First-time homebuyer loan: What it is and how it works

First-time homebuyer loans provide eligible buyers access to affordable mortgages with flexible terms, manageable down payments and other benefits. 

They’re for—you guessed it—first-time homebuyers, but they can take different forms, including government-backed homebuyer loans or low-down payment conventional loans. There are also down payment assistance programs.

What you’ll learn:

• First-time homebuyer loans are intended to make homebuying more accessible.

• Government agencies and private lenders—backed by Fannie Mae and Freddie Mac—offer pathways to first-time homebuyer loans.

• Down payment assistance in the form of grants and loans could also help first-time homebuyers. 

• Before applying for any loan, it can help to talk to lenders, determine eligibility and compare options.

A first-time homebuyer loan is a type of mortgage designed to make it easier for first-time homebuyers to purchase their first homes. 

These loans often come with lower down payments, lower rates and more flexible credit requirements. Some lenders might accept applications from people with lower credit scores than they do for conventional loans.

Several types of first-time homebuyer loans are available, including low-down-payment conventional loans and those made possible by federal and state loan programs.

Strange as it may sound, first-time homebuyer loans may be available to people who have previously owned homes. Eligibility may vary by loan and by state, but there are a couple of typical requirements. 

• Applicant has never owned a home.

• Applicant hasn’t owned a home in the past three years.

And the purchase typically must be for a primary residence, not an investment property.

Unlike conventional loans offered through the private sector, government-backed loan options are sponsored by several government agencies. These loans can be ideal for a first-time buyer because they feature low to zero down payments and lenient credit requirements. These loans are often restricted to certain communities, geographic areas or professions.

Loans backed by the Federal Housing Administration (FHA) are aimed at helping low-income borrowers with lower credit scores purchase a home. An FHA loan can have a down payment as low as 3.5%, as long as the borrower has a minimum credit score of 580. FHA loans require borrowers to purchase mortgage insurance if their down payment is less than 10%.

Loans backed by the Department of Veterans Affairs (VA) are designed specifically for veterans of the U.S. military. Borrowers show proof of service history and duty status to qualify. VA loans often feature no down payment, lower interest rates than other loans and no need for mortgage insurance.

Loans backed by the U.S. Department of Agriculture can help low-to-moderate-income residents living in rural areas afford a home with no down payment. These loans help applicants buy, build or rehabilitate a home in an eligible area. Income eligibility requirements can vary state by state.

The Department of Housing and Urban Development (HUD) backs the Section 184 Indian Home Loan Guarantee program. According to HUD, the Section 184 program was developed in 1992 to provide homeownership opportunities to Native American communities. An eligible borrower applies with a participating lender, which reviews documentation and submits the loan to HUD for approval. The loan is for single-family housing and comes with fixed-rate interest for a period of 30 years or less.

The Good Neighbor Next Door Program offers significant discounts on homes listed in HUD-designated revitalization areas to: 

• Law enforcement officers

• Firefighters 

• Emergency medical technicians

• Teachers

Low-down-payment conventional mortgages may require as little as a 3% down payment. And they’re often offered through private lenders like banks and credit unions. But these types of mortgages are backed by two government-sponsored entities: the Federal National Mortgage Association (also known as Fannie Mae) and the Federal Home Loan Mortgage Corporation (also known as Freddie Mac).

Some low-down-payment conventional loans could require private mortgage insurance (PMI). PMI insures the lender if borrowers can’t make their monthly mortgage payments.

The Federal Housing Finance Agency (FHFA) regulates both Fannie Mae and Freddie Mac. You can get a Fannie Mae or Freddie Mac low-down-payment conventional loan by working with a private mortgage lender, like a bank or credit union.

 Several low-down-payment conventional mortgage options offered by these two entities include:

• Conventional 97 mortgage: Backed by Fannie Mae, the Conventional 97 mortgage is for first-time homebuyers. This option offers mortgages that cover 97% of the home with only 3% down. Eligible borrowers can take a homebuyer education course to qualify.

• HomeReady mortgage: Backed by Fannie Mae, the HomeReady mortgage is for low-income borrowers. It features a 3% down payment and requires a minimum credit score of 620. The HomeReady mortgage allows for down payment and closing cost funds to come from gifts, grants or cash.

• Home Possible mortgage: Backed by Freddie Mac, the Home Possible mortgage is for low-income borrowers and is comparable to the HomeReady mortgage. The Home Possible loan features a 3% down payment and caps on credit fees. The down payment can be funded by things like sweat equity (using construction skills and materials instead of cash) and employer assistance programs.

• HomeOne mortgage: Backed by Freddie Mac, the HomeOne mortgage is for a range of first-time homebuyers. It features a 3% down payment and has no geographic or income limits. But borrowers must take out mortgage insurance if putting 5% or less down. They also have to take a homebuyer education course.

• HFA Preferred and HFA Advantage loans: Offered through state housing finance agencies (HFAs), these loans are for first-time homebuyers with low to moderate incomes. Most HFA loans also require a down payment of at least 3%.

First-time homebuyers might qualify for down payment assistance through state or local agencies. Typically given in the form of a grant or “second mortgage,” these programs can help cover a down payment and closing costs.

Down payment assistance grants are often a one-time sum to help first-time homebuyers who may earn low to moderate income. Generally, borrowers can’t make more than 80% of the annual median income. A down payment assistance grant may also have a limit for the home purchase price or a minimum credit score.

A down payment assistance loan is a second mortgage that’s taken out at the same time as the initial mortgage. These types of loans can vary by their terms, such as:

• Low-interest loans: With this type of down payment assistance, borrowers receive a lower interest rate on a second mortgage. While making monthly payments on the mortgage, the low-interest loan is repaid over the course of a few years to cover the down payment assistance, plus the interest. 

• Deferred payment or forgivable mortgage loans: These “soft second” mortgage loans may not carry interest and could defer mortgage payments until the borrower sells or refinances the home. Many of these loans might also be forgiven after a specified period of time.

To apply for a first-time homebuyer loan or program, you can work with a mortgage lender to learn more about any local or state programs you might qualify for. You can also visit the HUD website to find FHA-approved lenders. 

Before applying, it can help to compare the different loan programs and lenders so you understand the benefits, requirements and long-term costs associated with each type of loan.

Purchasing a home for the first time is a big step. From saving for a down payment to shopping for a mortgage, there’s a lot to consider. Before you apply, a few simple steps might help you prepare.

• Credit monitoring: Good credit scores can help you qualify for better financing and different loans. You can check your credit reports and use a tool like CreditWise from Capital One to see where you stand.

• Budgeting: Paying attention to expenses like closing costs, mortgage insurance and property taxes gives you a clearer picture of how much house you can afford. 

• Comparing mortgages: According to the Consumer Financial Protection Bureau, “multiple credit checks from mortgage lenders are recorded on your credit report as a single inquiry” when they happen within a 45-day period. Being pre-approved for a mortgage might make the offer process easier.

First-time homebuyer loans can help you open the door to a new home, whether the mortgage is secured from a private lender or with backing from the federal government. It’s also possible to receive down payment assistance and get help with closing costs.

Monitoring your credit can be a smart step toward buying your first home. You can use CreditWise to review your credit report and credit score. It’s free. And using it won’t hurt your credit score. Plus, with the CreditWise Simulator, you can see how taking out a mortgage could affect your credit score.