On the heels of our first-ever Agent Appreciation month, Inman is leaping into February with our Residential Finance theme month. Join us as we investigate how buying and selling a home is changing, from companies backing consumers in new ways to integrated services that handle the entire transaction.
Although budgeting and making smart financial decisions are an integral part of the home-buying journey, there’s another simple misconception that could be doing more damage than a daily latte — the belief that a 20 percent down payment is needed to purchase a home.
“Approximately 19 million millennials in the 31 largest metropolitan statistical areas (MSAs) are qualified and able to afford a home, but are not buying one,” wrote First American Deputy Chief Economist Odeta Kushi in an essay published in August.
“Surveys, like those conducted by Fannie Mae, reveal that many Americans still overestimate the qualifications needed to get a mortgage, resulting in qualified potential buyers not even considering homeownership.”
“Indeed, the Urban Institute report revealed that 16 percent of consumers believed that the minimum down payment required by lenders is 20 percent or more, and another 40 percent didn’t know at all,” Kushi added.
Phoenix-based Campbell & Co. real estate agent and marketing expert TessaBella Jelten agreed with Kushi’s sentiments, and said many millennials disqualify themselves because they believe buying a home “is going to be extremely expensive.”
“It’s always imagined that it’s something your parents did, and sometimes it’s hard for millennials to get to that position of realizing, ‘Oh, I’m at that age where it makes sense [to buy a home], and it could be me,’” Jelton, who is millennial, said. “They instantly disqualify themselves because they think you have to have 20 percent down or that they won’t be able to qualify for any other options.”
Jelton points her clients toward first-time homeownership programs that provide federal down payment grants and help millennials access low-down-payment loan options, such as a Federal Home Administration (FHA) loan that requires only 3.5 percent down.
A FHA loan would reduce a $40,000 down payment for a $200,000 home to $7,000, a much more manageable amount for the average millennial. However, Jelton said buyers must be aware of two caveats associated with low down payments — higher loan rates and mortgage insurance premiums.
“If you’re going with a lower down payment initially, you’re going to have higher rates and you’re typically going to have to pay mortgage insurance premiums,” she said. “So, it’s important to think about those long-term costs and what [offering a lower down payment] is going to cost you over the life of the loan.”
However, Jelton and NerdWallet mortgage expert Holden Lewis both said millennials don’t have to fear higher rates and MIPs, since well-timed and strategic refinancing can eliminate the extra cost.
Mortgage insurance premiums are based on buyers’ credit scores and down payment size, and can vary from 0.55 percent to 2.5 percent of the loan amount per year, Lewis explained. If a buyer used a FHA loan, Lewis said they can refinance to a conventional, MIP-free loan after gaining 20 percent equity.
“That’s the only way you can get out of paying an MIP for a FHA loan,” he noted.
Jelton said millennials can prepare for the refinancing process by staying on top of mortgage payments and making smart financial decisions, such as building their liquid savings, paying off debt, and improving their credit score.
“One of biggest things I typically recommend is that you’re outlining your budget based on your priorities,” she said. “You need annual, monthly and quarterly budgets.”
Lewis agreed with Jelton, saying millennials need to create air-tight budgets that allow them to easily save for a down payment and other costs associated with homeownership.
“It’s a multi-step process,” he said. “The first step is to use an affordability calculator that tells you how much home you can afford based on your income information and your debt information.”
“From there, you can calculate what a 3 percent or 3.5 percent down payment would be,” he added. “Once it’s not just a vague idea that ‘you need to save’ and you know how much you need to save per month, then balancing your other debt payments and spending gets easier.”
Lastly, both experts said real estate agents can help millennials overcome financial misconceptions and hurdles by educating them about loan options, first-time homebuyer program options, and encouraging them to make smarter financial decisions.
“Talk to them about the options,” Lewis said while noting there needs to be more awareness about zero-down VA loans for active and retired military. “Talk to them about FHA loans, talk to them about private mortgage insurance, and get a sense of what their credit score range is.”
“Getting the financial picture of the homebuyer is always a good initial step.”