By: Gina Pogol
You’re graduating from college, eager to start “real life” and ready to ditch your dilapidated digs in favor of more adult accommodations. You’ve weighed the pros and cons of homeownership and have decided to invest in real estate as soon as possible. Of course, homeownership for people other than Trumps or Kardashians usually involves a mortgage, and getting approved for one could be tougher than snagging a 4.0 GPA. Do you have what it takes?
Hurdle #1: Employment
Unless you have a generous trust account or other passive income, you need employment to get a mortgage. It’s the underwriter’s job to determine if your employment income is sufficient to pay a mortgage and your other obligations. He or she decides if that job is stable enough to be acceptable as a source of income and verifies that the income can be expected to continue for at least three years.
Many mortgage lenders require a two-year work history before they’ll consider employment income. However, most make allowances if any positive factors (like those listed below) are present.
FHA is more flexible. Its guidelines state that:
To be eligible for a mortgage, FHA does not require a minimum length of time that a borrower must have held a position of employment. However, the lender must verify the borrower’s employment for the most recent two full years, and the borrower must explain any gaps in employment that span one or more months, and indicate if he/she was in school or the military...
If you’re self-employed or on commission, however, it will be virtually impossible for you to secure a mortgage until you’ve been at it for two or more years.
Hurdle #2: Payment Shock
A big factor in mortgage underwriting, and one that gets very little mention outside the mortgage industry, is payment shock. Payment shock refers to new housing expense (including mortgage principal and interest, property taxes, homeowners insurance and HOA dues) that significantly exceeds your previous housing expense. If you’re currently paying $1,000 a month for rent and your new housing expense would be $1,200 a month, payment shock is just 120 percent and not considered a problem. If, however, you were splitting an apartment with five buddies and paying $100 a month, your payment shock balloons to 1200 percent! That’s a potential problem because underwriters worry about your ability to handle a big jump in expenses. You may have to increase your savings or your down payment to make lenders more comfortable.
Hurdle #3: Limited Credit History
According to mortgage data firm Ellie Mae, the average FICO score for purchase mortgages guaranteed by Fannie Mae and Freddie Mac was 762 (compared to 729 for denied applications), while FICO scores on FHA-backed purchase loans averaged 701 (compared to 665 for denied applications). Sadly, according to Credit Karma, the average credit score for Americans under 34 is less than 640. It takes time to build a solid credit history and exemplary scores, and many younger grads haven’t been around the block enough to develop one.
All is not lost, however. FHA guidelines specifically prohibit penalizing applicants for not using consumer credit, so if your file is “thin,” your lender can order a “non-traditional” credit report, using your payment history from utility companies, landlords and other accounts to determine that you manage your finances responsibly. Even a series of regular contributions to a savings account can be used to demonstrate that you habitually take care of business.
FHA and some other programs also allow co-signers or co-borrowers to beef up your application when the problem is too little credit rather than bad credit. A larger down payment (say 10 percent instead of 3.5 percent) may help you secure an approval as well.
Hurdle #4: Those Student Loans
If your income is $40,000 per year and you pay $250 for car loans, credit cards or other monthly debts, you qualify for a mortgage of about $141,000, according to LendingTree’s Home Affordability Calculator (conservative scenario, $10,000 down and a 4.0% rate). However, graduates who borrow their tuition are exiting college with an average balance of $26,600. The payment on that pile at 3.8 percent over ten years is $320 – and that payment reduces what you can borrow to just $46,496! You may be able to help your cause with a student loan refinance. According to FinAid.org, you can extend your repayment to as much as 30 years (the payment in our example drops by nearly $200 with a 30-year term), or you can select a graduated payment, which gets you a lower payment in the early years, then gradually increases it as (hopefully!) your income rises.
Getting a mortgage when you’re fresh out of college presents challenges, but if you’re really ready for homeownership, you should be able to finagle a home loan approval.
Author Bio: Gina Pogol spent over a decade in mortgage lending, originating, processing and underwriting home loans. She has written about mortgage rates and finance issues for a number of publishers since 2006. Currently a senior marketing manager with Lending Tree, Gina advocates for consumers and loves answering their mortgage and personal finance questions.