If you've been finding it hard to choose a mortgage, you're not alone. Home loans…
It’s a common misconception that it’s impossible to get approved for a home loan in your early working years. But did you know that the federal government offers zero-down payment options? They can also help you get approved even with a relatively low FICO score.
Today, we’re going to talk about the mortgage loan options for people aged 25 to 40 and what millennials can do if they would like to improve their home mortgage chances.
These are home loans you might take on for two reasons. For one, you might not have the cash to finance your dream home. The other reason for some is that they prefer to keep their liquidity for investing in other financial instruments. Whatever your motive, you may or may not get approved for a home loan as mortgage lenders often look deep into your credit history to review an application.
Applying for a Mortgage
There are three basic mortgage requirements you’ll observe regardless of the lender. To qualify, you need to look at your: down payment capability, credit score, and debt-to-income ratio. Let’s discuss this one by one.
Depending on the mortgage you would like to get, the lender may or may not require you to make a down payment. (Later, we’ll also discuss different mortgage types.) At best, this upfront payment could be zero, as in the case of a USDA loan, and at worst, you might have to pay up at least 20 percent for a free pass on private mortgage insurance.
Clearly, the mortgage lender will have to look into how much money you have for this requirement. But in some cases, you are allowed to get your down payment from other sources like cash gifts or grants.
The most common credit score used for reference by mortgage lenders is from the Fair Isaac Corporation (FICO).
Let’s take a look at its breakdown:
- Payment history – 35%
- This is important to lenders, so if you have missed out on a deadline recently, your score is bound to take a nosedive.
- Accounts owed – 30%
- Lenders also want to find out just how much you owe from all financial institutions. They will pay attention to details, such as if you have gone over your credit card limit or paid less than the minimums required.
- Length of credit history – 15%
- Another factor that affects your score is your length of borrowing experience. The longer you’ve kept a credit account, the better this is to your advantage.
- New credit – 10%
- It can be a warning sign for lenders if you have been acquiring loans left and right recently. This is a sign of risk that they would want to avoid.
- Variety of credit products – 10%
- Finally, as another way to show your scope of experience, it’s better to have more than one type of credit or loan product to your name.
Simply put, your debt-to-income ratio is the quotient of your accumulated monthly debt to your monthly income. Imagine that your income is a whole pizza, and every time you make a payment for whatever loan, you take a slice out of that pie. The remaining slices after you’ve paid everything is very important. These must be more than enough for additional payments you need to make for new loans.
Millennial View on Home Equity
For many Americans, monthly payments for a mortgage loan are just a fact of life. But while applying for a mortgage program is more logical for most, it has increasingly been observed that many millennials (those who were born from 1981 to 1996) are choosing to delay financing for a home for understandable reasons.
Today, many of them are still saddled with student loan debt. In fact, in an Experian survey in 2019, it was found that millennials had the third-highest average student loan balance compared to previous generations. Since most millennials are also just in their early working years, many of them are still only starting to beef up their savings and credit history. However, through a 2014 survey conducted by Fannie Mae, millennials could still express a desire to own real estate, considering this more sensible than making a monthly payment for rent.
So what available options are there for millennials who are interested in buying a home? Is it a worthy conquest, or should they go with their gut and focus on building their savings first? To answer these questions, we’ll discuss the different types of home loans.
Types of Mortgages
There are two ways we can classify mortgages: according to who insures them and depending on the interest rate.
According to Mortgage Lenders and Loan Amount
If you owe your home loan from a private mortgage lender, you have a conventional loan. This type of loan is usually for those who already rate high financially. The minimum FICO score that may qualify for a conventional mortgage is a rating of 620, although you might be hard-pressed to find a lender this generous. A high debt-to-income ratio of at least 45% is also required by most.
Borrowers might take on a conventional loan for two possible reasons: first, they might be capable of making a down payment of at least 20% of the purchase price. This is so they can escape private mortgage insurance, which is obligatory for conventional loans. A free pass can dramatically reduce your monthly payments. If you don’t have 20% of the cash needed up front, you can still make a down payment of 3 percent; you’ll have to make private mortgage insurance payments with the downside. The second reason some people opt for a conventional mortgage is because of the loan limit. Government-backed loan limits are usually determined by location. With a conventional mortgage, the maximum amount you may be allowed to borrow could be half a million dollars!
If you are an active duty member or a military veteran, you can be qualified for a VA loan insured by the U.S. Department of Veterans Affairs (VA).
While there is no minimum credit score for VA loans as determined by the VA, most lenders still ask for a rating of at least 620. But the benefits are incomparable when you don’t have to make any down payment apart from a 0.5% to 3.6% VA funding fee.
Now, if you intend to buy a home in a rural country, one of the mortgage options you can qualify for is from the U.S. Department of Agriculture (USDA). This is another zero-down payment mortgage from the federal government.
Just like VA loans, however, even though the USDA does not particularly prescribe a qualifying credit score, lenders still have the prerogative to set their own, and most of them usually set the standard at least 640. You also have to pay for an upfront 1% USDA guarantee fee as well as a 0.35% annual guarantee fee.
Of the loan options insured by the government, more people are bound to choose a home mortgage from the Federal Housing Administration (FHA).
If you have not served in the military or plan to buy rural property, an FHA loan might be attractive for you. FHA loans are mostly intended for first-time homebuyers, but a newbie status is not required for you to submit a mortgage application.
With an FHA loan, you can get a home mortgage with a FICO score as low as 500, although you will be obligated to make a 10% down payment. Improve your score just a bit to get it up to 580, and you can be allowed to start at just 3.5% home equity.
Fixed-Rate Mortgages and Adjustable Rate Mortgages
When it comes to the rates and fees applied to a mortgage, you either get a fixed interest rate or a variable (adjustable) interest rate.
A fixed-rate mortgage is usually preferred so that you are protected from increasing interest rates. On the other hand, when the loan market heads in the other direction and mortgage rates keep on decreasing, you might want to get an adjustable-rate mortgage (ARM) wherein your rate will be fixed only for an initial period before getting adjusted at a set frequency.
How a Millennial Should Choose a Mortgage
When it comes to our personal finances, there’s no one one-size-that-fits-all. To each borrower are his or her own loan terms. Even if you narrow down that market to a generation, it will still depend on the circumstances.
It might be logical to expect millennials to be first-time homebuyers so that FHA loans might seem like a good prospect. But there will also be older millennials who are more experienced with financial products and services. There are also millennials in the military, and there will be millennials who might want to buy homes in rural locations.
What it comes right down to is improving your credit score so you can become qualified for the loan amount you need (remember that conventional loans can award a higher loan amount), the down payment you prefer, and the interest rate that will affect your monthly payment.
Here are some tips for millennials so that they can up their chances of getting the mortgage they want.
- Use your credit cards wisely. It can be tempting to swipe your credit cards all the time for all types of purchases, but make sure that you only do so when you already have the cash to pay for the transaction anyway. Otherwise, you put yourself at risk of racking up fees through interest, which will significantly increase your monthly costs.
- Pay yourself first. Every time you receive your salary put money into your savings first before proceeding to slice it all up into expenses. Even if you already have personal loans and you’re already feeling the squeeze, make it your business to save steadily. Remember, aside from potential down payment for a home mortgage, and loan terms include closing costs, origination fees, and other expenses you have to think about.
- Shop around for lenders. When you start having an interest in buying your own home, do your best to compare mortgage rates. It’s not enough to talk to just one lender. Even if one lender pre-approves you, consult another lender to find out if they might have a more attractive offer. Don’t be one of the 47% of people who skip this important step!
Whether you are curious about a 30-year fixed-rate home mortgage, FHA / VA loan, or ARM loan rate, check out this online calculator to compare mortgage rates and estimate your monthly payment.