A Millenial’s Guide to Buying a Home
“Homeownership” and “Millenial” are two terms that often do not go hand-in-hand. Compared to previous generations, Millenials, or those born in the early 1980s through the mid-1990s, have tended towards renting or living with family members as opposed to purchasing a home. A portion of this new trend may be attributed to the personal preferences of these individuals, but it’s also not surprisingly linked to a poor economic climate coupled with the unfortunate side effect that comes with higher education: student loans.
But fear not: even those with high student loan debt and a lower than expected income are capable of navigating the real estate and mortgage markets to secure a home to raise their family, or even an income property to build savings while completing their studies or living in the city before settling down in the suburbs. If you find yourself questioning the feasibility of purchasing a home due to your student loan debt, the following Q&A should answer some of your questions and you may even find out that homeownership is closer than you think.
Q: What percentage of the home’s purchase price do I need for a down payment?
A: According to the National Association of Realtors® 2016 Profile of Buyers and Sellers, the average down payment for first-time home buyers has been just 6% over the last few years of the study. This is much less than the common thought of 10%. If you’re looking at a $250,000 home, 6% is $15,000. For an FHA loan (mortgages insured by the Federal Housing Administration), down payments can be as low as 3.5% even with a credit score as low as 580, but borrowers have to pay an added cost for a mortgage insurance premium, plus there are added stipulations to qualify. Be sure to talk to your agent about these qualifiers before going this route. Either way, as a recent grad with a less than stellar income, $10-15,000 is a much more realistic number to reach in savings than the traditionally thought 10%.
Q: What do mortgage lenders look for when approving home loans?
A: When you apply for a home loan, a mortgage lender is ultimately trying to determine if you will be able to pay off the loan. If they determine you will, they should approve you for the loan with good terms. If they determine you might not, they’ll either reject your application, or approve of the loan, but with not so good terms. Aside from your credit score (as mentioned earlier), mortgage lenders tend to look at a few different factors when determining if they will approve you for a home loan. These include your credit history, your debt-to-income ratio, your employment history, the capital, or money in the bank, you have available, and also the current housing market and economic conditions.
Q: How does my credit affect my chances of securing a home loan?
A: One of the factors that goes into a lender’s decision of approving a home loan is your credit score. Unfortunately, the score that is often needed to secure a lender’s best rate is higher today than it was in years past. As a younger individual, you may not have built up great credit yet, but there are steps to improve your score. Hopefully, you already have a few credit cards across varying industries (e.g., one from a bank, one from a retail chain, one from an airline – if you don’t, there are plenty of cards with great perks you can apply for, just be sure not to apply to multiple too close together, as this negatively affects your score). For these cards, contact them and ask for an increase in your credit limit. Also, be sure to pay off your credit cards entirely each month and also never miss a payment for any of your monthly bills. And of course, be sure to never miss a payment on your student loans. These steps will help boost your score and give you a better shot at securing top-notch rates.
Q: How do I improve my debt-to-income ratio when I have large student loan payments due each month?
A: Your debt-to-income ratio is just that, a comparison of how much you have to pay each month towards your debts (such as credit card payments, car payments, student loan payments, etc.) to how much income you bring in each month. Lenders will look at your debt-to-income ratio and partially base their approval decision or mortgage rates off of how good your ratio is. With a debt-to-income ratio of more than 43%, it becomes much harder to get that mortgage approved. In other words, you want low debt payments and high income (sounds nice, right?). As always, there are steps you can take to improve your ratio.
Step one is to assess your situation, make a plan, and start as soon as possible. You won’t be able to change your ratio overnight – it will take a little time. As stated earlier, try to pay off your credit cards each month so you don’t carry a balance. Large balances lead to accrued interest and higher debt payments. Try avoiding any new debt or credit changes, such as buying a new car, opening a new credit card, or taking out new loans. You can also reduce your living expenses by eating out less, skipping your daily #iced-skinny-nonfat-hazelnut-macchiato-with-soy-milk-and-extra-whip-cream, and passing on buying that new pair of pants. I know it doesn’t sound fun, but homeownership takes work. Consolidating your student loans and applying for a repayment plan can also help tremendously (see next section below). And of course, you can always increase your income. Apply for a better job or take on another side-gig on the weekends.
Q: What’s the best course of action if I have multiple student loans from different institutional lenders that each require a high monthly payment, or just a high monthly payment on my one loan?
A: Recent graduates who took out student loans through undergrad and grad school may be faced with more than one student loan from different lenders. On top of that, these loans commonly trade hands when they are bought by other lenders. It can become very burdensome to keep track of who to pay and how much each month. Plus, with all of these loan payments combined (or with your one high payment), your debt-to-income ratio is probably through the roof. Your best course of action is to consolidate your student loans and apply for a repayment plan.
If you have multiple federal student loans (not private loans), you can apply for a Direct Consolidation Loan, which is essentially one government approved company buying all your loans, leaving you with a single monthly payment at a single interest rate to that company. This makes it much easier to keep track of your loans. You can also apply for a repayment plan, such as an income-driven plan that will base your monthly payment off your income, which should reduce your monthly payment compared to what you had previously been paying. There are other benefits to a consolidated loan repayment plan as well: if you work in the teaching or public service fields (and nearly 25% of jobs qualify for these categories), and you make your minimum monthly payment for 10 years, the remaining loan balance you have will be forgiven and you won’t have to pay any taxes on the amount that is wiped out. For more information, be sure to check out the Federal Student Aid site here: https://studentaid.ed.gov/sa/? (please note: there are other steps you need to take to qualify for the loan forgiveness – if you would like more info, feel free to contact me!)
Q: How do my employment history and my assets affect a mortgage lender’s decision?
A: When figuring out whether or not you are capable of paying back a mortgage loan, a lender will look at your past income over the previous 24 months. Salaried employees may be easier for a lender to assess compared to hourly employees, and someone who has had the same job for the past two years is a pretty straightforward situation. However, if you’ve changed jobs, received a pay increase, or changed industries altogether, you’ll need to provide extra documentation to the lender so they can average out your history. Your best bet is to work with a lender early on in the process so they can obtain all the necessary information from you so you can get pre-approved.
As for your assets, a lender will need to know how much you are holding in your checking and savings accounts that could be used to cover a down payment. If you’re looking into an FHA loan, you can use money as gifts from relatives to show proof of funds for the down payment. If you have poor credit and low income, high balances in your accounts could still result in an approved mortgage.
Q: How do housing market and economic conditions alter my chance of receiving a home loan?
A: The conditions of the housing market will play a role in mortgage rates. When there is a trend towards fewer new homes being built and fewer homes being sold overall, sales numbers will drop, resulting in fewer mortgages being sought by buyers. The lenders will then reduce interest rates on the mortgages to entice buyers with better deals. The trend towards renting instead of buying has the same effect. However, at the same time, fewer homes for sale could mean a low supply and coupled with high demand, could lead to higher home prices.
Economic conditions will also come into play. Economic growth, inflation, the Federal Reserve’s Monetary Policy, and the bond market will all alter the mortgage rates in one way or another. These conditions and the housing market aren’t things you need to worry about figuring out – it’s one of the reasons you hire a real estate agent so they can do the dirty work for you and let you know the best times to get a loan.
Q: What type of costs will I face at closing and during my first year of homeownership?
A: Saving up for a down payment and budgeting a monthly mortgage payment are unfortunately not the only expenses you need to plan for when it comes to owning a home. There can be a lot of different fees associated with closing costs and your purchasing agreement should list whether the buyer or the seller is responsible for each. These closing costs can include (and are certainly not limited to) a closing fee, credit report, home inspection, origination fee, pest inspection, private mortgage insurance, title search, title insurance, and transfer taxes. You will receive a listing of these costs at least three business days before closing from your lender in the Closing Disclosure statement. A good rule of thumb is to budget anywhere between 2 to 5% of the purchase price for closing costs.
Then there’s the costs associated with actually owning a home. Property taxes are usually the largest home expense following the purchase. The average property taxes in Broward county are roughly 1.3%. Florida residents also pay the highest home insurance costs in the nation at an average of $300 per month. Don’t forget about your utility bills and any maintenance or remodeling costs, either (washers and dryers aren’t cheap!). It can sound intimidating, but when budgeted out, owning a home can be cheaper than renting, plus you are building equity and will eventually own the home outright. Homeownership is not just to provide a quality home, it’s also an investment!
Have more questions or want to discuss if homeownership is possible for you?
I’m here to offer any assistance I can. You can contact me here with questions or if you’re ready to become a homeowner.
-Cook, S. (January 2015). Tips for Getting a Mortgage When You Have Student Loan Debt. Retrieved from https://blog.equifax.com/credit/tips-for-getting-a-mortgage-when-you-have-student-loan-debt/
-Federal Student Aid (n.d.). Here’s Your Guide to Repaying Your Federal Student Loans. Retrieved from https://studentaid.ed.gov/sa/reapy-loans
-John, C. (n.d.). Do Assets Affect Prequalification for a Mortgage? Retrieved from https://budgeting.thenest.com/assets-affect-prequalification-mortgage-23737.html
-Maverick, J.B. (December 2015). The Most Important Factors that Affect Mortgage Rates. Retrieved from https://www.investopedia.com/articles/wealth-management/120115/most-important-factors-affect-mortgage-rates.asp
-National Association of Realtors® (2016). 2016 Profile of Home Buyers and Sellers: 35th Anniversary Edition.
-Realtor® Mag. (June 2017). “Most Expensive Bills Your Clients Will Pay. Retrieved from http://realtormag.realtor.org/daily-news/2017/06/05/most-expensive-bills-your-clients-will-pay
-Sheldon, S. (July 2014). Why Your Job Matters When Buying a Home. Retrieved from http://blog.credit.com/2014/07/why-your-job-matters-when-buying-a-home-88105/
-Wegener, K. (June 2017). Guiding Millenials Into Their First Home. Retrieved from http://realtormag.realtor.org/for-brokers/network/article/2017/06/guiding-millenials-their-first-home
-Zillow (n.d.). What are Closing Costs and How Much Are They? Retrieved from https://www.zillow.com/mortgage-learning/closing-costs/
-Zillow (n.d.). What is an FHA Loan? – The Complete Consumer Guide. Retrieved from https://www.zillow.com/mortgage-learning/fha-loan/