If you qualify as a first-time buyer and have begun shopping around for a mortgage and a new home, we have good news to tell you: some of the nation’s best lenders will be willing to offer you a home loan with a down payment of less than the usual 20%. All you need to do in return is pay private mortgage insurance (PMI), which typically costs 0.5% to 1% of the value of the loan annually.
First things first, a “first-time buyer” doesn’t just refer to people buying their first home. Under the Department of Housing and Urban Development’s definition, lenders should treat borrowers who meet any of the following requirements as a first-time buyer:
- A person who has never owned a property.
- A person who has not owned their principal residence for at least 3 years.
- A single parent who previously co-owned a home while they were married.
- A homemaker who previously co-owned a home with a spouse but who is now separated and no longer receives financial support from that spouse.
- A person who has only owned a residence not affixed to a permanent foundation, such as a mobile home or a trailer.
The 2 major benefits of being a first-time buyer are the lower down payments and the fact that certain mortgage expenses are tax deductible.
Let’s not underestimate the importance of lower down payments. The minimum down payment for a conventional fixed-rate or adjustable home loan is 20%, meaning that if your home value is $300,000, you’ll need to pay $60,000 up front (in addition to closing costs). Thankfully, first-time buyers don’t need to pay such a high amount to get into the housing market. Many of the nation’s top lenders offer conventional mortgages for as little as a 3% down payment: if your home’s value is $300,000, that means your lender will only ask for $9,000 up front. And if you can’t meet the credit requirements, then a government-backed FHA loan requires a down payment of 3.5% for borrowers with a 580-619 credit score and down payment of 10% for borrowers with a 500-579 credit score. The only catch with an FHA loan is that the borrower must take out private mortgage insurance (PMI) to protect the lender.
The other major benefit is that some mortgage expenses are tax-deductible, and again this can lead to significant savings for the borrowers. Interest is deductible, so long as your mortgage is worth less than $1 million. To understand just how much you can save, let’s use the example of a borrower with $60,000 income taking out a $300,000 home loan over a 30-year term. In this example, the borrower would pay $247,220 in interest over the term of the loan; using a 25% income tax rate and all other things being equal, they would save a whopping $61,805 on their taxes over the duration of their loan. Real estate taxes are also deductible. On the other hand, the recent federal tax reforms stripped mortgage insurance of its tax-deductible status.