If you're a new college graduate and your life plan includes homeownership, don't be daunted — there are steps you can take to embark on your journey to the American Dream.
But first, take a moment to reflect.
"New graduates should carefully consider whether buying a home makes sense at their current time in life," says Robert Farrington, founder of TheCollegeInvestor.com. "Recent graduates typically have a high amount of uncertainty in employment, location, family and more.
If you've already landed a high-paying job, have a squeaky-clean credit rating, and have saved or been gifted cash for a down payment, you're golden. You may want to start house shopping today.
On the other hand, if you're not sure if your life or financial situation is house-ready, consider the following issues to tackle and actions to take to reach your goal.
1. Decide If You're Ready to Buy
The first thing to do is to evaluate the pros and cons of renting versus buying.
Renting has many pluses, especially for recent grads who tend to be mobile, cash-strapped and debt-laden. You don't need much equity, you save money and time in the form of home maintenance and repairs, and you aren't tied down to a location should you receive a job offer in a far-off city.
On the other hand, buying gives you an appreciating investment, access to tax credits, autonomy in home improvements, stability to start a family and, eventually, freedom from mortgage payments.
2. Take a Look at Your Finances
The next step is to assess your financial situation. Mortgage lenders are interested in your credit score, your employment history and your income versus your expenses.
Start with your credit score. If you don't already have a credit history, [open a credit card and start building your history](https://www.moneygeek.com/credit-cards/first-time/). Student loans contribute to your credit rating, so be sure to make all payments on time.You should start by checking your credit score, which you can do for free. If you have a bad credit history and score, work on improving both. Generally speaking, you'll need a credit score above 650 to qualify for a mortgage and above 750 to get the best mortgage rates, but the threshold varies depending on your circumstances and the type of home loan you're seeking.
Work diligently to pay off your debt, whether it consists of student loans, credit cards or any other kind of debt. Securing a mortgage with a pile of debt is difficult, as is managing hefty student loan and home loan balances.
You may also need to make sacrifices, like living with your parents for a while, eliminating luxuries like dining out or even getting a second job to supplement your income. The bonus is that making regular payments to whittle down your debt will improve your credit score.
As for employment history, lenders typically want borrowers to have at least one to five years on the job.
3. Calculate Your DTI Ratio
New grads have several considerations when embarking on their journey to homeownership, Farrington says.
"The biggest is debt-to-income ratio," he says. "This is one of the biggest metrics banks look at before lending."
This means that your total debt payments, including mortgage and student loans, should not exceed 36% to 50% (dependent on assorted variables) of your income. If it does, you'll have a difficult time getting a mortgage.
It’s also important to start saving as early as possible. Remember that you need more than just the down payment when purchasing a house. Other upfront costs include paying for a home inspector, taxes and closing costs, not to mention home furnishings and incidentals — everybody needs a new bathroom throw rug, right?
4. Mortgage Preapproval and First-Timer Programs
When you're ready to go house shopping, first get a mortgage preapproval. It tells you how much you can borrow and is essential at the bargaining table. Don't be tempted if you're approved for a higher-than-expected mortgage amount. Homeownership brings many expenses, including utilities, insurance, maintenance, taxes and possible homeowners’ association (HOA) fees. You don't want to end up house-rich and cash-poor.
"In some areas, there are first-time homebuyer programs that could help 20-something graduates purchase their first home," Farrington says. "Check with your state or local housing authority to learn more." Many states offer some form of housing assistance to first-time homebuyers. Additionally, Fannie Mae policies implemented in 2017 can also help student loan borrowers qualify for a mortgage.
In one initiative, Fannie Mae will exclude non-mortgage debts, such as student loans, car loans or credit card debt paid by someone other than the student — such as a parent or grandparent — from consideration in the debt-to-income ratio for a borrower looking to qualify for a mortgage.
In another, Fannie Mae no longer requires lenders to factor in 1% of your college loan balance when deciding whether to lend you a mortgage. Instead, lenders can now consider a borrower's actual student loan payment, which may be lower than 1% of the balance and can favorably tilt the debt-to-income ratio.
One last piece of advice: make sure you're buying where you can actually afford to live, and adjust your expectations if need be. It's okay to start out small and work your way up to your dream home.
About the Author
Michele DiGirolamo is a writer for MoneyGeek. She is a former longtime reporter for United Press International.
Sources
- Carter, Matt. “These States Help People With Student Loan Debt Buy A House.” Accessed March 27, 2020.
- DiGirolamo, Michele. “Mortgage Preapproval: Step #1 In A House Hunt.” Accessed March 27, 2020.
- Fannie Mae. “Selling Guide Announcement SEL-2017-04.” Accessed March 27, 2020.