Whether housing markets are strong and steady or a bubble about to burst is anyone’s guess (and quite a few so-called experts have weighed in on this topic, I might add), but you are considering buying your very first home. Your piece of this grand old land of America. Your first slice of the American dream that somehow involves apple pie, 2.38 children and a little house in the suburbs with a white picket fence…
OK, enough with the clichés. On to business.
The first-time homebuyer’s loan is designed for, well, first-time homebuyers (makes sense, right?) and in some respects is a rather nifty little marriage of lending and law. It’s generally underwritten by a state (or in very rare occasions by a city or a private foundation) and targets people who have decent jobs, but little in the way of savings. The theory is admirable: reduce closing costs to allow the person to get the house, and keep interest rates low to avoid massive debt overload.
A nice thought, right? So why doesn’t everybody have a house of their own? And do you qualify? And, for that matter, do you want one? To explain this loan package, I asked veteran loan specialist Clarisse O’Brian to give me a rundown (in non-legal, non-banking terms) and explain what it means when you close on your house and what it means down the road.
Sherwood: OK, so tell me. What is the first-time homebuyer’s loan?
O’Brian: The first thing to understand is that it’s not just one loan. Essentially, the first-time homebuyer’s loan is a package of several smaller loans and, often, a grant or two. These loans come from a number of different places: the lender you’ve chosen to work with, the state or foundation that’s underwriting the package, sometimes even from other private lenders. The grants are usually government money, some federal, some state.
Sherwood: So what’s the breakdown in amounts? Are all of these pieces the same size?
O’Brian: No, they’re not. A conventional mortgage generally covers between 80% and 95% of the purchase price of the home, and you make up the difference with your down payment. A 15% down payment is pretty common in the housing market, but that can run $30,000 on a $200K house. A lot of people don’t have that much available. So what the first-time homebuyer’s package does is take a conventional mortgage for about 90% of the home value and then start adding to it. Usually, the second piece is a second mortgage on which payment is deferred, or not paid, until the house is resold or the first mortgage is cleared, whichever comes first. The second mortgage is usually about 7-½% to 10% of the house’s price.
Sherwood: And then the grants on top of that?
O’Brian: Exactly. The grants aren’t usually a lot, less than 5% of the house price. But they can help cover the closing costs of the deal, which include the first year’s taxes, insurance, title fees and a whole lot more.
Sherwood: So what does this mean on closing day?
O’Brian: It means that the person doesn’t generally have to come up with a lot of money at closing, and may sometimes not have to come up with any at all. The loans cover the price of the house, the grant or grants cover the rest.
Sherwood: Sounds great. But what are the drawbacks?
O’Brian: Well, there are a few. First off, this isn’t a package deal for people who plan to “flip” the house. By that, I mean that there are some people who buy a property and then turn around and sell it again almost instantly. It’s called “flipping” in the real estate market, and it can be very lucrative. But a “flipper” want to unload the house right away, and this loan package wasn’t meant for that.
Sherwood: So how does this package prevent “flipping?”
O’Brian: In general, a person can only qualify for a first-time homebuyer’s loan once every five to eight years, and there are some other requirements for people who have already had one.
Second, the grants I mentioned are time-sensitive; if you sell the house within a specified time period, you have to pay them back. It might be easier to think of them as forgivable loans rather than grants. Over time, the loan amount goes down until it’s all gone. But if you sell the house before the time period is up, there’s yet another cost on your plate that eats into the amount you get from selling the house. In most states, the grant spaces out over five years, with one-fifth of it being forgiven each year.
Last, the second mortgage that I mentioned is due and payable in full when the property is sold, or when the first mortgage is retired, including interest if there was any that would be accruing over the normal life of the loan. Essentially, the second mortgage comes “pre-loaded” with the interest; if it was originally $100 and the annual interest rate is 3% and the first mortgage was only for one year, the “flipper” would be forced to pay, not only the $100 in the second mortgage principal, but also the additional $3 in interest fees. This has the unsurprising effect of lowering the amount the “flipper” gets for the house.
Sherwood: So, you have to buy the property and hold onto it for 5 years to avoid repaying the grants. And then you’ve got a second mortgage as well. Sounds like you may have trouble unloading the house at any time for profit.
O’Brian: If you plan to sell within the first 8 years, that’s exactly right. Most of what you pay the mortgage holder during that first 8 years on a 30-year loan is interest; it isn’t until later that the principal starts getting paid down in big amounts. Unless the housing market is really hot and prices are jumping to a lot more than you paid, selling the house won’t make you a lot of money.
Sherwood: But isn’t the point of the first-time homebuyer’s loan to allow people to buy their first house, then sell it and move into something a little larger later on?
O’Brian: On paper, sure. But reality doesn’t always mirror the theory.
Sherwood: OK, so say that I want to get a loan package. What are the basic qualifications?
O’Brian: Well, in general, you cannot have owned your own house for the last three years. In some places, that includes manufactured housing as well as site-built; in others, you can have a trailer and still qualify. You also need to meet creditworthiness and income guidelines. Requirements can vary pretty widely based on location, though, so it’s best if you talk to a loan specialist about your current area.
Sherwood: So, the next step is a lender?
O’Brian: Actually a loan counselor. You’ll need to go through loan counseling, which will allow you to tot up your income, your out-go and determine how much you realistically have for a house payment. After the counseling session, you’re ready to find a lender.
Sherwood: How about a realtor?
O’Brian: An absolute requirement. A good one can make the process much easier. In fact, some jurisdictions require that you be working with one in order to qualify for the loan package.
Sherwood: OK, bottom line time. Is this package a good deal?
O’Brian: Bottom line, only when another option isn’t available. That second mortgage really hurts you on resale unless the house is worth a lot more than you paid for it. Another problem that has been showing up recently is that some lenders are linking the first-time package to a subprime loan, like one that changes its rate three to five years down the line. A lot of lenders push adjustable-rate mortgages when the borrower has credit problems or not a lot of money, and tell the borrower that they can always refinance the house when the rate is about to change. But refinancing your home pays off that first mortgage, which means the second comes due immediately and you could be out of pocket by quite a lot.
It’s like everything else in money matters: read the small print and try to get some good advice. Loan and debt counselors allied with non-lending groups are a good bet for advice.
Sherwood: Thank you Ms. O’Brian. I appreciate your time.
Clarisse O’Brian was, until her retirement last year, a long-time mortgage and equity loan counselor for Bank of America in the Maryland area. James Sherwood interviewed her as part of a multi-piece series on first-time homebuyer’s loan packages