The best mortgages for first-time home buyers

As a first-time home buyer, you have several options to help make your dreams of owning a home come true.

Ready to buy your first home? Read on to find the best mortgage that could make your dreams of owning a home come true. (Photo: Thinkstock)

Are you a first-time home buyer shopping for a mortgage? Depending on your financial situation, certain loans may be better for you than others.

Whether you need help with a down payment or want to keep your monthly payments low, there's a mortgage option for you. Keep reading to find the best home loan to fit your needs.

5/1 ARM

If you're a first-time buyer looking for a home loan with the lowest monthly payment possible, an adjustable-rate mortgage (ARM) may be the answer.

These mortgages have an initial rate and payment amount for a limited period ranging from one month to five years, then "adjust" to a new rate and payment terms once that period ends, according to the Federal Reserve Board's Consumer Handbook on Adjustable Rate Mortgages.

A 5/1 ARM, which adjusts after five years, is a good choice if you plan to stay in your home for five years or less, says David Hall, president of Shore Mortgage, a mortgage lender operating in fifty states.

"What's great about ARMs is they are locked at a fixed rate for a select number of years, and they typically come with a very low interest rate, which means a low monthly payment," Hall explains. And low payments are typically a major priority for first-time home buyers.

If you stay in the home for more than five years, be prepared for the rate to reset, often to a higher rate which may mean higher payments, he says.

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FHA Loan

If you don't have much to put down on a home, a Federal Housing Authority (FHA) insured loan could be the way to go. Insured by the U.S. government, they are available for first-time buyers and allow you to put as little as 3.5 percent down, according to the Housing and Urban Development FHA website.

"Down payments are typically a barrier to entry for first-time home buyers to enter the housing market, so minimizing this challenge for clients to buy their first home is always exciting [for them]," says Hall.

Another draw is that FHA loans allow more relaxed credit score requirements, which is good for first-time home buyers, says Hall. Typically, they haven't established much of a credit history so their scores tend to be a bit lower.

While some FHA lenders will accept credit scores as low as 580, the majority of them still prefer scores in the 640 range, he explains.

"Typically, with conventional loans, there are penalties - such as higher interest rates - for borrowers with credit [scores] in the 640s," says Hall. "However, one of the benefits of the FHA loan is the penalties are drastically reduced for the lower credit scores."

Veteran Loan

Did you or your spouse serve in the U.S. military? If one of you is a veteran, a Veterans Affairs (VA) Loan is a good option for you as first-time homebuyers.

"The [VA] loan provides 100 percent financing, which means the home buyer doesn't need to put any money down," says Hall. He adds that the interest rates for VA loans are the most competitive rates for fixed rate mortgages.

These loans are also unique because they don't require the veteran to pay monthly mortgage insurance, which is typically a requirement when a home buyer is putting less than 20 percent down, explains Hall.

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Are you an aspiring homeowner dreaming of buying a country house? If so, a USDA loan is just what you need, says Deb Tomaro, an associate broker with Re/Max Acclaimed Properties in Bloomington, Indiana.

USDA loans are often called rural housing loans, and they offer no money down, as well as a different kind of mortgage insurance structure to keep your monthly payments low, says Tomaro.

"Its interest rate is usually about the same as an FHA loan, making it a great option," she says. "The only catch is that it is location-dependent."

So, while you don't have to buy a home way out in the country, you'll likely have to find a home outside the city limits or somewhere in surrounding counties, says Tomaro.

Also keep in mind that there are income eligibility limits. To check if a property in your area is eligible for a USDA loan, you can visit the USDA's Property Eligibility website.

State-Specific Home Loan

When looking to buy your first home,  don't forget to check out your state-specific home loans, says Hall. He says that in his home state, the Michigan State Housing Development Authority (MSHDA) is the place to go.

This program provides assistance of up to $7,500, which can be used for down payments, closing costs, and even the taxes and insurance that are due at closing, according to Hall.

To qualify for a MSHDA loan, you must be a first-time home buyer, the sale price of the home must be under $224,500, and your family income is usually required to be between $60,400 to $122,360, says Hall. He adds that qualification requirements also depend on the location of the home and your family size.

"Of course there are the traditional requirements, too, and any home buyer considering a MSHDA loan should contact a trusted mortgage lender for all the qualifications," says Hall.

Don't live in Michigan? Not to worry. Hall explains that there are similar assistance programs in many other states.

Another example of a state-specific home loan for first-time buyers is the Smart Start Program, offered by the New Jersey Housing and Finance Agency.

"This is a great first-time buyer program through the state which grants the 3.5 to 5 percent down payment typically required for FHA buyers - provided that they stay in the home for three years," says John Campbell, of John Campbell Realty.

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In order to qualify for this loan, you must be a first-time homebuyer who lives within certain regions that have been designated by the state as areas that are targeted for growth, known as "smart growth areas," says Campbell.

It works by offering qualified home buyers (depending on income and family size) a second mortgage to help cover the down payment and closing costs, which should not exceed 4 percent of the first mortgage amount.

However, if the home buyers stay in the home for more than three years, they may not have to pay the mortgage off.

"In essence, this is an interest-free loan which is completely forgivable after three years," he explains. "Buyers will have the flexibility to use the down payment towards future mortgage payments and repairs."

Conventional Insured

If you think you can save more for a down payment, Tomaro says you may want to aim for a 5 percent down payment and choose an insured conventional loan instead of the FHA loan. While the FHA loan only requires 3.5 percent down, choosing a conventional loan will save you money upfront, as well as down the road when you've paid your mortgage down, she explains.

"FHA loan changes in the past few years have made the product less desirable," says Tomaro. "These changes include higher upfront costs, but the biggest change is that you can no longer drop your PMI [mortgage insurance] when you reach 20 percent equity in your home."

However, Tomaro adds, with a conventional loan, once you reach 20 percent equity in your home, you can request the removal of your PMI payment, thereby reducing your monthly payments by hundreds of dollars and saving even more money.