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Is owning a home out of reach for millennials? Rising home prices, a shortage of housing and soaring student debt have made buying a home harder for this generation—but it's still far from impossible.
The millennial generation—ages 24 to 39 in 2020—is by and large achieving homeownership later than previous generations, but that's a statistic that may be informed more by the Great Recession of the late-2000s than by stereotypes about millennial spending habits.
Statistics also show that while homeownership may be coming later to the millennial generation, it is coming. As of 2019, the generation made up the largest share of homebuyers, according to the National Association of Realtors, and mortgage balances are up too. From 2018 to 2019, millennials saw their mortgage balances grow more on average than almost any other generation, according to Experian data.
Are you trying to join the ranks of millennial homeowners? Budgeting, paying down debt and limiting your credit usage will not only help you qualify for a mortgage today, but also set you up for financial success in the future. The key is to commit yourself to becoming mortgage ready the same way you would commit to a weight-loss or fitness plan.
To get mortgage ready, you should also start getting your credit in good shape. Here's how to get your credit and finances in shape and prepare for a mortgage.
First, see where your finances currently stand. Start by obtaining your credit reports and credit scores. You can get a free credit report and free FICO® Score☉ from Experian and can get one free credit report every 12 months from Experian, TransUnion and Equifax at AnnualCreditReport.com. It's a good idea to check your credit report with all three credit bureaus so you can spot any discrepancies.
Next, pull together your financial data. Collecting all your financial information will prepare you to fill out mortgage applications and provide the data that lenders will request.
Make a list of all your loans (such as student loans and car loans), the lenders who service them, as well as your monthly payment amounts. Then make a list of all your assets (including checking and savings accounts), retirement plans such as 401(k)s and IRAs, and any other savings you have. Finally, review your credit cards, the balances on each, and any other outstanding debts.
Personal accounting apps or websites can help you gather all your financial data in one place and track your spending so you can better manage your money.
Set Your Goals
Once you've gathered all your financial information, it's time to identify your financial goals. For example, in addition to buying a home, you might want to pay off your student loans and save for a vacation. Figure out by what time you want to achieve the goal and how much will it cost to do so.
Finally, prioritize your goals based on what's most important to you. Depending on your current financial situation, this may require some tradeoffs. If you want to pay off your student loan debt, buy a home and save for a vacation, you may need to put your vacation plans on the back burner for a while to make the other goals a reality.
Create a Budget
After you've set your financial goals, figure out your current income and expenses so you can make a budget, which is key to achieving your financial goals. When getting ready for a mortgage, your budget will have a big impact on your down payment and determining monthly payments you can afford. Here's how to create a budget:
- Estimate your monthly net income. This is the pay that's deposited in your bank account after taxes and other paycheck deductions. If you get a regular paycheck, this is easy to do. If you rely on freelance income, tips or otherwise unpredictable sources of income, make the best estimate based on past income.
- List all your monthly expenses. Some, such as rent or car loan payments, will stay the same each month; others, such as groceries and entertainment, will vary from month to month. Review your bank transactions for the past year to come up with a realistic estimate.
- Determine how much you have left. Once you know your income and expenses, see much money you have left over each month to put toward your goals. If you don't have enough extra money to reach the goals you've set, you'll need to reduce your expenses, increase your income, adjust your goals or do all three.
This may mean taking in a roommate, or cutting back on entertainment to save money. You may consider asking for a raise or getting a second job to make more money. Or, you could adjust your homeownership goals by looking for a more affordable home or accepting that it will take longer than you planned to save up your down payment.
Work on Paying Down Debt
Over the life of a mortgage loan, even a small difference in interest rates can add up to tens of thousands of dollars in savings. A good credit score is key to getting the best interest rate and maximizing your savings. You can make a positive impact on your credit score by focusing on eliminating debt and consistently making your payments on time.
Mortgage lenders also heavily consider your debt-to-income ratio (DTI) when deciding whether to approve you and, if approved, what rates to offer you. DTI considers all your monthly debt obligations, so paying off car loans or student loans can help you improve this number. When reducing your debt, focus on paying down any debts that are in collections, as these can severely impact your credit score and chance of securing a mortgage. Once these debts have been brought current, work on eliminating credit card debt.
Finally, set up automatic bill payments so you never miss a due date. Paying your bills on time is a crucial habit to form. All it takes is one late or missed payment to drag down your credit score—and those late payments will remain on your credit report for seven years.
Keep Your Credit Utilization Ratio Low
As you work on reducing your debt, try to keep your credit utilization ratio as low as possible. Your credit utilization ratio is the amount of revolving credit (such as credit cards) you're using compared with the total amount of revolving credit available to you. For example, if you have three credit cards, each with a credit limit of $3,000, you have $9,000 in total available credit. If you carry a balance of $2,000 on each card, you are using $6,000 of that credit, or 66.67%.
To help improve your credit score, always keep your credit utilization ratio under 30% and ideally under 10%.
Using our example above, carrying a $2,700 total balance across all three credit cards would give you a credit utilization ratio of 30%. However, you need to consider your per-card credit utilization ratio as well as the overall ratio. If all $2,700 of that balance is on one card, you're well over the 30% credit utilization ratio on that card, which could hurt your credit score. Make it a rule never to spend more than 10% of the available credit on each card, and you're more likely to see a positive impact.
Avoid Applying for New Credit
Speaking of credit, you should avoid opening any new credit accounts while you're getting mortgage ready. Whenever you apply for credit, the credit issuer will check your creditworthiness. This generates a hard inquiry on your credit report, which can temporarily hurt your credit score. The point impact of a hard inquiry may be small (less than five points), but it could drop you down into a lower credit score range.
Opening new credit accounts also makes it easier to take on additional debt just as you're preparing to apply for a mortgage, which is never a good idea.
Check Your Credit Regularly
As you pursue your goal of becoming mortgage ready, make it a point to check your credit report at least once a year. You can get a free credit report from Experian and receive one free credit report every 12 months from all three major credit bureaus (Experian, Equifax and TransUnion) by visiting AnnualCreditReport.com. As you work to become mortgage worthy, monitoring your credit score is an important piece of the puzzle.