble qualifying for a home loan as a first-time buyer.

4. Documents, Documents, Documents

We just talked about how mortgage lenders will verify income and debt levels. They do this by looking at your tax records for the last couple of years, bank statements, pay stubs, and more. Be prepared to provide these and other financial documents when qualifying for a home loan.

5. Minimum Down-Payment Requirements

Down payments are another important requirement for first-time buyers. Unless you use a government-backed program, such as a VA or USDA loan, you will probably have to make a down payment of some kind.

The minimum down-payment requirement for qualifying for a home loan can vary, depending on the type of mortgage being used. Conventional loans can require as little as 3% down in some cases, though some lenders might require 5%. The FHA mortgage loan program allows for a down payment of 3.5% of the purchase price or appraised value.

The good news is that first-time home buyers can obtain down payment funds from a third-party, such as a family member or close friend. Most mortgage programs allow for down payment gifts, which is money given by a third party to the borrower who is actually buying the home.

The important caveat is that the money must truly be a gift, and not an interpersonal law. In fact, the person providing the funds will have to provide a gift letter as well, which must state that they do not expect any kind of repayment.

So those are some of the important considerations when qualifying for a home loan as a first-time buyer. Generally speaking, borrowers seeking a mortgage loan need a decent credit score, a manageable level of debt, and in many cases a down payment.

What Things Are Needed to Buy a Home in 2018?

Over the last few weeks, one of the most common questions we receive from our readers has been: What things are needed to buy a house in 2018?

The answer to this question has changed over the last couple of years, partly because the mortgage industry has eased. So we thought it was high time for an updated look at this question. Here are some of the things that might be needed when buying a home 2018 with a mortgage loan.

3 Things Needed to Buy a House in 2018 (With a Mortgage)

Note: This article assumes that you are using a mortgage loan to finance your purchase. Buyers who pay cash for a house have fewer requirements than those who use loans. But since most people use financing when buying a home, that is the audience we will address.

Here are three things you might need to qualify for a mortgage and buy a home in 2018.

1. A decent credit score, ideally 600 or higher.

You don’t necessarily need perfect credit to qualify for a home loan these days. In fact, the average credit score among close loans has dropped a bit over the last few years. That’s because lenders are relaxing some of their qualification criteria.

So, what credit score is needed to buy a home in 2018?

While the rules aren’t written in stone, a score of 600 or higher will generally put you in a good position to qualify for a home loan and buy a house in 2018. Some lenders might set the bar higher than that, while others will allow for a slightly lower score. It can vary, which is one of the reasons you should shop around.

The FHA program is one of the most “forgiving” mortgage options, when it comes to the credit score needed to qualify. The minimum score required by HUD is 500, but borrowers will need a 580 or higher to qualify for the 3.5% down payment option.

2. A down payment of some kind, at least for most loan programs.

Are you a military member or veteran? If so, you might qualify for the VA mortgage loan program, which offers 100% financing. A down payment is not needed when buying a home in 2018 through the VA loan program. The same goes for the USDA program, which offers financing for select home buyers in rural areas.

For everyone else, a down payment is usually required.

The size of the down payment that is needed to buy a house in 2018 can vary from one mortgage program to the next. Conventional loans allow borrowers to make an investment as low as 3% in some cases (a trend that started a couple of years ago). The FHA program requires 3.5% down. And we’ve already talked about the VA mortgage option, which allows for 100% financing to eligible borrowers.

3. A debt-to-income ratio no higher than 50%, in most cases.

Banks and mortgage lenders use the debt-to-income (DTI) ratio to ensure that a person is not taking on too much debt, with the addition of a mortgage loan. This is simply a percentage that shows how much of a person’s monthly income goes toward recurring debts.

For example, a person with a “back-end” DTI ratio of 40% uses 40% of his or her income to cover monthly recurring debts.

Which begs the question: what debt-to-income level is needed to buy a house in 2018? While the requirements can vary from one mortgage program to the next, most lenders will set the bar somewhere around 43% to 50%. So, if taking on a home loan will push your total DTI above 50%, it might raise a red flag.

Related: Higher debt ratios allowed in 2018

But again, these are just general guidelines used by most mortgage lenders most of the time. Exceptions are often made for otherwise well-qualified borrowers, particularly those with compensating factors that offset a relatively high debt level.

Bonus Points for Being Open-Minded and Flexible

Limited inventory was the big housing news story of 2017. In many real estate markets across the country, there just aren’t enough homes for sale to satisfy buyer demand.

That’s one of the reasons why home prices have risen so steadily over the last few years, particularly in the more constrained markets like California and the Pacific Northwest.

If you live in a city with limited housing inventory (and there’s a good chance of that), you’ll need to be flexible and open-minded about buying a home in 2018.

This is not a mortgage requirement, obviously, but more of a personal character trait that will benefit you during your housing search. Chances are, you will have to make compromises at some point during your house hunting process. You might have to expand your search area, scale back on your price range, or give up some of those desired features on your wish list. That’s the reality of the market.

Related article: 10 tips for first-time buyers

Disclaimer: This article gives a basic overview of what is needed to buy a house in 2018. It is not all-inclusive. We have covered what we feel are some of the most important requirements for home buyers who need to use mortgage loans to finance their purchases. Depending on the type of loan you use and other factors, you might encounter additional requirements that are not mentioned above.

Do Jumbo Loans Have Higher Interest Rates? Not Always!

This is part of an ongoing blog series where we answer common questions among home buyers. Today’s question deals with jumbo loan mortgage rates in relation to smaller mortgage products.

Do jumbo loans have higher interest rates than their smaller conforming counterparts?

The answer might surprise you. Over the last few years, jumbo loans have actually had lower rates than conforming products, on average. The secondary market for these “oversized” mortgage loans has been very competitive in recent years, resulting in lower pricing.

What Is a ‘Jumbo’ Mortgage Exactly?

A jumbo loan is a relatively large mortgage loan. It exceeds the size limits set by the Federal Housing Finance Agency (FHFA). Freddie Mac and Fannie Mae use these limits when purchasing loans from lenders. A loan that can be sold to Freddie or Fannie is referred to as a conforming loan. It falls within the size limits established by the FHFA.

When a mortgage loan exceeds these conforming limits, it is referred to as jumbo.

I know what you’re thinking. A jumbo loan is basically a really big mortgage, so it probably comes with a higher interest rate. Right? Not always.

In fact, weekly application surveys conducted by the Mortgage Bankers Association (MBA) have shown the exact opposite — at least in recent years. Their data reveal that jumbo loans often have lower rates than conforming products.

Jumbo Loans Have Lower Rates, on Average

Let’s look at the MBA’s latest weekly survey (as of the publication date). On November 15, 2017, the industry group reported the following findings:

  • The average “contract interest interest rate” for a 30-year fixed mortgage with a conforming loan balance (equaling $424,100 or below) averaged 4.18% for the week.
  • The average contract interest rate for a 30-year fixed mortgage with a jumbo loan balance (greater than $424,100) was 4.12% during the same week.

If you were to search their archives and look at application surveys going back several months, you would find the same trend. On average, jumbo loans tend to have lower interest rates than their smaller conforming counterparts. Surprise!

Why Is This the Case?

This might seem counterintuitive. Why would a larger mortgage loan – which would seem to be a bigger risk to the lender and/or investor – come with a lower rate? After all, lenders generally charge higher rates for riskier loans.

In short, there has been growing demand for jumbo mortgage products among investors, creating a more competitive market for these “oversized” non-conforming loans.

Here’s how Joel Kan, an economist with the MBA, explained it to CNBC:

“A strong appetite for jumbo loans and a highly competitive market has led to increased availability and lower pricing of jumbo loans over the past few years.”

But it hasn’t always been this way. A few years back, jumbo loans tended to have higher interest rates than smaller conforming mortgage products. This trend began to change a few years ago. Since around the middle of 2013, jumbo mortgage products have come with lower interest rates (on average) than conforming loans.

Other Factors That Can Influence Your Rate

The type of loan you use can affect the mortgage rate you received from a lender. As we’ve covered (thoroughly) above, jumbo loans tend to have lower interest rates than conforming. But that’s just one factor that can affect your borrowing costs.

Here are some other factors that can influence the rate you receive from a mortgage lender:

  • Your credit score: These three-digit numbers are essentially an indicator risk. A lower score suggests that a person might have had trouble repaying their debts in the past. A higher score usually indicates a person who manages their debts and pays bills on time. Borrowers with higher credit scores tend to qualify for lower mortgage rates, and vice versa.
  • Fixed versus adjustable: On average, adjustable-rate mortgage loans (or ARMs) tend to start off with lower interest rates than their fixed counterparts. You can see this clearly enough if you look at the weekly survey conducted by Freddie Mac. Of course, the interest rate assigned to an ARM loan can change over time, making it less predictable than a fixed mortgage.
  • Discount points: Some borrowers choose to pay points at closing in exchange for a lower mortgage rate on their loans home loans. In this context, a point is equal to 1% of the base loan amount. It’s a trade-off. The borrower pays more money up front in exchange for a lower rate, which could save them a significant amount of money over time.

Disclaimer: This article answers the question, do jumbo loans have higher interest rates than conforming? This article includes data, statistics and commentary provided by third parties not associated with our company. The rate you receive on a home loan will vary based on a number of factors, including those covered above.

How the Down Payment Affects Private Mortgage Insurance

This is part of an ongoing series that addresses common questions from home buyers. Today we have a two-part question: How does the down payment affect private mortgage insurance or PMI, and how much do I have to put down to avoid paying PMI?

The short answer: If you make a down payment below 20% when buying a house, you might be required to pay for private mortgage insurance. These policies are usually required when the loan-to-value (LTV) ratio rises above 80%. That’s the industry standard. You could avoid PMI by making a larger upfront investment.

PMI Trigger: A Loan-To-Value Ratio Above 80%

Private mortgage insurance, or PMI, is a special kind of insurance policy that protects mortgage lenders from losses resulting from borrower default (or failure to pay). It is the home buyer who typically has to pay for a PMI policy, even though it protects the lender.

When it’s required: Private mortgage insurance is typically required when borrowers take out a loan that accounts for more than 80% of the home’s value. This is often the case when a borrower makes a down payment below 20%. When the loan-to-value ratio rises above 80%, PMI is usually required.

So we’ve answered the first question: How does the down payment affect private mortgage insurance when buying a house? If you take out a single loan and put less than 20% down, you will likely be required to pay for PMI coverage.

On the other hand, if you put down more than 20% when buying a house, and thereby keep the LTV ratio at or below 80%, you should be able to avoid private mortgage insurance entirely.

And that answers the second question: How much of a down payment should I make to avoid paying for a PMI policy? If you are using a single loan to buy a house, an upfront investment of 20% or more will generally allow you to avoid this extra cost.

There are scenarios where a borrower could put down less than 20% and still avoid private mortgage insurance. Depending on the circumstances, this might be accomplished by “piggybacking” two different loans so that neither has an LTV above 80%.

To Be Clear, a 20% Down Payment Isn’t Always Necessary

A survey conducted by Realtor.com found that many home buyers think they have to put down at least 20% when buying a house. But this is simply not true.

These days, there are quite a few mortgage financing options that allow for a smaller down payment. The FHA loan program allows borrowers to put down as little as 3.5% of the purchase price. Some conventional (non-government-insured) mortgage loans allow for down payments as low as 3%.

Here are two examples of conventional home loan programs that allow for 97% financing:

  • Freddie Mac’s Home Possible Advantage® product fact-sheet states the following: “Minimum down payment of 3 percent allowed for Home Possible Advantage.”
  • Fannie Mae’s HomeReady® fact sheet says the program allows for “financing up to 97% loan-to-value (LTV) for purchase of one-unit principal residence.”

A study by Freddie Mac found that the average down payment among first-time buyers in 2016 was 6%. During that same year, the average upfront investment from repeat home buyers was 14%. This is further evidence that it’s not always necessary to make a down payment of 20% when buying a house.

Everything’s a Trade-off

Of course, if you do make a smaller investment, you could encounter private mortgage insurance. So there’s a very clear trade-off here.

The upside is that PMI coverage allows home buyers to purchase a house sooner, and with less money down. Without the private mortgage insurance industry, the low-down-payment financing options mentioned above probably wouldn’t be available anymore. Without PMI, most home buyers would be required to make an investment of 20% or more – and that would have a dramatic effect on the housing market by shrinking the pool of eligible borrowers.

Another advantage of making a larger down payment is that it reduces the size of your monthly payments. It’s simple math. The more you pay up front, the less you are financing. This results in a smaller mortgage payment each month.

There is a trade-off with almost every choice you make when taking out a home loan, and that goes for the down payment as well.

How Do Down Payment Assistance Programs Work?

This is part of an ongoing series that answers frequently asked questions from home buyers. Today’s question is: How do mortgage down payment assistance programs work?

Before we get to the logistical details, let’s start with a basic definition. What is a down payment assistance program, exactly?

What Is a Down Payment Assistance Program?

These programs offer some form of financial help to home buyers who don’t have a lot of money to put down when buying a house. They are often referred to as “DPA” programs, or DPAPs, for short.

There are several different kinds of down payment assistance programs. Some are offered by housing-related nonprofit organizations, while others are managed by state or local government agencies. Most of them include partnerships with select mortgage lenders.

Three Common Types of Assistance

Let’s move on to talk about how down payment assistance actually works. While these programs are offered by many different organizations, they usually fall into one of three categories:

1. Down payment grants: A grant is different from a loan in the sense that it doesn’t have to be paid back (if certain conditions are met). Down payment assistance grants are funds that the home buyer does not have to repay as long as he or she occupies the home for a certain period of time. At least, that’s usually how they work. Occupancy is a common requirement associated with down payment grants. But the specific rules and requirements can vary from one program to another.

2. Second mortgage loans: This is the most common form of down payment assistance program available these days (as of summer 2017). The primary or “first” mortgage is applied to the purchase price of the house, with a second loan that covers the upfront investment. As with down payment grants, stipulations for second mortgage loans can vary widely depending on the agency that offers it. Many of the second loans offered by state and local housing agencies have very low interest rates – or even zero interest. It’s also common for the payments to be deferred for a certain period of time. In some cases, the loan is completely forgiven once a certain number of years has passed.

3. Tax credits: Some housing finance agencies and government organizations offer mortgage credit certificates to home buyers who meet specific requirements. Strictly speaking, it’s not a down payment assistance program, like the two mentioned above. But it can reduce the home buyer’s tax burden and free up additional money for the down payment and closing cost expenses.

In some cases, the grant or second loan will be offered along with a primary mortgage loan that is offered by a partnering lenders. They’re usually 30-year fixed-rate mortgage loans, since that’s the most stable and predictable financing option for borrowers.

Some DPAs Are Limited to ‘First-Time’ Buyers

Some down payment assistance programs are limited to first-time home buyers, while others are more broad in nature. But the exact definition of a “first time” buyer can vary from one program to the next.

In some cases, eligibility might be limited to people who have never owned a home in past. Other times, the down payment assistance program might be offered to people who haven’t owned a home within the last three years. So the precise definition of a first-time buyer might be narrow or broad, depending on the agency that is offering the program.

Counseling, Size Limits, and Income Requirements

Educational counseling requirements are another common feature of down payment assistance programs. This means that the home buyer must receive some form of counseling or training from an approved counselor or agency. The training topics can vary, but they usually relate to mortgage finance and home buying. Counseling sessions are often brief and, in many cases, can be completed within a few hours.

With many down payment assistance programs, there are usually limits to the purchase price and/or loan amount. A lot of times, the agency offering the program will use median home values to set these limits.

Income restrictions are also common. For instance, if a program is geared toward low- to moderate-income home buyers, it might limit the borrower’s income to 115% of the median home value in the area (a common threshold). That’s just one example of how these limits might be set. But it can vary from one down payment program to the next.

An Real-World Example of a Down Payment Assistance Program

You’ll have an easier time understanding how a down payment assistance program works if we look at a real-world example. The Arizona Public Housing Authority (APHA) is a good example, because it offers a couple of the options mentioned above – grants and second mortgage loans.

APHA offers a loan program called “Home Plus.” It’s a 30-year fixed-rate mortgage with down payment assistance in the form of a grant. The size of the grant varies depending on the amount being borrowed, and it can range from 0% to 5%. It’s truly a grant, in the sense that there are no repayment terms.

APHA also offers a “Pathway to Purchase” program. This option includes “an attractive 30-year fixed-rate mortgage with a down payment assistance second mortgage equal to 10% of the purchase price, up to a maximum of $20,000.”

This just one example of a government housing agency partnering with lenders or other groups to create down payment assistance programs for local home buyers. I chose this particular agency because they offer two of the DPAP options described earlier — grants and second mortgage loans.

Using Gift Money From a Family Member / Third Party

When people mention a “down payment assistance program,” they are usually referring to the grants and/or second mortgages discussed in the previous section.

But there’s another form of assistance that can be equally helpful, and a lot of first-time home buyers don’t even know it exists. This is the down payment gift.

These days, most mortgage programs allow buyers to receive funds donated from a third party. These funds can be used for the down payment and, in some cases, the closing costs.

The list of approved donors varies based on the type of home loan you’re using, but it’s generally a broad category. For example, some mortgage programs allow funds to be provided by close friends, family members, employers, or nonprofit organizations.

A key requirement for this kind of down payment assistance is that the person donating the funds must also provide a letter stating that they do not expect any repayment. In other words, the money being provided must truly be a gift, and not a short-term loan from one person to another.

This article answers the question, How do down payment assistance programs work? Our website offers hundreds of articles and tutorials, many of which are closely related to this topic. You can use the “Learn” link in the main menu to access additional tutorials.

Top 10 Things First-Time Home Buyers Should Know in 2018

A lot has changed in the mortgage industry and real estate market over the last couple of years. So we thought it was time to create an updated guide for first-time buyers pursuing the goal of homeownership in 2018. Here are 10 things a first-time home buyer should know in 2018.

Top 10 Things First-Time Buyers Should Know in 2018

1. It’s getting easier to qualify for a mortgage loan.

This is a trend we’ve been following for the last couple of years. Mortgage lenders today are allowing lower down payments and higher debt levels for borrowers. In 2018, some first-time home buyers will be able to qualify for a conventional mortgage loan with as little as 3% down. Additionally, the maximum debt level has increased as well. These changes will likely increase access to mortgage financing in the latter half of 2017, and into 2018. Read: Are mortgages easier to get?

2. Debt limits have increased.

In July 2017, Fannie Mae announced it would start purchasing loans with borrowers who have debt-to-income ratios up to 50%. This was an increase from their previous limit of 45%. This is something first-time home buyers should know in 2018, because it could make mortgage loans easier to obtain — particularly for those borrowers with higher levels of debt. Read: How much debt can I have?

3. Home prices are rising more slowly.

Many local real estate markets across the country experienced a cooling trend in 2017, at least were home prices are concerned. As a result, prices are expected to rise more slowly during 2018. But they will likely continue moving north in most cities, to some degree. Economists expect home prices nationwide to rise by around 3.5% – 5% during 2018. Some cities could see larger gains. This is something all first-time buyers should know in 2017 and 2018, because it affects your buying power.

4. Mortgage rates are expected to creep upward.

When this article was published, in August 2017, the average rate for a 30-year fixed mortgage loan was 3.90%. A July 2017 forecast from the Mortgage Bankers Association predicted that 30-year loan rates would rise to 4.5% by the fourth quarter of 2017, followed by a gradual rise throughout 2018. They expect rates to climb above 5% during the second half of 2018. First-time home buyers should know about these trends and forecasts, especially since house values are also expected to rise. (Read: Housing forecast for 2018)

5. You don’t need 20% down to buy a house.

Surveys conducted over the last couple of years have shown that many people believe they need to make a down payment of 20% or more when buying a home. In truth, there are mortgage programs today that allow for down payments as low as 3%. The FHA loan program requires a relatively low investment of 3.5%. VA loans offer 100% financing for eligible borrowers — military members and veterans. Some credit union programs are now offering 100% financing to first-time buyers. (Read: Putting down less than 20%)

6. Inventory is limited in many cities.

Low housing inventory was one of the big real estate stories of the last couple of years. As a result, we will enter 2018 with supply shortages in many cities across the country. Granted, there are exceptions to this general trend. But in many local housing markets, there is not enough supply to meet demand. This is definitely something a first-time home buyer should know in 2018, because it affects everything from your offer to your negotiating ability. In a “tight” market with limited inventory, sellers tend to have more negotiating leverage.

7. Trump has made FHA loans more expensive.

In January 2017, then-President Barack Obama approved a reduction in FHA mortgage insurance that would’ve saved borrowers an average of $500 per year. But within hours of his inauguration, Donald Trump ordered HUD to cancel this reduction. As a result, first-time buyers who use the FHA loan program will continue to pay the elevated mortgage insurance levels put in place after the housing crisis. Appeals to reinstate the insurance reduction have fallen on deaf ears. (Read: Trump scraps insurance reduction)

8. Most home loans today have credit scores of 600 or higher.

A report released by the mortgage origination software company Ellie Mae in July 2017 showed that most closed home loans were issued to borrowers with credit scores of 600 or higher. A very small number were given out to borrowers with scores in the 500 range. But the vast majority (99.5%) of purchase loans went to borrowers with scores of 600 or higher. That’s not a hard-and-fast requirement, but it is an important industry trend that first-time home buyers should know in 2018. (Read: Minimum credit score for buyers)

9. It’s wise to have a real estate agent, now more than ever.

The housing market has changed considerably over the last few years, going from one extreme to another. Today, many local markets are experiencing inventory shortages that make things more difficult for first-time home buyers. So it’s wise to have professional guidance from an experienced real estate agent. And when you consider that the seller typically pays the agent commissions, it becomes even more of a no-brainer.

10. We have dozens of articles and tutorials written just for you!

The Home Buying Institute (HBI) has been educating first-time buyers for more than a decade. We have created one of the largest online libraries of home buying advice, and it’s available to you at no cost. We publish well-researched, unbiased information to help you make informed decisions. You can start by following the hyperlinks spread throughout this article, or by using the “learn” tab in the main menu above.

So there you have them, the top 10 things a first-time home buyer should know in 2017 and 2018!

Maximum FHA Debt-to-Income Ratio Requirements in 2017

  • The debt-to-income (DTI) ratio limit for an FHA loan in 2017 is 43%, for most borrowers.
  • In some cases, home buyers using the FHA loan program can have up to 50% debt-to-income, at a maximum.
  • A higher level of debt might be allowed if there are certain “compensating factors,” such as a minimum increase in monthly housing costs, or additional cash reserves.

That’s a quick overview of the debt-to-income ratio limits for FHA loans in 2017. Here’s a more detailed look at this important qualifying factor for borrowers.

FHA Debt-to-Income Ratio Limits: 43% – 50%

Let’s start with a definition. A debt-to-income ratio is simply a percentage that shows how much of your gross monthly income is going toward your recurring debts. When it comes to FHA loans, there are two of these ratios:

  • The front-end ratio looks at mortgage and housing-related debts only. This would be your monthly mortgage payments, property taxes, etc.
  • The back-end DTI ratio considers all of your monthly recurring debts. This includes your monthly mortgage payment, in addition to any credit cards, car payments, personal loans, etc.

The debt-to-income ratio limit for an FHA loan is the maximum amount of recurring debt a borrower can have, and still qualify for this mortgage program. The Department of Housing and Urban Development (HUD) refers to this as the “maximum qualifying ratio.”

Related: How much debt is too much?

HUD Handbook 4000.1 states that borrowers can have a maximum qualifying ratio of 31/43. This means that a person’s total debts — including the mortgage loan — should use no more than 43% of monthly income.

But this is a general rule for which there are several exceptions. As you can see in the table below, FHA allows higher debt-to-income ratio limits for borrowers with one or more “compensating factors.”

For example, if a home buyer uses an FHA loan that results in only a minimal increase in housing payments, then a higher debt level might be allowed. The same goes for borrowers with cash reserves in the bank and/or residual income left over after making their mortgage payments.

FHA compensating factors
FHA loan debt-to-income guidelines. Source: HUD Handbook 4000.1

The Credit Score Connection

In the table above, you will also notice a credit score column. This is an important detail, because it directly relates to the maximum debt-to-income ratio limits for FHA loans.

The absolute minimum credit score for this program is 500. In order to be eligible for an FHA-insured mortgage loan, borrowers need a score of 500 or higher. To qualify for the 3.5% down payment, borrowers would need a score of 580 or higher.

With regard to DTI limits, only those borrowers with scores of 580 or higher are allowed to have the higher debt limits.

In other words:

  • If you get approved for the program with a score between 500 and 579, you will most likely have to meet the 31/43 debt-to-income ratio limit shown in table above.
  • If a borrower has a score of 580 or higher, and one or more of the compensating factors shown above, then he or she might be allowed to have a higher level of debt and still qualify for an FHA loan.

Note: These are general guidelines applicable to most borrowers. Your situation could differ.

A Look at Conventional Home Loans

A “conventional” home loan is one that is not insured or guaranteed by the government, which sets it apart from the FHA program.

In the past, conventional loans have traditionally had stricter requirements for debt-to-income ratio limits. But that has changed over the last two or three years. These days, conventional loan programs are trying to compete with FHA by relaxing their qualification criteria. And this is true for DTI limits as well.

In a recent article, we explained that Fannie Mae (one of the government-sponsored enterprises that buy mortgage loans from lenders) recently raised its debt-to-income ratio limit for conventional home loans. They now allow borrowers to have a total or back-end ratio up to 50%. Previously, they imposed a limit of 45%.

The point is, you shouldn’t just look at FHA loans if you have a relatively high level of debt. Conventional (non-government-backed) mortgage loans are more forgiving these days, when it comes to the borrower’s maximum debt-to-income ratio. So be sure to explore all of your options when shopping for a home loan.