First Time Home Buyers Loans: Understanding Capacity in the Lending landscape

Getting ready to buy your first home? Chances are, you need a mortgage to make the purchase. In this series, we will look at the basic 4 Cs of lending. In this first blog of the series, we will explore the first ‘C’ which stands for capacity. Getting a mortgage for your home purchase will be based on many factors, including the risks that the lender is willing to take on. 

The specific requirements to buy your first home, or to qualify for a mortgage will vary significantly depending on the lender you go for and the type of mortgage that you can qualify for. For instance, the VA loans and the FHA loans guarantee financing for eligible borrowers. This means that the government will back up the loan so that a lender does not face any financial losses thus can finance risky borrowers. 

For a lender to approve you to buy your first home, you’ll need to meet certain criteria. These are what we are calling the 4 Cs and they will form the lending landscape determining whether you will qualify for a loan or not. To begin with, we will delve deeper into the first ‘C’ which simply means Capacity. 

Your Capacity as a Borrower

When making the decision whether to approve you to buy your first home or to deny you the finances, most lenders will look to see if you have the capacity to repay the loan. By capacity, they will look at your monthly income which then determines whether you will be consistent in your repayments. 

One of the many ways that lenders verify your income is by reviewing several years of your federal income tax returns and the W2s along with the current pay stubs. Qualifying income is usually evaluated based on 1) the source of your income; 2) the length of time in which it has been received and 3) how long that income is expected to continue into the future. 

One other consideration your lenders will make before approving a loan to buy your first home is the debt-to-income ratio (DTI). This is a ratio that determines the amount of debt you have relative to your income. For a person to qualify for a conventional loan the DTI is usually capped at around 43% max but there are several exceptions. If you are working with a small lender, they may be laxer allowing you to stretch your borrowing capacity while other lenders may be stricter capping the DTI at 36%. 

For FHA and VA loans, the guidelines for DTI are very similar to the requirements for a conventional loan. The VA loans require a preferred maximum DTI of 41%, while the FHA is much more flexible allowing you to go up to 43%. At times it is possible to qualify even with a higher DTI. Therefore, before deciding on the lenders to finance you to buy your first home, do proper research to find the lenders who are more flexible. 

Can You Provide a Down payment to Buy Your First Home?

Still, on the capacity consideration, another factor that lenders will look at is your ability to put money down on a home so you have some equity in the house. The down payment acts as security for the lenders as they want to recoup all the money that they have loaned you to purchase your first home. Assuming you borrow 100% of what the home is worth and unfortunately you default on your loan, the lender will not get the money they’ve lent you in full because of the fees for selling the house and the potential for the market fluctuations causing a fall in the prices. 

As such, most lenders will ask you to put down 20% of the total cost to buy your first home and in turn, they will provide the remaining 80%. However, most people end up putting far less than 20%. Therefore, most conventional lenders allow a minimum 5% down payment and some will even go as low as 3% if you have shown a greater capacity as a borrower. 

The FHA loans are available with as low as 3.5% down payment if you have a credit score of at least 580 while the VA loans do not require you to put any down payment not unless the property you want to buy is worth less than the money that you are paying it. 

Supposing that you are using conventional mortgages to buy your first home, you will have to pay for private mortgage insurance (PMI). Typically, it will cost you around 0.5% to 1% of the loaned amount each year. Basically, the PMI will be paid until you owe less than 80% of the home’s value. 

Do Prior Research

Before deciding on who you want to finance your loan to buy your first home, it is advisable that you do prior research because some lenders will be more flexible and willing to bend a few rules for you. Be sure to explore all the options that are available to you for different kinds of loans you can qualify for at the best rates in the market. 

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