It’s tough out there for first-time homebuyers. They’re facing multiple challenges, including rising mortgage rates, high home prices and limited inventory. However, that doesn’t seem to scare off young Americans — in fact, 71.5% of Gen Zers plan to buy their first home in the next one to six years, according to a Rocket Mortgage survey from earlier this year.
At the same time, not every Gen Zer knows what mortgage lenders are looking at when evaluating a home loan application. On average, 33.9% of Gen-Z were wrong about the factors lenders consider when deciding whether to approve a mortgage, according to the survey.
What most mortgage lenders look at when considering your application
CNBC Select explains what factors influence mortgage approval and what young people can do to increase their chances of qualifying for a home loan.
Credit score
Most Gen Zers know that their credit score can impact their ability to secure a mortgage (73.2%). And while they’ve had less time to establish a credit history, Gen Zers have an average FICO score of 679 according to the latest data from Experian. That’s lower than that of older generations but still considered good.
The minimum credit score to qualify for a conventional mortgage is 620. Government-backed mortgages have more relaxed credit requirements. The minimum credit score for an FHA loan is 580 with a down payment of 3.5% or as low as 500 if you can put at least 10% down. USDA and VA loans don’t have set credit requirements, but lenders that offer them might.
Besides approval chances, a homebuyer’s credit affects the interest rate on the loan. A small difference in interest rates can add hundreds of dollars to a monthly mortgage payment.
It’s best to work on building credit before applying for a mortgage. Free credit monitoring services such as CreditWise® from Capital One and Experian free credit monitoring can be helpful in tracking progress and finding opportunities to improve.
CreditWise® from Capital One
Information about CreditWise has been collected independently by Select and has not been reviewed or provided by Capital One prior to publication.
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Cost
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Credit bureaus monitored
TransUnion and Experian
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Credit scoring model used
VantageScore
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Dark web scan
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Identity insurance
Terms apply.
Experian Dark Web Scan + Credit Monitoring
On Experian’s secure site
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Cost
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Credit bureaus monitored
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Credit scoring model used
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Dark web scan
Yes, one-time only
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Identity insurance
Terms apply.
Note that the scores credit monitoring services offer differ slightly from the scores mortgage lenders use when making their decisions. That said, they should be pretty close and provide a good idea of your overall credit health.
Debt-to-income ratio (DTI)
Almost one-third of Gen-Z didn’t name the debt-to-income ratio (DTI) as one of the factors affecting mortgage approval (32.8%). In reality, lenders evaluate this closely when determining whether to approve a mortgage and what the terms of the loan will be.
DTI is the amount of debt relative to income. To qualify for a conventional mortgage, you don’t want a DTI any higher than 43%. For USDA and VA loans, the DTI limit is typically 41%, while the FHA might allow you to go up to 50%. Remember, these are guidelines — it’s up to individual lenders to determine the cutoff for what’s an acceptable number.
Calculating your DTI
To calculate your DTI, divide your total monthly bills, such as rent and any debt payments, by your gross monthly income (how much you make before taxes).
For example, let’s say your monthly bills total $2,500 and your gross monthly earnings are $5,000.
$2,500 / $5,000 = 0.5
Multiply the result by 100 to get the percentage. In this case, your DTI would be 50%.
Down payment
When a homebuyer makes a sizeable down payment, the lender may consider them a less risky borrower. Having more money to put down increases the chance of mortgage approval and can lower the monthly mortgage payment.
According to the survey, 10.1% of Gen-Z plan to put down 20% of their home price. If they do, they’ll start off with a good amount of equity in their home and won’t have to worry about private mortgage insurance (PMI). PMI is a monthly fee rolled into the mortgage payment, designed to protect the lender if the borrower can’t pay their home loan.
That said, it’s possible to secure a mortgage without a 20% down payment. In fact, FHA loans require as little as 3.5% down with a credit score of at least 580. Qualified first-time homebuyers can also put 3% down with conventional mortgages, such as HomeReady and Home Possible. USDA and VA loans have no down payment requirement at all.
Saving up for a down payment can take some time — often, several years. Putting the funds in a high-yield savings account can help them grow a little faster. Some of CNBC Select’s favorite accounts include LendingClub High-Yield Savings and the Western Alliance Bank Savings Account for their high APYs and ease of use.
LendingClub High-Yield Savings
LendingClub Bank, N.A., Member FDIC
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Annual Percentage Yield (APY)
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Minimum balance
No minimum balance requirement after $100.00 to open the account
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Monthly fee
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Maximum transactions
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Excessive transactions fee
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Overdraft fees
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Offer checking account?
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Offer ATM card?
Western Alliance Bank Savings Account
Western Alliance Bank is a Member FDIC.
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Annual Percentage Yield (APY)
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Minimum balance
$1 minimum deposit
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Monthly fee
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Maximum transactions
Up to 6 transactions each month
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Excessive transactions fee
The bank may charge fees for non-sufficient funds
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Overdraft fee
The bank may charge fees for overdrafts
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Offer checking account?
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Offer ATM card?
Terms apply.
Employment
Current employment, as well as work history, are also factors in mortgage lending decisions. It’s not uncommon for a lender to require two years of consistent employment history. Note that it doesn’t necessarily mean working for the same company. More likely, the lender will be looking to see whether the borrower has been employed in the same line of work or career field and if there are any lengthy gaps without a job.
Showing this kind of consistency can be tricky for Gen Zers who have only just started building their careers. However, as long as the homebuyer can prove they have a stable income and are a responsible borrower, the lack of two years of work history might be something a lender can live with.
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How Gen-Z can prepare for a mortgage application
While mortgage lenders generally examine the same things when evaluating an application, they might not always agree on what’s an acceptable risk. Individual lenders also may offer different types of home loans, work with different down payment assistance programs or even have their own unique offers for first-time homebuyers.
For that reason, it’s wise to speak to several lenders before choosing one. Plus, this will also allow for interest rate shopping, which is essential to securing the best possible mortgage terms.
CNBC Select picked PNC Bank as one of the best lenders for first-time homebuyers, thanks to the variety of home loan options they can offer. Rocket Mortgage can be a good choice for borrowers with lower credit scores, and Ally Bank Mortgage can help new homebuyers save on lender fees.
PNC Bank
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Annual Percentage Rate (APR)
Apply online for personalized rates; fixed-rate and adjustable-rate mortgages included
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Types of loans
Conventional loans, FHA loans, VA loans, USDA loans, jumbo loans, HELOCs, Community Loan and Medical Professional Loan
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Terms
10 – 30 years
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Credit needed
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Minimum down payment
0% if moving forward with a USDA loan
Terms apply.
Ally Bank Mortgage
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Annual Percentage Rate (APR)
Apply online for personalized rates; fixed-rate and adjustable-rate mortgages included
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Types of loans
Conventional loans, HomeReady loan and Jumbo loans
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Terms
15 – 30 years
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Credit needed
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Minimum down payment
3% if moving forward with a HomeReady loan
Terms apply.
Bottom line
Gen-Z are entering a challenging housing market, but many feel up for the task and plan to buy a home in the next few years. Homeownership can be an excellent way to build wealth, but before springing into action, it’s a good idea to educate yourself on what impacts mortgage lending decisions and get your financial ducks in order based on what you’ve learned.
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Editorial Note: Opinions, analyses, reviews or recommendations expressed in this article are those of the Select editorial staff’s alone, and have not been reviewed, approved or otherwise endorsed by any third party.
Source: cnbc.com