Why a Millennial Should Buy a Home – And How
As a millennial thinking about buying a home, you may be hesitant. When you consider all that student loan debt, being a new member of the workforce (more specifically your entry-level salary), and the desire to enjoy whatever time you have before taking on too many responsibilities, it’s easy to put home buying on the back burner. But what if I told you buying a home is more doable than you might think? And what if I told you that as a young person, it’s possibly the most intelligent financial decision you could make, almost guaranteeing dividends in the not-so-distant future? Well, it’s all true! Here is the skinny on how you could go about it.
The biggest obstacle for a millennial to overcome when buying a home is saving for the down payment. This is especially true if you want to avoid paying an average of 1.15% on your monthly mortgage payments, a fee known as private mortgage insurance (PMI).
In order to achieve this, it is standard for most lenders to accept a 20% down payment, or for example, $40,000 on a $200,000 home. Yikes! That’s a lot of money, especially if you just graduated anywhere near the new record-high average student loan of $28,950. It’s like being at an immediate disadvantage, and trust me, we understand why you’d want to wait. But remember that everything you do now is an investment for the future, so to set your sights on a sunny days ahead is extremely important when you’re making a big decision like buying a home.
One of the best-kept secrets of first-time home ownership is the down payment assistance programs that can save you money. In fact, the average amount saved on these programs is around $17,000. Many youngsters like yourself are often painfully unaware of these programs, but if you talk to our friends at Cross Country, someone could point you in the direction of how to get started.
The other option that a lot of millennials choose is to take out a parental loan, if possible. Making a deal with your parents to help with the down payment and paying them a small payment per month (it’s up to them if they want to charge interest!) could be feasible. Ben Franklin said to ask your neighbor for a favor when you move into a new neighborhood, so ask your parents for this favor and it could even help boost your relationship!
So what’s the takeaway here? It is perfectly OK to put less than 20% down on a first home; it’s just that you will have a higher monthly payment as the result of your private mortgage insurance (PMI). But there is nothing more liberating for a young person than owning a home, whatever the cost, and you will begin to build equity, which is of course beneficial in the long term.
Getting back to what we were saying about student debt, it doesn’t need to prevent millennials from getting into a nice home. What you really need to be aware of is what mortgage lenders call debt-to-income ratio – how much money you owe divided by your income. The ratio needs to be somewhere near 36% or less, meaning you owe 36% or less than what you make per month.
The thing to remember is that a mortgage is going to contribute to your debt-to-income ratio, which could pose some difficulty. If you have student loans or a car payment, you’re going to have to consider those as well.
So if your car payment is $300 per month and your student loans cost $250, you’ll have to make around $5,000 per month to cover a $1200 per month mortgage payment. We are here to give you the facts.
But it isn’t so bad. There are always options for millennials whose hearts are in the right place. You can make room for a mortgage by refinancing and extending the life of your college debt, or even your car payment. Or if you want to spend a little time cutting down your debts by making principle payments on your bills for the next 6 months, you will be at a much greater advantage come springtime.
If you are a millennial looking to buy in the next 6 months to a year, it will be highly beneficial for you to budget. Break down your monthly expenses into two categories: definite and variable bills.
In definite, you’ll have things like rent, car payments (and any principle you might want to add), student loans, gym membership – all things that have a concrete, set in stone monthly amount tied to them.
For variable expenses, you’ll have to estimate the amount to budget per month, like $100 for gasoline, $500 for food, and you can have a savings goal. Then you keep track of every single variable expense; this means you take home all your receipts from restaurants, gas stations, and retail shops and enter them into your spreadsheet. Save time and set up your sheet to auto-sum your totals.
It gets a lot easier the more you do it, especially keeping track of variable expenses. It will become habit to always say yes when you’re asked if you want a receipt, and to enter your expenses on your spreadsheet. And estimating how much each variable expense costs per month will get easier with a little trial and error.
Ultimately, this method will be very useful for any millennial saving money for a down payment or paying down your debts more quickly so you can maximize your debt-to-income ratio.
Another thing that might be useful for a millennial to think about is their credit score. Many young people have a short credit history. This could mean that they have limited (usually mediocre) credit, or no credit at all.
Mortgage lenders really like to see credit upwards of 660 before they hand out mortgages; and meanwhile they’ll check your credit utilization, or current debts divided by the total credit limit of all your accounts.
So if you’re carrying a debt of $300 on your $1200-limit credit card, your credit utilization is 25%. The problem with a lot of new credit users (usually millennials), however; is that they tend to have a higher ratio, causing problems with getting a mortgage.
There are a few free places to get estimates of your credit score, like CreditKarma.com or AnnualCreditReport.com. Many credit card companies have these estimates as well (Capital One, or Chase, for instance). Along with the budgeting we talked about earlier, you can take control of your credit score in a few months’ time. Also, if your credit is really bad, you could reach out to your folks to co-sign on a mortgage until you have enough time to build your credit back up.
Remember that you don’t need to rush into your Forever Home quite yet. Buying a starter home allows young people to build equity, so you can get acclimated to owning your own home for a while before you making the jump to an upgrade.
Your mortgage payments will be a lot more affordable if you do this, and you just might be able to get yourself into a 5- or 7-year adjustable-rate mortgage, which would also allow you to qualify for a lower interest rate than the mammoth-sized 30-year fixed rate loan.
Millennials are proving to be statistically less responsible financially than their older generations. Therefore, if you want to buy a home and start building equity, it’s really time to start budgeting, just like we laid out in this post.
Any small, incremental change will affect the possibility of buying a starter home soon. It’s so important to know where your money is going each month and to plan your savings and rainy day funds accordingly.
It can be done. The author of this post is a millennial saving to buy his first home, and he started budgeting in March with remarkable results. If you’d like a free blank excel document to get started, just fill out the form below. We’d love to help get you started today!