If you’re a twentysomething or a thirtysomething, or a maybe a recent college grad or newlywed, you’ve no doubt wondered how you cross over to become a first-time home buyer. It can sometimes be a perilous voyage, especially given how housing prices have largely rebounded to their pre-crash real estate highs, but you can do it.
There are multiple routes you can take. The one you choose, however, will largely depend on how amenable you are to trying some conventional as well as unconventional approaches.
Here’s a look at five possibilities, starting from the fairly conservative to the fairly extreme. All can work. It just depends on how creative and daring you want to get and how badly you want to be that first-time home buyer.
1. FHA (Federal Housing Administration) loans
They’ve been around forever (1934), but they’re still largely misunderstood. That’s because people think they’re government loans. They’re not. They’re government-insured loans, which means if you drop the ball and stop paying your mortgage, leading to foreclosure, the government will bail out your lender who made you the loan. Because Uncle Sam is insuring your lender’s loan, your lender can afford to give you the loan at a rate less than you would pay without the government’s help.
What’s more, to obtain an FHA loan, for which you could qualify with only a 580 FICO, you only need a down payment of 3 percent. In other words, you don’t have to work half your adult life, to come up with a down payment. If you can come up with, say 10 percent down, you might qualify for an FHA-insured loan with an even lesser FICO.
As for income limits, minimum or otherwise, there aren’t any. You just have to satisfy the FHA’s debt-to-income (DTI) 31/43 debt ratios, which mean your total housing debt can’t exceed more than 31 percent of your income and your total debt (including those nagging credit card balances and student loans) can’t surpass 43 percent of your income. Some lenders have been known to stretch that bottom number to even 55 percent.
Following these guidelines, if you made $3,500 a month, you would have to keep your mortgage below $1,225 (31 percent of $3,500). You would have to keep your total debts below $1,505 (43 percent).
Few things in life come without downsides, including FHA-insured loans. The FHA charges you both upfront and monthly mortgage insurance premiums (MIPs). The one-time, upfront fee can total as much 2 percent of your loan and the ongoing monthly charge is about a half percent. Fortunately, you can roll your upfront MIP into your FHA loan balance and pay it as part of your monthly mortgage payment.
Another way to cushion this upfront charge is to get creative with your purchase offer. For example, if you find a $100,000 home you want to make an offer on, offer $103,000, asking the seller to pay $3,000 in closing costs. That way, you reduce your upfront out of pocket costs without affecting your monthly payment too much.
2. VA (U.S. Department of Veterans Affairs) loans
The VA does the FHA a few better because eligible veterans (current or ex-military) can obtain a VA loan with no down payment, there’s no private mortgage insurance to pay on the amount they do borrow, and the VA limits what lenders can charge for closing costs, origination fees and appraisals.
On the downside, income and credit history with the VA counts more than they do with the FHA. In addition, to make up for all those loan benefits you get (no down payment, no private mortgage insurance and limited fees), the VA charges a one-time funding fee, which varies according to a range of factors, including the length of your military ervice. Buyers, however, can finance their funding fee along with their home.
So, along with the FHA-insured loan, your VA loan is a great entry loan for buying your first house. Conventional and VA loans are often priced similarly, so run your calculations on the MyBankTracker Mortgage Calculator.
3. Buy a house with a friend
If you’re paying monthly rent, say $1,500, in one part of the city and your friend is paying the same amount of rent in another section of the city, it doesn’t take PriceWaterhouseCoopers to figure out you could pool your resources and buy a house together, where the payments were about $3,000 a month.
What’s more difficult to figure out is determining if you have the disposition, temperament, foresight and contractual good sense to make such a bold move.
Should you decide to forge ahead, there are four key points to consider. Foremost, you want to discuss how you’ll share ownership. It’s likely your ownership will be a “tenants-in-common” arrangement, whereby your ownership passes to whomever you designate (not necessarily the co-owner, but more likely a family member), in the event of your death. Second, only one of you will be able to claim a tax deduction, so discuss what compensation would be fair for the non-claiming party. Third, discuss whether either of you will be able to encumber (take out a loan against) the property. Normally, you can unless you specify otherwise. Fourth, set up an exit plan in case one of you wants to move on for whatever reason (marriage, job transfer, etc.)
4. Buy a house with mom and dad
If your parents want to help you become a homeowner, don’t blow them off. If you’re parents are well-off, each could gift you $14,000 each for a total of $28,000 without incurring any gift tax. That would make a pretty good down payment, at least in some parts of the country or could certainly help with closing costs.
You might also become co-owners, in which case you would probably take ownership as joint tenants, whereby your right of ownership passes to the surviving co-owner. This automatically keeps ownership all in the family.
Purchasing a home with parent, however, could involve tax and Medicaid liabilities, so you’ll want to seek professional advice to help structure your arrangement, especially if you have elderly parents. For example, if you purchased a home with your mom on a 50-50 basis, no gifting would be involved and your mom’s interest in the house would be exempt were she to apply for Medicaid at some point.
Furthermore, if it got to the point where your mother required nursing care, you could step in and provide that care. If you provided that care for two years before she enters a nursing home, your mom could transfer her ownership to you without any gift penalty. Again, these can be complex issues, so discuss them with your tax adviser.
5. Rent a room
You’ve got the down payment and you know you have the credit history and income to qualify for a house, you meet all the DTI requirements, but in the back of your mind, you wonder whether making the monthly payments will be too much of stretch. But rather than defer homeownership, why not just decide to rent out a room or two and get in the first-time home buying game now.
Renting a room out after you’ve taken ownership is certainly not a new concept. To prevent foreclosures during the Great Recession, millions of homeowners did whatever it took, including renting out a room to help them make their mortgage payments and keep their homes.
Again, this is another sort of arrangement, you don’t want to undertake willy-nilly. After all, renting a room to a stranger, even one who looks immaculate on paper, is the epitome of risk. But you can minimize your risk by doing the following:
Check the legality. Some homeowners associations have strict rules and bylaws regarding renters, so make sure they allow renters.
Check the functionality. Ideally, your renter could access your home and their room via a separate entrance.
Check your insurance. There may be a provision in your homeowner’s policy that prohibits renting out rooms. If there isn’t, it’s still best to inform your insurer in the event the renter is injured on your property.
Check your tax liability. The IRS has specific rules on declaring rental income on your taxes. If you don’t declare your rental income, you could be subject to IRS penalties.
No one said becoming a first-time home buyer would be easy, but there are both conventional and unconventional courses you can take to complete your homeownership voyage. That’s up to you. How creative do you want to get? Do you want to sail alone or do you want a few crew mates to help you captain the ship?
You have plenty of options to make it happen! The horizon is wide open.