A Millennials’ Guide to Mortgage Loans
Remember when real estate professionals worried that Millennials weren't buying enough homes? Those days are over, with young adults from the ages of 18 to 35 buying more homes than any other generation according to the latest research from the National Association of Realtors.
Many of these Millennials, though, are buying a home for the first time. This means that they are applying for mortgages for the first time, too. What, then, do Millennials need to know about working with mortgage lenders and financing the purchase of a home?
There's plenty of jargon for young buyers to decipher, and plenty of steps to complete to qualify for a mortgage. But mortgage lending pros offer one key piece of advice: Don't take out a loan that you can't afford to pay back every month.
"Choosing the best mortgage for you is more complex than picking the one with the lowest interest rate," said Alyssa Schaefer, chief marketing officer at Laurel Road, an online lender based in Darien, Connecticut. "Deciding to buy a home is a big step at any age, but for Millennials, the task can be particularly daunting."
According to the 2018 Home Buyer and Seller Generational Trends study from the National Association of Realtors, Millennials made 36 percent of all home purchases during the past year. That's up from 34 percent in 2017.
That’s a lot of new buyers entering the housing market and working with mortgage lenders for the first time.
What can you afford?
The most important question for any Millennial to ask? How big of a mortgage payment can you afford to make each month?
You need to draft a budget before you start hunting for homes or a loan. Determine how much income comes into your household each month. Then list all your monthly expenses, including those that vary, such as the amount you spend each month for groceries, eating out and entertainment.
You’ll then be able to figure how much of a mortgage payment you can afford. But don’t take out a mortgage that consumes all your extra income. You don’t want to be house-poor, which is what happens when you spend all your extra money on a home.
Remember, too, to include every part of your monthly mortgage payment. You’ll have to pay principle and interest on your loan, of course. But you’ll probably have to pay extra with each mortgage payment to cover the cost of your homeowners’ insurance and property taxes. If your insurance and taxes come out to a combined $6,000 a year, this means you’ll have to pay $500 more each month with your mortgage payment.
It can be difficult for Millennials to determine how much mortgage they can afford, said Natasha Rachel Smith, personal finance expert at TopCashback.com, a UK company whose U.S. headquarters is in Montclair, New Jersey.
She recommends that Millennials follow the 50/20/30 rule: You should spend up to 50 percent of your after-tax income on essentials such as housing and food; 20 percent on financial priorities such as debt repayments and building your savings; and 30 percent on lifestyle choices such as vacations and entertainment.
"Don't allow yourself to buy a property priced so high that the mortgage payment, property tax, insurance and other fees, plus your food costs, exceed 50 percent of your take-home pay," Rachel Smith said.
Get preapproved for a home loan
You might be tempted to start your home search by immediately touring homes for sale. But you should get preapproved for a mortgage first.
During a preapproval, a lender will review your credit and ask for documents that prove your income and debts, everything from copies of your weekly paycheck stubs to copies of your monthly bank statements and income-tax returns.
Your lender will review this information and provide you with a pre-approval letter stating how much of a loan it is willing to give you. This is important; if your lender says you can qualify for a $200,000 mortgage, you won’t waste time searching for a home that costs $300,000.
Having a preapproval letter also makes you a more attractive borrower. Sellers prefer working with borrowers whom they know can already qualify for a mortgage.
Klaus Gonche, a real estate agent with RE/MAX House of Real Estate in Fort Lauderdale, Florida, said that preapproval is important for all home buyers, but is a must for Millennials who've never bought before.
"The last thing you want is to begin looking at homes, fall in love with one and later come to find out that you aren't able to buy it," Gonche said. ""Get a thorough preapproval first, and understand the nuances of what you can truly afford before looking at homes."
Know what your credit reports say
Lenders rely on your three-digit credit score to determine whether you qualify for a mortgage and at what interest rate. The higher your score – a FICO credit score of 740 or higher is best – the more likely you’ll nab a lower interest rate, and a smaller monthly payment.
If your credit score is too low, you might have to take out a bad credit mortgage. Such a loan, though, will come with higher interest rates.
Before searching homes, then, visit AnnualCreditReport.com. From here, you can order a copy of each of your three credit reports, maintained by the national credit bureaus of TransUnion, Experian and Equifax, for free, once a year. These reports list how much money you owe in loans and on your credit cards, and if you’ve missed any payments or made any late payments in the recent past.
Your three-digit FICO credit score is made up of the information contained in these reports. If you see late or missed payments, you’ll know that your score will suffer. You can boost your score by making payments on time and by paying down your credit card debt.
You can also order your actual credit score from any of the bureaus or from MyFico.com. But you will have to pay for it.
Pay attention to APR
When shopping for a mortgage, you might be tempted to go with the loan that comes with the lowest mortgage rate. But you should pay more attention to your loan’s annual percentage rate, better known as its APR.
This figure is a more accurate representation of what you’ll pay in total each year for your loan. That’s because APR includes not only your interest rate but also any fees or charges you’ll have to pay for your loan.
The lower your APR, obviously, the better.
Bigger down payments can help
Coming up with the money for a down payment can be a big struggle for Millennials. A 10 percent down payment on a home costing $200,000 comes out to $20,000.
Fortunately, there are plenty of programs that require smaller down payments. If you take out a loan insured by the Federal Housing Administration, known as an FHA loan, you’ll only need a down payment of 3.5 percent of your home’s purchase price if you have a solid credit score. Some conventional loan programs – a conventional loan is any that isn’t insured by a government agency – require down payments as low as 3 percent.
The more you can provide as a down payment, though, the better. If you provide a down payment of at least 20 percent of a home’s purchase price, you won’t have to pay for private mortgage insurance, or PMI, an extra fee charged to you to protect your lender in case you default on your loan.
And if you come up with a higher down payment, you’ll boost your odds of qualifying for a lower interest rate.
It’s not a quick process
It varies by lender, but you can expect your loan approval to take 30 days or more from the moment you send in your completed Uniform Residential Loan Application to the day you sit at the closing table to finalize your mortgage.
That’s because your loan has to go through the underwriting process. It’s during this time that your lender determines how likely you are to pay your loan back on time.
At the start of the lending process, you’ll fill out that loan application. You’ll have to include such basic information as your name, age, Social Security number and current address. You’ll also have to provide information regarding your income and debts.
Next, you’ll need to send your lender copies of your last two paycheck stubs, two months of bank account information, last two years of income-tax returns and most recent W-2 statements. Your lender will use this information to verify that you earn enough to afford your monthly mortgage payments.
Your lender will also run your credit. If you do have blemishes on your credit reports and a low credit score, expect your lender to ask plenty of questions. You might also face a higher interest rate.
The process ends at the closing table, usually held in the offices of your title insurance company. Here, you’ll sign a stack of papers transferring ownership of your new home to your name. You’ll also sign documents stating that you promise to pay your loan back on time.