Have you ever wondered what it would actually take to afford a home by the time you were 30? From whether you can qualify for loans to sources of your down payment, there is a plethora of important financial factors a potential homebuyer should be aware of. Then, you need to consider if you can actually have enough money in the bank to make it all work.
Homeownership by age 30 for millennials is down to a mere 35.8%. But that low number doesn't mean this goal is only possible for the select few. While the entire process isn't simple — for pretty much everyone, we would like to add — if you have the knowledge of strategies to save, invest, and navigate the buying process, your goal of purchasing a house can feel a bit more tangible. You can even figure out if being a homeowner is really the right choice for you (because honestly, it's not for everyone).
To get some insight, we asked Rachel Sanborn, director of advisory services at Ellevest, and Shannon L. McLay, founder and CEO of The Financial Gym, to break down everything you need to know before you even consider entering the home-buying market. Not only did they give amazing tips on preparing to purchase a house, but they provide truly helpful advice to help you take on planning for you future. Read ahead to get adulting.
When asked for the various factors that can apply to being able to afford a home, Sanborn replies,"Obviously the biggest one is credit score. I’m sure lots of people think about it because it can prevent people from getting home loans and qualifying for houses."
"Manage your credit score as soon as you are able to access credit. Whether that’s getting your first student loan or having your first credit card or even if your parents add you as an authorized user to their card, that’s when it starts," she explains. "So it’s really important to maintain your credit score preferably between 720 and 740. That will actually get you good rates. Below that you can still get loans sometimes but it’s a lot more difficult. That actually does require a slightly higher than the average U.S. credit score of 700."
"So it’s really important to manage that well and that’s something we can all do when we’re in our twenties. That’s a big one," Sanborn notes. "There’s so much that can go into that. Of the factors that go into your credit score, there are two significant ones that make up about 60 to 70 percent of your credit score are on-time payment and the amount of credit that you’re using out of the total that you have available. You can really do a lot of work on managing those yourself."
Shannon L. McLay of The Financial Gym made sure to note, "If you're applying for a mortgage with someone else, they will take the lower of the two credit scores, so you want to make sure both people have great credit. Otherwise, you may want to think about just one person applying for the mortgage if you could get approved with the one salary."
Have your credit score covered? Now take a look at the debt on your plate. "Folks who I work with who are under 30 find when they apply may have a great credit score and may have the full down payment ready," says Sanborn."But, their student loan burden may be too high in terms of what lenders are looking for in a debt-to-income ratio."
"This burden can depend on what income you’re making. So if you got an income of $400,000 a year, then $100,000 in student loans might not be worrisome," she explains. "But if you make $30,000 a year and have $100,000 in student loans, that would be different." McLay adds, "Most lenders will not give you a mortgage if your debt-to-income number is greater than 43 percent."
"It’s not just the monthly payment they’re looking at — a lot of folks I work with think it’s the percent of their monthly income that’s taken up that matters, but it’s also the balance," Sanborn notes. "On top of that, those payments can often be adjusted — especially with federal loans — so if someone is on an income-based repayment plan, that is actually not the amount that would be used when looking at the affordability of a mortgage. They would use the full standard repayment amount instead."
While loans are an essential for most homebuyers, they can vary depending on the market you want to buy it in and the amount you have saved. "There’s a concept if you want to buy a home that’s costs around $300,000 to $400,000 in lower-cost areas and around $690,000 in more expensive areas," says Sanborn. "If you have to finance more than that amount, then they no longer conform to the requirements for the government to kind of guarantee those loans. So you’ll no longer find programs like FAHA loans or VA loans or any other government-guarantee products."
Need more money to afford a home you're looking at within that range? "Then those are what are called jumbo loans and they’ve got some very different requirements than most of what they call conforming loans," she says. "You usually have to have higher credit scores and 20 percent down in almost every case. There’s very few exceptions."
"If a person really wants to get into a home and doesn’t have that payment, then that’s an issue," notes Sanborn. "It also requires you to have much bigger reserves. They often require you to have six months or one year of mortgage payments somewhere — cash, investments, etc." She adds, "But there are a lot more requirements around jumbo loans that can affect people in big markets such as San Francisco and New York City."
A house down payment is possibly the largest financial step you must face. "It is the single biggest hurdle for most people buying a home," shares Sanborn. "The recommendation is always 20 percent for lots of reasons. It tries to make sure you’re not going to go underwater with your mortgage. If you had enough to get down that 20 percent, then it’s likely that you’ll be able to afford a monthly payment to support the mortgage as well."
"But there are some instances where it makes sense to jump in sooner and not wait for the full 20 percent," the expert notes. "If you’re in an expensive place like New York or San Francisco, and you find a home that falls into that forming mortgage and you can get it for less than 20 percent down, sometimes it makes sense not to wait that long. Because the longer you wait, the higher the real estate prices go. And if you know you’re staying put somewhere and the rental costs are a lot more expensive than buying a home, than it absolutely makes sense for someone to do less than 20 percent. In a place where a mortgage would be cheaper, then it makes sense to put 10 percent down to get that lower monthly cost."
While you may be able to get enough to get that initial cost covered, you need to be conscious of where those funds come from. "One thing a lot of people don’t realize about the mortgage process is they look very carefully about the sources of that down payment," Sanborn explains. "You can't just borrow from your 401k and call it part of your down payment. They’re going to look at that. They’re going to look at ‘gifts’ from friends and family, and if there is any expectation of being repaid. So if people are trying to come up with creative ways to have that money, then it’s really important to make sure that it’s all kosher. I would talk with a mortgage broker about the sources of your down payment before you take a loan from family, something you can’t pay back soon, or anything like that."
"So we’ve been talking about a 20 percent down payment, but there are lots of other costs that come with buying a house that a lot of people don’t think of," Sanborn shares. "The closing costs range from three to five percent of the cost of the home. So if you’re buying a $200,000 home, that could be as much as $10,000. You have to think about paying a lawyer to do the title, the company to put together all the papers, commission for the real estate agent, and all of that. So we usually tell people to budget another three to five percent of the price of the home for those closing costs."
You also have to think ahead for other financial burdens that are tied into your purchase. "On top of that, you also want at least another one percent budgeted per year for your ongoing home maintenance," she says. "It’s not renovation or upgrades, but just the typical upkeep of the home." McLay echoes, "No matter how great your home inspection or how new your home, once you become the home owner, something is guaranteed to break and it's now your responsibility to fix it. So we advise clients to have a $5,000 to $10,000 contingency fund saved for any unexpected mishaps like a broken refrigerator or toilet after the home closing."
"Even the concept of whether someone should buy a home really depends," says Sanborn. "At Ellevest, we don’t think everyone should buy a home. That’s something important to point out. It’s not right for everyone. In fact, my favorite tool to recommend is the New York Times’ “Is It Better To Rent Or Buy” calculator. Do the comparison first because in some markets it’s not worth it to rent and it’s worth it to buy."
"In others, it’s the opposite. So in a very expensive place to buy, renting is often worth it and it gives you so much more freedom," she explains. "You have to first start with the question, 'should you buy a home?' Once they determine that they really do want to buy a home and it’s the right decision for them — like they won’t need any flexibility to move any time soon and they know that it’s worth it in their market — then it makes sense to look into a jumbo mortgage."
"So for those people that aren’t ready, that’s not even going to be an option because they’re not going to be able to get financing to do it. So it kind of crosses itself off the list," she shares. "But for even just regular mortgaging, there are many more options. So any government program like a FHA loan or a VA loan will give you more room to make decisions about how much you want to put down towards the house."
Feel like you may be ready to take the plunge and start the home buying process? Make sure you hit a few milestones first. "I think is really important to note is part of what we consider at Ellevest as our fundamental philosophy around financial planning," says Sanborn. "There are a few things that have to happen first before you move into bigger goals."
"One is you have to make sure that you have a plan to tackle high interest debt," she shares. "That’s something that we consider over five to ten percent. We want you on track to pay that off first before you pass go and collect $200. We always pay that off first."
"Then after that, having a minimum amount of emergency savings is so critical, especially when you’re about to buy a home," she says. "In every situation that I’ve ever seen someone buying a home, there’s always something that goes wrong. So it’s critical to have an emergency fund before you buy a home, and to not wipe it out during. That has to be preserved."
Her recommendation? "Adjust at least three months of your take-home income pay. For most people that will get them through three to six months of expenses," she advises. "For those with more risk factors like they’re going to buy a home, have kids, or are self-employed, we recommend having saved six to nine months of take-home pay. It is so so helpful and saves so many of my clients from major problems."
"The last thing is we always want people to get on track for retirement first before moving onto those other major goals. For some people that might not be as important, but we take a view that there are loans for almost everything else," Sanborn remarks. "You can get a loan for a house, you can get a loan for a vacation, and you can get a loan to have your kids go to school. But you really can’t get a loan to pay for your retirement. We want to make sure that people are saving for that and be on track to be able to cover themselves before they really start to tackle those other bigger goals."
Want to use investing to make affording a home a possibility? Sanborn advises taking a long-term approach. "When it comes to investing, we generally don’t recommend investing in the stock market if your goal is less than a year away," shares Sanborn. "So if that’s coming up really soon, then we usually recommend a high-yield savings account instead. You don’t want to expose that money to any risk if you’re going to need it."
"If it’s more than a year or two away, that’s when you can start thinking about investing," she explains. "Ellevest offers investing, but in a goal-focused way. So you tell us how far away your goal is — both in terms of the time and how much you have left to save versus what you already have saved. We use that info along with the turnaround and what you tell us about yourself. This includes if you want to take a little more or a little less risk."
"Then we come up with the investment allocation for it versus just picking one mutual fund out there and hoping it kind of coincides with what your goal is," the expert says. "You definitely want to take an approach driven by how long you still have left before you might need the money, and how much you still need to save towards it versus what you have already saved. So if you have a lot left, you can take a little bit more risk to get to your goal. If you got most of it there, we would not recommend taking as much risk."
Of course, the number one thing you need to do to prepare for all these costs is to save. "What I’ve seen work the best for my clients over 15 years is consistently sticking to saving strategies. So whether that’s $25 or $1,500 a month, limit your lifestyle costs overall to leave yourself enough room to meet your progressive goals," Sanborn advises. "Even just leaving 20% of your income pay for future you can be split up between things like an emergency fund, debt, and saving for a home."
"Really just carving out a portion and setting up a consistent strategy with auto-deposits to savings or direct deposits to your investments is a good idea," she explains. "Having it come out of your paycheck can be an important move for lots of people. I find it critical for myself because if I see it in my account first and I don’t auto-deposit, I feel like it’s always going to get swooped up for something else."