While today’s homeownership rate among 25-40 year-olds is at a historic low (18%), 80% of millennial respondents to a Business Insider survey said they want to buy a home and 52% said that renting is a waste of money. Why is there such a disparity? Maybe because millennials have been discouraged from buying homes by misinformation and mythology such as: renting is cheaper; 20% down is necessary; a perfect credit score is required to get loan; it’s advisable to pay off student loans first, and others.
Not only are these inaccurate, but there’s actually some good news for potential homeowners. The housing demand among millennials has led the U.S. Department of Housing and Urban Development (HUD) and private lenders to ease credit scoring and lending standards; to institute concessional loans with lower down payments; to provide flexible interest rates to lower monthly payments; and to offer other incentives to facilitate first-time homeownership.
Here are real facts behind common mortgage myths that can help millennials make the transition into property owners confidently:
Myth #1: Renting is cheaper than buying a home
Fact: Trulia’s recent Rent Versus Buy report states that buying a home in the DMV is 28.4% cheaper than renting one in 2017. That’s because the demand for rental housing has grown while supply has dwindled, resulting in an increase in rental rates by nearly 86% in the last ten years, according to an Apartment List study. As in other popular millennial cities, skyrocketing rents have left renters paying heavily to live in homes that provide no equity, tax advantages or investment potential.
Further, renters are subject to yearly inflation-driven rent hikes for which they have no control and little recourse. Conversely, homeowners can predict and control their housing costs through fixed rate mortgages and, to a lesser degree, adjustable rate mortgages that are subject to caps on the number of times in a year the rates can be adjusted.
Myth #2: Home ownership requires a 20% down payment
Fact: A large number of millennials are delaying buying a home because they can’t afford the standard 20% down payment. This may be because 76% of millennials are either unaware of the down payment options available to them or are misinformed about the credit and income eligibility requirements for these programs. The fact is that many lenders (federal as well as private) underwrite loans with down payments as low as 0% to 10%. RealtyTrac estimates that about 30% of all homebuyers put down 3% or less on the cost of their homes in 2016. Freddie and Fannie assistance programs work with local lenders to provide homes for a down payment of just 3%; the USDA’s assistance program targets rural areas and requires no down payment; the Good Neighbor Next Door Program offers a 50% discount on the list price of homes in revitalization areas (areas designated by the HUD as “revitalized” based on the average household income, homeownership rates, and FHA-backed mortgage foreclosure activity); and VA loans require no down payment or insurance from service members and families. A realtor who specializes in helping first-time homebuyers can advise on the best program based on a client’s credit score, income and regional eligibility for these programs.
Myth #3: A perfect credit score is needed to qualify for a mortgage
Fact: Credit scores range from 300 to 850 and anything above 680 is considered “qualifiable.” This is a major reason why those with shaky credit histories give up on their home-buying dreams. But the truth is that borrowers can get a loan insured by the FHA or the USDA, even with lower credit scores. These agencies guarantee a portion of the loan that frees the lenders to broaden their acceptance standards. The FHA loan has become the go-to source for millennial buyers, judging by an Ellie Mae report that states that 37% of all closed loans to millennial applicants this year were FHA-backed. These loans come with an up-front and ongoing additional cost built in called Primary Mortgage Insurance(PMI). It protects the lender’s stake in the loan if the borrower should default. Another option for borrowers with credit scores below 640 is the USDA-insured loan that comes with income conditions and requires additional payment history documentation.
Myth #4: It’s not wise to buy a home before student loan debt is paid off.
Fact: The average amount of student-loan debt in America has tripled over the past 20 years, and many cite this as a barrier to home buying, reports the Washington Post. But NAR’s Student Debt and Housing Report states that 41% of homebuyers in 2016 had student loan debt at the time of purchase. They managed mortgages with debt by enrolling in government repayment programs such as Fannie Mae’s PAYE and REPAYE that lets borrowers devote as little as 10% or 15% of monthly discretionary income to repaying their federal student loan debt if they are also paying a mortgage simultaneously. The trade-off is that the student loan repayment period stretches to 20-25 years, but the monthly payments are significantly lower. Student loan refinancing may be another good option. Refinancing saves money by replacing an existing student loan with a new, lower-rate loan. To qualify, applicants need a credit score in the mid-600s or higher and a steady income, or access to a co-signer.
The good news is that college graduates can expect to earn 66% more than high school graduates during a 40-year career, enabling them to pay back their debt and mortgage more easily, according to the U.S. Census Bureau. In this way, student debts become more of an investment than an impediment towards homeownership.
Myth #5: Mortgage payments should not exceed 30% of monthly salaries
Fact: Borrowers are advised to explore different types of mortgages and lenders since this can impact their monthly payment and the loan tenure. If they opt for an ARM loan (loans that adjust their interest rate annually, based on inflation), they may have a monthly installment that is lower than a corresponding fixed loan for the initial period, but there is the uncertainty of adjustments later on. They’ll pay for the certainty of a fixed loan by paying additional interest through the loan tenure, even if market rates are lower.
By Zillow’s estimates, a 30-year $400,000 loan at a 4% fixed rate and a 20% down payment for a two-bedroom condo would require a monthly payment of approximately $2,000. If the median household income in D.C. is $90,000, as stated by a 2015 U.S. Census report, the monthly mortgage payment amounts to less than the commonly-accepted threshold of 30%. On the other hand, a rental of comparable market value would require about $2,400 monthly rent, according to a Rentcafe study.
For the same loan amount, different lenders might calculate different monthly payments. The reason is that closing costs (costs related to the processing of the paperwork before settling a deal with the seller) and other fees vary widely across lenders. These additional costs are either bundled in the mortgage and divided into monthly installments (resulting in higher monthly payments) or paid later as settlement costs.
Considering that millennials grew up in the 2007 housing crisis that saw home prices crashing and put owners into financial misery, their reluctance to buy a home is entirely understandable. But awareness of financial assistance programs and guidance from a skilled realtor for the best mortgage and lender options can help in fulfilling first-time homeownership dreams.
There may be other misconceptions regarding homebuying that are not addressed here. For a consultation on those, and more first-time homebuyer assistance, contact me or a member of my team.