What’s the number one reason that so few millennials, those born between 1978 and 2000, are getting into the housing market? It’s all about that stubborn student loan debt they racked up. In fact, a recent study by the Federal Reserve claims that the 12 million millennials in their 30s with student loan debt, owe more than those in their 20s. The average student loan balance for the former sits at slightly more than $34,000 and most of you are, or were, grad students, according to U.S. News and World Report. Birmingham is also in the top 2% of cities with student debt. People 25 to 44-year-old owe an average of $35,893 per a 2016 study from wallethub.com.
On top of that millennials are not getting off easy on rent in the Birmingham Metro, nearly 60% of renters pay nearly 40% of their income to rent according to a 2016 study.
Homeownership-Your debt and your income and why they matter
That brings us to the most common reason a borrower is turned down for a mortgage is because they have what is known as an unacceptable “debt-to-income” (DTI) ratio. Millennials are the largest group of would-be homebuyers who walk away from a pre-approval session with a rejection. Lenders naturally want to know that lending you the money to buy a home does not expose them to risk.
After you drop off your tax returns, pay stubs, bank statements, and all the other documents the underwriter wants to see, they will determine your DTI two ways, a so-called front-end and a back-end DTI. The latter involves dividing the amount you pay for total recurring debt every month by your gross monthly income. To get a mortgage in the past, this figure would typically need to be no higher than 36%. We say “typically” because Fannie Mae would consider a DTI of 45% under certain circumstances (high credit scores and reserves, for instance).
To determine the front-end DTI ratio, which represents the percentage of your income you will have to put toward housing expenses, the lender will determine the total amount of your expected housing expenses and divide it by your gross monthly (before-tax) income. Hopefully, the result will be no more than 28 percent.
But wait – that’s about to change
So, you used Fannie Mae’s online calculator and figured out that your DTI is 50 percent. Does that mean you should give up on your home-ownership dreams? Not any longer.
In early June of 2017, Fannie Mae announced that it will now accept a backend DTI of up to 50 percent for loan applications submitted, after July 29 of this year, through its new version of Desktop Underwriter (DU). Not to get all technical on you, but DU is a software program that uses algorithms to weigh a loan applicant’s risk factors. Some borrower files aren’t DU eligible (for any number of reasons) but many are. Hopefully, you are among the latter because if you require manual underwriting you will fall into that dratted “don’t-lend-money-to-anyone-with-a-DTI-higher-than-36-percent” pile.
Why the change? Are they crazy?
In its aftermath of the housing market crash, an interesting University of Chicago Booth School of Business study was published September 2010. It found that a small percentage – 35% – of borrowers defaulted on their home loans because they were underwater on them and could not make the payments — simply “walked away” from their homes and their mortgages. These people became known as “strategic defaults.” Further study of them produced surprising results. Strategic defaulters tended to have high credit scores, didn’t use credit often and when they did, their balances were lower than the other group of underwater borrowers and they rarely exceeded their credit limits. In other words, these folks were the quintessential ideal credit risk.
Fast forward to 2017 and a new Fannie Mae study finds that borrowers with a 50 percent DTI are much better credit risks than previously assumed. The study looked at more than 15 years of statistics and data from borrowers with back-end DTI ratios between 45 and 50 percent. Many of them had decent credit scores and the default rate was quite acceptable. Steve Holden, Fannie Mae’s VP of single-family analytics said that they were seeing a lot of other factors, aside from a borrower’s DTI ratio, in the data that make this group of borrowers more attractive. These included the borrowers with hefty cash reserves (at least 12 months or more) or a willingness and ability to come in with a higher down payment. And many of these borrowers are millennials, just like you.
And thus, thanks to Fannie Mae’s launch of its “trended data” initiative which provides a new data element to its automated underwriting process, we conclude there is hope for Birmingham’s heavy laden, hard-working Millennials to improve your financial horizon. The first step, call a local lender to sit down with and discuss your financing options. Once they give you the green light contact your local agent (shameless plug- Call Christina James at 205-965-6483) to begin your search for your new home. Last…wait for it…tell your landlord, “good riddance!” You can literally own a home for equal or less than renting plus build equity in a home. Now that’s a step in the right direction.
Birmingham has experienced 6 years of growth in the housing market, don’t be among those that think they cannot participate. The key is to act quickly. The time is now to look to the Birmingham housing market before interest rates become the next culprit that keeps you out of your dream home.
© Christina James and BirminghamHomeAgents.com, 2017. Unauthorized use and/or duplication of this material without express and written permission from this site’s author and/or owner is strictly prohibited. Excerpts and links may be used, provided that full and clear credit is given to Christina James and BirminghamHomeAgents.com with appropriate and specific direction to the original content.