Unless you’re paying in cash for a property, you must get preapproved for loan financing before you make an offer on a home. The loan process can be overwhelmingly complicated if you’re a first-time home buyer. Speaking with a loan officer in the pre-approval process will provide clarity about your financial position and whether or not you’re ready to buy your dream home.

Most people starting out and buying their first home will have to choose between a standard mortgage or a loan by the Federal Housing Administration. There are pluses and minuses for either one that you should weigh carefully. For example, though an FHA loan is easier to qualify for, a standard mortgage won’t require as much cash upfront for a down payment on the house.

Something else to consider is mortgage insurance. No matter how much money you put down on the property, mortgage insurance is required with an FHA loan. On the other hand, mortgage insurance is not necessary for a standard mortgage if the applicant can pay 20% of the asking price, which is not typical for first-time home buyers.

FHA loans are a popular choice for people purchasing property for the first time because they are more accessible for those with lower credit scores and incomes. According to the downpayment rules of the FHA, you need at least a 580 credit score to qualify for a loan covering 96.5% of the asking price, which means you’ll need enough cash to cover a minimum upfront payment of 3.5%. If you have a lower credit score of 580, you can still qualify for a 90% loan but will have to pay a minimum of a 10% downpayment.

Overseen by the Department of Housing and Urban Development (HUD), the Federal Housing Administration’s (FHA) downpayment rules are decided by HUD. For those wanting to learn more about FHA loans, the HUD Handbook 4000.1, the Single Family Housing Policy Handbook, has all the details.

The handbook says that for an FHA loan, there is a required 3.5% minimum down payment of the adjusted value of the home. Adjusted value equates to what the house appraised for, or the purchase price minus any costs taken off that the seller agreed to, whichever number is less.

The meaning of loan to value

“Loan to value,” a common term used in the mortgage approval process, is the total sum of money you borrow to purchase the property. The loan amount is dependent on your downpayment. For example, say you are trying to buy a home for $500,000. If you put down $50,000, or 10%, as a downpayment, your loan to value will be $450,000, or 90% of the house’s purchase price. HUD allows loans to value up to 96.5%, leaving a minimum down payment of 3.5% for you to cover upfront.

Downpayments and credit scores

According to the HUD handbook, you need at least a 580 credit score to qualify for the maximum FHA loan to value of 96.5% with a 3.5% down payment. If your credit score is between 500 and 579, you must put a minimum of 10% down on the house to qualify for a 90% loan. You won’t qualify for an FHA loan if you have a credit score that is 500 or less and it would be wise to try and improve your score before house hunting.

Help with the down payment

There's good news if you don’t have the total amount needed for the down payment on your new home. Borrowers can accept donations from approved sources such as family or friends, according to the 2019 FHA guidelines. These gifts are not equivalent to loans as they are not expected to be paid back in any way. People involved in the sale of the home, including the seller, real estate agents, the home builder, and other invested parties, cannot contribute to your down payment as this is seen as a direct conflict of interest.

Grants are also another option for those who can’t pay the minimum down payment requirement of an FHA loan. State, county, and local housing agencies offer grants to individuals. If you search for “down payment assistance” in Google and include your city, county, and state, you will find options for your area.

If you’re looking for more information on the mortgage process, the FHA research library is a great resource that has in-depth information, well-researched articles, and handy tutorials for learning.