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Home Buying Isn't As Easy As It Looks

This article is more than 8 years old.

I get lots of questions from people in their earlier career years asking how to approach a part of the American Dream they’ve put off - buying a home.   I’ve met plenty of young people with student loan debt - a record 40 million Americans now have it - so when something has to get put off, it’s been house buying in recent years.  Add in a weak job market for young people and you have the makings of the lowest homeownership numbers for young buyers yet recorded.

But some developments over the past year could brighten this picture.  Home lenders have eased home buying credit requirements according to the Fed’s lender survey. Thankfully for prospective home buyers, the process of getting approved for government-backed loans such as FHA, VA and USDA loans also got easier. Additionally, the FHA lowered annual mortgage insurance premiums and Fannie Mae and Freddie Mac lowered the minimum down payments it will accept to 3%.

All of this looks like good news for Millennials and Gen-X’ers, who according to a number of surveys have the lowest group credit scores.  Even with their debt concerns, younger buyers have pent-up demand and overall home prices are expected to head higher in 2015, with markets like Denver showing 10% year-over-year rises. So is qualifying to buy a house the good news for younger workers it’s cracked up to be?  There are a few situations where making a home easier to get can make life harder in the end:

1) If your job has a real possibility of transferring you to a new area, think twice about taking the buying plunge. I’ve recently seen a few cases of young homeowners who have a former home left behind in the city they got transferred from, usually a first-time purchase through a low down payment loan program to promote home ownership. Because they have little or no equity due to a short ownership period, the house sits empty or is rented to avoid taking a loss. Often these buyers forgot to treat the house like any other asset and require it to make enough money to support itself. Using a calculator like this early on can help these buyers cut their losses or reconsider the move when they see the sometimes impossible situation they face - a house with unaccountable tenants, managed by amateur landlords, and with guaranteed monthly losses after rehab costs to sell it are factored in.

2) If you want to stretch your buying power by taking on a foreclosure or HUD home in “as is” condition, you might as well plan for more rehab costs than you think to get the home ready. If you’ve already stretched the budget to get the house you might leave yourself exposed to undiscovered repair needs without emergency reserves to pay for them.  I’ve seen cases where what looked like a “deal” to start ended up a disaster as extra repairs and furnishings got paid on credit cards since no other sources of funds were an option.

3) Student loan debt is a home buying issue as the loan balances and required payments will affect your ability to buy.  FHA loan requirements say a buyer must have no more than a 43% debt-to-income ratio including the house payment, tax and insurance, mortgage insurance and homeowners fees.  If you lower your student loan payment by changing it to a longer-term such as through forbearance or the “pay as you earn” plan, your higher interest student loan balances might keep growing faster than the value of the house you’re buying. If your student loan interest rates are higher than your mortgage rate, it might be a red flag suggesting that you deal with those first.  In some cases, you can refinance your student loans at lower rates to help make having both a mortgage and a student loan possible.

4) Just because the rules allow hardship withdrawals or loans from workplace retirement plans for home buying, doesn’t mean it’s necessarily a good idea.  You may eliminate the mortgage insurance and even lower your mortgage interest rate, but the cumulative cost of possible taxes and penalties and loss of retirement funding growth could very likely wipe out all the benefits. If you have to raid an account for down payment money, try your Roth IRA first - at least the contributions can be taken out free of tax and penalty. (You can also withdraw a lifetime total of up to $10k from an IRA penalty-free for a home purchase as long as you haven’t owned a home in the last 2 years. This is in addition to the tax and penalty free withdrawal of those original Roth IRA contributions.)

5) Getting the house with a lower down payment loan might cost you extra, especially if your credit score isn’t top-rated.  At most lenders, a lower down payment means a higher interest rate, usually at least 1/2% higher.  That adds $21,232 to the cost of a 30-year $200,000 mortgage at 4.125% over the loan term (compared to a 4.625% interest rate).   Borrowers also need to factor in closing costs, which themselves average 2-5% of the home price, and private mortgage insurance, which adds up to another 1/2 to 1% of the loan amount to the house cost.  Adding these costs into the mortgage makes building equity in the house even harder. Saving for a 20% down mortgage isn’t easy, but in some cases it results in hundreds of dollars of savings per month in payments versus low-down payment options.

If you live in an area where rent costs are much higher than homeownership, it might make sense to buy rather than be at the will of a landlord. But for most young workers, the decision to buy a home takes more than just a casual home tour. Few mistakes are as expensive as having a home that turns into a “black hole” within your household budget!