What’s the Best Type of Mortgage for First-Time Buyers?

Reader question: “What is the best type of mortgage loan for a first-time home buyer?”

The best mortgage financing option can vary from one first-time buyer to the next, and for a variety of reasons. The truth is that different borrowers have different needs, so there is not a single best mortgage loan that fits all first-time home buyers.

It largely depends on your qualifications, your down-payment capacity, and your long-term financing goals. We’ll talk about all of those factors below.

Best Mortgage Options for First-Time Buyers

For starters, you might want to forget about the fact that you’re a first-time home buyer. Choosing the best mortgage loan has more to do with your financing goals and your qualifications as a borrower.

Instead, focus on your top priorities when choosing a loan:

  • Are you trying to minimize your upfront, out-of-pocket costs?
  • Or do you want to minimize your monthly payments?
  • Do you plan to stay in the home for a long time, or just for three to seven years?

Instead of randomly choosing a best type of mortgage loan for all first-time homebuyers, we thought it would be more helpful to explain the different financing scenarios. Use the links below to jump to any section.

The seven financing scenarios covered in this lesson:

  1. Big down payment? Look at conventional
  2. Limited funds? Compare FHA vs. conventional
  3. Bad credit? Consider FHA loans
  4. Military service? Explore VA loans
  5. Long-term stay? Consider a fixed mortgage
  6. Short-term stay? Look at the ARM loan
  7. Consider local home buyer programs

1. Big down payment? Go with a conventional loan.

If you can afford to make a down payment of 20% or more, you’re probably better off choosing a conventional mortgage loan, instead of a government-backed loan like FHA.

By putting at least 20% down on your home purchase, you can keep your overall loan-to-value ratio at or below 80%. This allows you to avoid paying for private mortgage insurance, or PMI, which can increase the size of your monthly payments.

Mortgage insurance is usually required when a home loan accounts for more than 80% of the home’s value. In other words, if you put down less than 20% when buying a house, you’ll probably have to pay for private mortgage insurance.

This is why you hear the 20% figure mentioned so often in housing and mortgage-related articles. There’s no law or requirement that says you have to put down that much money when buying a house. But doing so can help you avoid the added cost of mortgage insurance.

Because of all this, the best type of mortgage for a first-time buyer with a large down payment is usually a conventional or “regular” loan.

2. Limited down-payment funds? Compare FHA with conventional.

If you don’t have a lot of money saved up for a down payment, the best strategy is probably to compare FHA and conventional loans with a low down payment. You’ll probably end up paying mortgage insurance with either of these options, but one will be cheaper than the other.

We talked about the conventional mortgage above. This is a home loan that is not guaranteed or backed by the government.

While some borrowers choose to make a down payment of 20% or more with conventional loans, it’s not always required. In fact, these mortgages often allow for a down payment as low as 3%. Additionally, the government-backed FHA loan program allows home buyers to make a down payment as low as 3.5%.

But with both of these options, you will be required to pay for mortgage insurance for the reasons outlined earlier. When you make a smaller down payment, you have a higher loan-to-value (LTV) ratio and therefore more risk. So mortgage insurance would be required, whether it’s provided by the government or a private insurer.

So, the best mortgage strategy for first-time home buyers with limited down-payment funds is to compare the costs of mortgage insurance on both the conventional and FHA side. Any reputable mortgage lender will show you how this breaks down, in terms of your monthly mortgage payments. Look at both financing options and choose the one that’s best for your situation.

In many cases, private mortgage insurance (PMI) for a conventional loan can cost more than the government-required insurance on an FHA loan. Plus, the interest rates for FHA-insured mortgages are often lower than those assigned to conventional loans (on average). But it doesn’t always work that way. It can vary, based on the length of the term and other factors.

That’s why it is so important to compare these financing options in side-by-side fashion. You want to know (A) what your monthly payments will be and (B) the full cost of the loan over time.

Also keep in mind that private mortgage insurance for conventional loans can be canceled later on, once your loan-to-value ratio falls to 78% or below. FHA loans, on the other hand, often require mortgage insurance for the full term or “life” of the loan. That’s another important consideration.

3. Shaky credit history? Consider the FHA loan program.

The Federal Housing Administration (FHA) loan program is the best type of mortgage loan for a lot of first-time home buyers, especially those who have had credit problems in the past.

Generally speaking, the FHA mortgage program can be a bit more “forgiving” than conventional programs, in terms of borrower qualifications and criteria. They can be easier to obtain.

The reason is simple. When making FHA loans, mortgage lenders receive insurance protection from the federal government. So they are often willing to approve borrowers they wouldn’t approve otherwise — borrowers with credit issues, for example.

If you fall into this first-time buyer category, FHA might be the best mortgage loan option for you. Just remember to explore all of your options, before choosing the best path forward.

4. Have military service? Explore VA loans.

The best type of home loan for first-time buyers with military service is almost always the VA loan. It’s hard to beat this program, especially when it comes to your upfront out-of-pocket expense.

The VA loan program allows first-time buyers to purchase a house with no money down. And borrowers can do that without being required to pay mortgage insurance, in most cases. There’s really no other mortgage option that compares to it, along those lines.

Most military personnel are eligible for the VA loan program. That includes both active duty members and veterans who have served in the past. If you’re currently on active duty, or if you’ve received an honorable discharge, you’re probably eligible for the VA mortgage program.

This is arguably the best type of mortgage loan for first-time home buyers who can qualify for it.

5. Planning a long-term stay? Consider a fixed-rate mortgage.

When it comes to choosing the best financing option, first-time buyers have options on top of options — with a side dish of options!

We talked about the difference between conventional and government insured mortgage programs above. As a borrower, you can also choose between a fixed-rate mortgage loan or one with an interest rate that changes over time.

For first-time home buyers planning a long-term stay, the 30-year fixed rate mortgage might be the best type of loan to use. As its name suggests, this product allows you to lock in your interest rate for the full term of the loan, up to 30 years. This gives you more payment stability over the long term. Even if mortgage rates rise down the road, yours will stay fixed.

Right now, in summer 2020, it’s a great time to use a long-term fixed-rate mortgage when buying your first home. That’s because mortgage rates have been hovering near historic lows for months. When this article was published, in June of 2020, the average rate for a fixed-rate mortgage loan was around 3.2%. That’s close to the all-time record low set a few weeks earlier.

To recap: If you’re a first-time home buyer and you plan to stay put for a long time, the best type of mortgage loan is probably one with a fixed interest rate. You might pay a little more for it, in the form of a higher interest rate. But you have the comfort and security of knowing your rate will never change in the years to come.

6. Only staying for a few years? Look at ARM loans.

An adjustable-rate mortgage loan, or ARM, is one with an interest rate that does change over time. Usually, the rate will remain fixed for a certain period of time, such as three to five years. After that initial phase, it will begin to adjust annually. It could adjust up or down, depending on current trends.

An ARM loan might be the best type of mortgage loan for a first-time home buyer who only plans to stay in the home for three to seven years.

You might wonder why someone would want a home loan with an interest rate that can change over time. The answer lies within the initial savings associated with these mortgage products.

Generally speaking, ARM loans start off with a lower interest rate than their 30-year fixed counterparts. (At least during the initial phase of the adjustable mortgage.) So it’s possible to secure a lower rate by using an ARM, and then sell or refinance the home later on before the adjustments begin.

This is a common strategy among first-time home buyers seeking the best and cheapest mortgage option. But again, you have to think about your long-term plans.

7. Lastly, look at home buyer programs in your area.

Many cities and counties across the country offer special programs for first-time home buyers. They’re often the result of a partnership between local governments and approved mortgage lenders. Sometimes there are nonprofit groups involved, as well.

While these programs can vary greatly, they usually have certain features in common. Borrowers who participate in these programs often undergo some form of home buyer education. They are then allowed to secure a mortgage loan with less money down, or even receive some kind of down payment assistance.

In some scenarios, these programs can be the best type of mortgage for first-time home buyers who meet their eligibility criteria. They offer a path to homeownership with less money down.

To find them, just do a Google search for “first-time home buyer programs” followed by the name of your city and state. They’re usually offered at the local level (city, county or state), as opposed to to the national level.

Now you can see why there isn’t a single best type of mortgage loan for all first-time home buyers. There are many variables involved, and many things to consider along the way. Everyone is different, in terms of their qualification criteria, down-payment funds, and long-term plans.

The key is to explore all of the different types of mortgage loans available to you, and choose the one that best suits your needs and goals.