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What You Need To Know About Mortgages and Loans

Buying your first home is an exciting adventure! Whether you’re looking for a cozy cottage, a chic condo, or a family-friendly house, you’ll need to understand how the mortgage process works. To turn your homebuying dreams into reality, let’s break down everything you need to know, starting with the basics.

What’s the Difference Between a Mortgage and a Loan?

The words “mortgage” and “loan” appear often in the homebuying process, but they have slightly different meanings:

  • A loan is a simple agreement to borrow money and pay it back with interest. Loans are used for various things, like buying a car or starting a business.
  • A mortgage is a special kind of loan used to buy property. It’s secured by the property itself, meaning that the lender can take the house back if you don’t keep up with payments. 

Think of a mortgage as a bridge between renting and homeownership!

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Do I Qualify for a Loan?

It’s tempting to start house hunting right away. But before you start booking showings and attending open houses, first check if you’re eligible for a mortgage. Qualifying for a mortgage depends on several factors, and understanding these can help you prepare and increase your chances of approval. Here are some factors that impact mortgage eligibility: 

1. Credit Score:

A credit score is a three-digit number that reflects your history of borrowing and repaying money. Your credit score is based on several factors, including:

  • Payment history: How often you've paid bills on time in the past
  • Outstanding balances: How much money you owe
  • Length of credit history: How long you’ve been using credit
  • Inquiries: How often you apply for new credit accounts
  • Credit mix: The variety of credit accounts you have, like mortgages, car loans, and credit cards

A higher score generally means a better interest rate (and lower monthly payments). Aim for a score of 620 or higher for most loans. Don't worry if your score isn't perfect yet–there are ways to improve it!

2. Debt-to-Income Ratio:

Lenders want to know that you can handle the mortgage payment. The debt-to-income (DTI) ratio compares your monthly debt payments (loans, credit cards) to your gross monthly income (any income before taxes). A lower DTI ratio shows lenders that you can comfortably manage your mortgage payment.

To figure out your debt-to-income ratio, start by adding all your monthly debt payments. Then, divide this total by your monthly gross income (pre-tax income). If you are self-employed, divide your total monthly debt payments by your net income (post-tax income). Multiply the result by 100 to get the percentage.

 

Monthly Debt ÷ Monthly Gross Income = Debt-to-Income * 100 = DTI Ratio

 

For example: If your monthly debt payments are $330 and your gross monthly income is $2,275, you would calculate it like this: 

 

$330 ÷ $2,275 = 0.1450. Multiply by 100, and you get 14.5%.

 

Remember that a DTI ratio only calculates your existing debt payments. It doesn’t include expenses, like rent, utilities, insurance, or child care. Consider those costs as you budget for a mortgage payment.

An acceptable DTI ratio varies by lender and loan type, but lenders generally prefer lower ratios. Borrowers with lower ratios have enough income available to cover new debt, making them safer bets for mortgage approval.

3. Proof of Employment:

Stable employment shows lenders that you have a steady income to pay back the loan. Be prepared to provide pay stubs, W-2 forms, or tax returns. These documents will demonstrate that you have a reliable source of income to support mortgage payments.

4. Down Payment:

Some loans require a down payment, which is a certain percentage of the home’s price that you pay at one time at the start of the loan, instead of spread out over monthly payments. This could be up to 20%, depending on the loan type. A larger down payment can reduce your loan amount and lower monthly payments.

There are many down payment assistance programs available to help lower barriers for first-time homebuyers. 

5. Savings and Assets:

Having savings or investment funds reduces your borrowing risk, as they can serve as a safety net for financial hiccups. Lenders may look at your savings to ensure that you can cover unexpected expenses or temporary income loss.

Don’t worry if you haven’t checked all these boxes just yet! There are programs and steps you can take to improve your eligibility over time.

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How Can I Improve Eligibility? 

The Twin Cities Habitat for Humanity Financial Coaching Program helps individuals and families achieve financial stability and prepare for homeownership. Here’s how it works:

Certified financial coaches provide tailored guidance and work one-on-one with you to manage finances. They can help you understand your financial situation and develop strategies to improve it. This might include:

  • Budgeting: Creating a personalized budget to effectively manage income and expenses.
  • Savings plans: Setting up savings goals for emergencies, down payments, or other financial needs.
  • Credit improvement: Offering tips and resources to improve your credit score, such as correcting credit report errors or managing credit card debt.
  • Debt reduction: Developing a plan to pay down existing debts and avoid new debts.

Your financial coach will help you set achievable goals and provide ongoing goal-tracking support. Regular check-ins can help you progress toward your goals and adjust your plan as needed.

With eligibility covered, let’s review different Minnesota loan options!

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What Are Different Kinds of Loans in Minnesota?

When shopping for a home, you should choose a mortgage that fits your financial situation and plans. Whether you’re a first-time homebuyer, a veteran, or a rural area buyer, there’s likely a loan that suits your situation. Here are some common types of mortgage loans:

FHA Loans

Federal Housing Administration (FHA) loans are a popular option for first-time buyers or individuals, typically with lower credit scores. These government-backed loans are insured by the FHA, making them accessible to borrowers who may not qualify for private, conventional loans.

FHA loans usually have lower down payment requirements, sometimes as low as 3.5% of the home's purchase price. This makes it easier for buyers to enter the market without needing a substantial upfront payment. 

Additionally, FHA loans allow for higher DTI ratios than conventional loans, which provide more flexibility for people with existing debts. However, FHA loans also require private mortgage insurance (PMI), which can increase your monthly payments.

VA Loans

Veterans Affairs (VA) loans are designed for veterans, active-duty service members, and their families. Backed by the Department of Veterans Affairs, VA loans have several benefits, including no down payment requirements and competitive interest rates. 

VA loans don’t require private mortgage insurance (PMI), which can mean significant savings over the life of the loan. Additionally, they often have lower closing costs. To qualify, you must meet certain service requirements. If you’re eligible, VA loans can help you secure affordable financing and achieve homeownership without substantial upfront payments.

HUD Rehab Loans (203(k) Loans)

HUD 203(k) loans are meant for homes that need significant repairs or renovations. These loans, backed by the Department of Housing and Urban Development (HUD), allow you to finance both the purchase of the home and the cost of necessary repairs or improvements. 

HUD 203(k) loans combine these costs into a single mortgage, making it easier to manage than taking out separate loans. This can help when buying fixer-uppers or homes that require major upgrades, as they provide the funds needed to make properties livable and increase their value. There are two types of 203(k) loans: standard versions for extensive projects and limited versions for smaller repairs.

USDA Loans

U.S. Department of Agriculture (USDA) loans can serve homebuyers in rural or suburban areas. These loans help moderate- and low-income individuals buy homes in eligible rural areas. USDA loans have attractive benefits, such as no down payment and low interest rates.

They also have flexible credit requirements, which can help individuals with less-than-perfect credit. To qualify, the property must be in a USDA-eligible area, and you must meet certain income guidelines.

Conventional Loans - Banks

Banks offer a range of conventional mortgage products for buyers who meet strict qualification criteria. Conventional loans aren’t insured by the government and typically require higher credit scores and larger down payments than government-backed loans. 

However, they offer competitive interest rates and various loan terms, including fixed-rate and adjustable-rate mortgages. Conventional loans may be a good fit for buyers with strong credit histories, substantial down payments, and stable incomes, looking for diverse loan options and potentially lower monthly payments.

Conventional Loans - Credit Unions

Credit unions are member-owned financial institutions offering personalized banking experiences and competitive rates. They provide several conventional mortgage options similar to banks but may have more flexible lending criteria and lower fees. 

Credit unions apply a community-focused approach, which can result in better customer service and potentially more favorable loan terms for members. They are ideal for buyers who prefer working with a local institution that prioritizes member needs over profit.

TruePath Mortgage

TruePath Mortgage is offered through TCHFH Lending, Inc., a wholly-owned subsidiary of Twin Cities Habitat for Humanity. Loans must be used to purchase homes in the seven-county Minneapolis/St. Paul metro area. TruePath Mortgage specializes in helping first-time homebuyers and people with non-traditional income sources. 

Unlike conventional lenders, TruePath Mortgage offers flexible qualification criteria and tailored mortgage solutions to accommodate unique financial situations. TruePath Mortgage is designed to support income-qualified borrowers with long-term affordability. The benefits include:

  • Low fixed mortgage with a 30-year term
  • Affordable, income-based payments
  • Down payment assistance
  • No mortgage insurance requirement
  • Closing costs assistance

To qualify for a TruePath Mortgage, you need to meet all income and other underwriting criteria.

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How Does Homeownership Build Wealth?

Owning a home is still the best way for American families to build wealth. When you buy a home, you build wealth in three primary ways: 

  1. Earned equity, also known as principal equity. This is built through monthly payments toward the first mortgage’s principal balance. A portion of each monthly payment goes towards paying down the principal–some people describe this part of homeownership as “living in your savings account.”
  2. Market appreciation. If a home sells for more than its original purchase price, the increase in value is the market appreciation.

Forgiveness subsidy or down payment assistance. Certain states may offer loan forgiveness or down payment assistance subsidies. These programs can also increase equity by reducing the mortgage amount.

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What is Long-term Affordability?

When you buy a home with Twin Cities Habitat, you're not just buying a house. You’re ensuring that home will still be affordable for future generations of homebuyers, despite rising housing costs and an unpredictable housing market. In short, you’re helping your fellow neighbors become homeowners! 

Long-term affordability (LTA) or lasting affordability refers to certain types of affordable homeownership. LTAs often restrict home selling terms, to ensure that a home will remain affordable for low- and moderate-income households. 

LTA models typically include shared equity homeownership, community land trusts (CLTs), inclusionary housing policies, limited-equity cooperatives, and deed-restricted housing programs. 

Twin Cities Habitat’s LTA model is focused on lasting affordability and includes: 

  1. A revised wealth-building model for homeowners. 
  2. Using deed restrictions, rather than subordinate mortgages. These are also known as Affordability Agreements. 
  3. A revised subsidy forgiveness model. 
  4. Involvement with CLTs.

The LTA model allows Twin Cities Habitat to increase our affordable housing stock over time, so we can continue serving more families long-term. That means helping more people transition from renting to homeownership, where they can truly build wealth.

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Your Path to Homeownership

Congratulations! You’re now equipped to navigate the complex world of mortgages and loans. Whether you’re ready to buy now or need to improve your financial standing, knowing your options and resources brings you closer to the home of your dreams.

Remember, you don’t have to embark on this journey alone. Twin Cities Habitat for Humanity and other supportive programs can guide you every step of the way, from qualifying for a mortgage to ensuring long-term affordability.

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Ready to Take the First Step?

If you're ready to take the first step toward homeownership with Habitat, please click the link below to find out if you're eligible.

Find Out if You're Eligible

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