Thanks to coming of age right as the stock, housing, and job markets were coming crashing down, members of the millennial generation learned quite a few lessons about living within our means and using caution when feeling out serious financial situations.
While we may still have a few things to learn – like the importance of investing wisely rather than hoarding savings in cash – Gen Y has been hesitant to make the same mistakes from previous generations.
One major milestone millennials have largely held off on: buying a home. Gen Y hasn’t been the home-buying demographic many economists were hoping they’d be, and little wonder. A group of people already saddled with heavy student loan debt loads is unlikely to jump at the chance to sign up for a 30-year debt repayment obligation.
But that may be changing as more and more members of this generation reach their late 20s and early 30s. As more millennials start house hunting – and thinking about applying for a loan that may even eclipse their student loan debts – it’s important to understand what you need to know before getting pre-approved for a mortgage.
Speaking from Experience
Many of my fellow millennials have held off home ownership and prefer to rent their living space instead. I’m a bit of an outlier.
I bought my first home at 22. At 25, I’m in the process of selling that home for a profit and buying my second. (The main reason I’m in this position, person reading this in Chicago, NYC, or San Francisco, is because I chose to live in the American South. Real estate prices and property taxes are considerably lower here than other areas of the country.)
Going through the mortgage loan application process for the second time makes me want to share my experience and knowledge with other Gen Yers who may start to consider purchasing their first home in the next few years.
Get Ready Before Approaching a Lender
The best thing you can do to ensure a smooth loan application process from start to finish is to prepare yourself before you even get pre-approved. That means understanding what kind of real estate you can truly afford, what a lender will look for when you ask for pre-approval, and what you’ll need to provide once you find a home and secure a contract on the property.
Not All Mortgage Companies Are The Same
The mortgage market in the US is dominated by Fannie Mae and Freddie Mac. These are government-owned entities that purchase mortgages, combine them with other mortgages (to create a pool) and then sell those loans to investors. Most people don’t realize it – but when you go to a bank (like Chase), your mortgage will likely be sold to Fannie or Freddie. Fannie and Freddie set the lending criteria – and since 2008 it has been very tight.
Fortunately, there are some new, private lenders that are creating products specifically geared towards first-time homebuyers and people with limited down payments. SoFi is a company (famous for student loans) that has recently launched a mortgage product that offers:
- 10% down up to $3MM, no borrower-paid PMI
- Low debt-to-income requirements
- Pre-qualify online in 2 minutes
- 30-day close
- Dedicated mortgage loan officers
In addition to SoFi, you can compare mortgage offers from multiple traditional lenders using the MagnifyMoney Mortgage Rate tool. If you have a 20% down payment, you will likely be able to get a better rate from one of the lenders offering traditional mortgages.
What Can You Really Afford?
The most important thing to understand with mortgages is that a lender will almost always provide you a larger loan than you should reasonably accept. Despite the housing bubble that imploded starting in 2008, despite new federal laws introduced in 2014 intended to hold lenders more responsible for the loans the underwrote, the guidelines still allow most people to take out loans that are far larger than they should be.
I’ll give you a personal example. My current mortgage payment, which includes principle, interest, taxes, and insurance, is $1,013 per month. In looking for a new home, I wanted to make sure I stuck close to this number.
Putting down a 20% down payment meant my comfort zone ended at a purchase price of about $260,000 – because with 80% of that amount financed, my monthly payments would work out to be about $1,114.
But the lender’s online mortgage calculator, based on my income and my assets, told me I “could afford” a $600,000 house. Do you see the problem with online mortgage calculators?
You need to look at a few things to determine what you can truly afford before house hunting:
- The list price of the home
- The estimated property taxes on the home
- Any monthly or annual dues, like HOA fees
- How much cash you’ll put down on the home (in other words, how much of the purchase price you’ll finance)
While lenders will provide loans with various percentages of cash down on the purchase, in most cases putting down 20% is a smart move. The less you put down in cash on a property, the higher your monthly mortgage payment will be.
If you put down less than 20%, you’ll also tack on a private mortgage insurance charge (PMI) which will mean paying an extra $50 to $300 per month (depending on your down payment and the purchase price of the home).
What You Need to Provide to Get Pre-Approved
Once you understand what you can reasonably afford to repay on your loan each month, you need to check in on your income, assets, debts, and credit score. All of these factors impact your pre-approval and your loan process.
In short, a lender wants to determine your:
- Debt to income ratio
- Income and reasonable ability to repay a loan
- Credit score
A lender will run a hard inquiry on your credit to pull your FICO score. This helps them determine how much of a risk you may be to default on the loan, and influences the interest rate the lender will offer you. It is a good idea to shop around with multiple lenders.
When you go through the pre-approval process, you need to know how much income, cash, and invested assets you have, and the source for each. (For example, you need to say you make $X amount per year at X Company. You also need to explain your employment status.)
You also need to report any debts or liabilities you have, which would include things like credit card payments, a car loan, or student loan debt.
Don’t even thinking about fudging the numbers here. Although the information you provide is good enough for the pre-approval process, you’ll have to verify every tidbit you gave the lender once you start your loan process.
Your finances – meaning your bank accounts, investment accounts, and other assets – will be closely scrutinized once you actually start the loan process. You’ll need to provide an explanation for any large or “suspicious” transactions, and in most cases you won’t be allowed to borrow cash (even from a friend or family member) for your down payment or to meet asset requirements.
Get Your Finances and Your Credit in Order
That’s what you’ll need to provide for your pre-approval. But before you call up a lender and ask for that qualification, take a look at the state of your finances and your credit.
You want to ensure you can prove you’ve been gainfully employed for at least a few months; most lenders want to see 30 consecutive days worth of paystubs, and it’s always advantageous to have more. If you’ve had some trouble keeping a regular income or job, it might be best to hold off on the house search until your earnings are more stable.
You also want to take a look at your credit history and your credit score. Many credit cards provide you with your FICO score on each statement. Tools Quizzle or Credit Karma can give you an estimate so you have a good idea what your score looks like.
If your score is on the low end, don’t panic. You may still be pre-approved and qualify for a loan, but you’ll pay a higher interest rate.
You can also take steps to help boost that credit score before you ask for pre-approval:
- If you have any debt, ensure you’re making all payments in full and on time.
- If you use a credit card, don’t let balances roll over. Again, pay in full and on time.
- Don’t open new lines of credit immediately before asking for pre-approval – and don’t close old accounts, either.
- Avoid making large purchases on credit cards, or using the maximum amount of credit available to you before paying off your card (even if you do pay that balance off in full and on time).
It may take a few months before your credit score starts working its way to higher numbers. Stick with these actions and stay consistent. You’ll be rewarded with a better score and a lower interest rate when you do ask for pre-approval – which means you’ll pay less over time in interest.
The Consumer Finance Protection Bureau (CFPB) offers an interactive tool to allow you to check mortgage rates based on credit score range. Based on research using the tool, 740 or higher is the ideal credit score in order to receive the lowest interest rates. If you drop below a 620, then it will become very difficult to qualify for a mortgage.
Let’s say you’re looking for a $200,000 home in North Carolina. You can afford a 20% down payment of $40,000 on a 30-year fixed mortgage.
You could save up to $12,305 by applying for a mortgage with a credit score of 740 or higher. The numbers above are also best case scenario mortgage rates for those with lower credit scores. Scores within the 680 – 699 range would be more likely to receive an APR of 4.125%, which would cost $119,158 over 30 years.
Find a Reputable Lender
You’ll also want to ensure you’re choosing a good, reputable lender. Mortgages make lenders money (from the interest you’re paying) so they have a vested interest in getting your business. Unfortunately, not all lenders are created equal. It pays to do your homework. As mentioned earlier, you can start with a price comparison tool here. You will be asked to provide some basic information, and lenders will start competing for your business.
In addition, ask a financial advisor, accountant, or attorney for a recommendation to get you started. You can also ask family and friends who originated their mortgage loan, and ask about the experience they had with that company.
Reputable lenders will provide you with a Good Faith Estimate and paperwork that explains the loan process, your rights and obligations, and “truth in lending.” You can be sure to see if you’re getting the lowest rates in your state by using the CFPB tool to check mortgage options. If you are struggling to find a low interest rate, look at Pentagon Federal Credit Union’s rates. Anyone can join this credit union and it often offers some of the lowest interest rates to eligible borrowers.
Bottom Line: Research and Ask Questions
Taking out a mortgage is a document- and time-intensive process. And you don’t need me to tell you that a hundred thousand dollar (or more) loan is a huge financial commitment.
The best thing you can do for yourself before even looking at a real estate listing is to ask questions, seek out answers, and do your research. If you don’t understand something, speak up.
Talk with financial professionals first, and speak with friends and family who already went through this process. And if the lender you want to work with can’t or won’t answer, look for another service provider to secure your loan.