If you’ve been paying attention to the housing market recently, you will have noticed it’s on fire. From Seattle, WA, to St. Petersburg, FL, there isn’t a market that hasn’t been affected by the low mortgage rates and high millennial demand for housing. The market hasn’t seen this much activity ever (even more so than the housing financial crisis of 2008). This article covers the pros and cons of mortgages and more.
Given the recent interest in homebuying, we thought it would be prudent to discuss exactly how Americans can afford such large homes. And, why now? After all these years, why are mortgages and refinances becoming popular all of a sudden? Let’s first discuss the basics of a mortgage and what its advantages are. They are equally complex and beneficial so it’s important to ensure we cover all the bases.
What is a mortgage loan?
Simply put, your home secures the mortgage loan. It might be a house, a store, or even a piece of non-agricultural land. Banks and non-banking financial institutions both offer mortgage loans.
The lender gives the borrower cash, and charges them interest on it. Borrowers then pay back the loan in monthly installments that are convenient for them. A portion of the payment goes toward the principal, and the remainder is the interest payment. Your property acts as security against the mortgage. And, your lender retains a charge until the borrower pays the loan in full. As a result, the lender will have a legal claim to the property for the duration of the loan, and if the buyer fails to pay the debt, the lender has the power to seize the property and sell it at auction.
The mechanics of the American home mortgage
The United States is unique from almost all other countries because its government has created quasi-government agencies to help subsidize the mortgage market. More on this below, but the TL:DR; is that the cost of a home is frequently far more than the amount of money most families have saved. As a result, the government created a way for homebuyers and their families to acquire a home with a smaller down payment, less than 20%, and pay the rest off over time, up to 30 years. In the event that the borrower fails to pay the mortgage, the lender can force a sale to repay the loan.
Millennials now account for over 37% of all homebuyers in the United States. This is great news. But, before we get too excited, let’s give thanks to generations past for their contributions that got us here today. These “quasi-government” organizations, as referenced above, were created decades ago to help homeowners like us secure a mortgage with less than the typical 20% downpayment required by most lending institutions. Those agencies are Freddie Mac and Fannie Mae, and they deserve extra attention for their support of homebuyers.
Freddie Mac and Fannie Mae
The United States Congress founded Fannie Mae and Freddie Mac, two government-backed mortgage firms, in 1968 and 1970, respectively. Fannie Mae and Freddie Mac are in charge of keeping the mortgage market in the United States functioning properly. Both firms acquire mortgages from a variety of lenders, ensuring that individuals, families, and investors have a consistent and stable supply of mortgage finance.
Fannie Mae and Freddie Mac loans feature minimal down payment requirements and competitive interest rates. However, the most significant advantage of Fannie and Freddie loans is that they’re the mortgages that most lenders want to make.
Homeowners with Fannie Mae and Freddie Mac mortgages were provided safeguards under the CARES Act. Lenders were banned from initiating a judicial or non-judicial foreclosure against you under the CARES Act.
What are the different types of mortgage loans?
No matter what anyone tells you, always remember: A mortgage is a debt. Debt is a very polarizing topic to discuss with friends because many of us were raised on the premise that debt is bad. The truth is, some debt is bad, some debt is okay, and some debt is good. Many today would argue that mortgage debt is good since the rate is so low and it affords you a bigger home. On the other hand, if you have to refinance your mortgage to pay off debt, then that would be an example of toxic debt (since it implies you may be living a lifestyle beyond what your current income can support).
Some people believe that debt should be prevented at all costs. Others view it as a means of improving one’s quality of life or as a means of increasing fortune. What’s awful about debt, factually, is reckless credit usage.
Here’s a rundown of the many types of mortgage programs, along with their benefits and drawbacks, to help you determine which is best for you.
A mortgage with a fixed rate
The interest rate is fixed for the duration of the loan. These loans provide a consistent monthly payment and a low-interest rate. Borrowers who wish to pay off their mortgage quicker can typically make extra payments toward the principal (not interest payments), as prepayment penalties are uncommon.
Pro: It is predictable because the monthly payment is fixed.
Con: Taking out a fixed-rate loan while the interest rates are high means you’re stuck with it for the duration of the loan. The only way out is to refinance at a lower rate.
A mortgage with an adjustable rate (ARM)
After a fixed-rate cycle of months to years, the interest rate on an adjustable-rate mortgage (ARM) varies. Lenders sometimes publish ARMs with as a pair of numbers, such as 7/1 or 5/1. Usually, a 5/1 ARM has a fixed rate for five years and then adjusts every year, rounding off if that option exists.
Pro: An ARM’s opening interest rate is often lower than that of a standard fixed-rate loan, so it’s easy to get lured in by the teaser rate. But, it might wind up costing more in interest over the term of your mortgage than a fixed-rate loan. An ARM may be the ideal option for someone who plans to market their home before the rate changes.
Con: Future rate hikes might be significant leaving many adjustable-rate mortgage borrowers with significantly elevated monthly payments than if they chose a fixed-rate mortgage.
Refinance loan or second mortgage
Sometimes, a homeowner already has a mortgage but wants to change the terms. Maybe they want a lower rate or a longer term. Or maybe they want to take out more equity from their home. Whatever the case, many options are available! The most common would be refinancing the home mortgage. With mortgage refinance, the homeowner closes out their original mortgage and obtains another one – ideally with more favorable terms.
With interest rates so low these past couple of years, refinancing has become much more popular. How often a homeowner refinances is usually a personal decision but they should consider at least these factors:
- market interest rate vs their current mortgage interest rate
- length/term of their loan vs the new one they want to get
- cost of the loan (“closing costs”) vs keeping still
- [cash-out refinance only] what to do with the funds
Pros: If you can secure a lower interest rate than your current loan, and the closing costs aren’t significant, then it could definitely be worth refinancing. On the other hand, if you need the money for home renovations, a cash-out refinance may be your best bet.
Cons: Refinancing costs money so make sure the math works in your favor.
The standards for conventional loans are generally more stringent than those for government-backed house loans. When reviewing traditional loan applications, lenders usually look at credit history and debt-to-income ratios.
Pro: A conventional mortgage may be used for a range of property kinds, and PMI would help borrowers qualify for a conventional loan even if they have less than 20% for the downpayment.
Con: Compared to government loans, conventional loans have tougher qualification standards and may demand a larger down payment.
The average age of home purchases has decreased, and an increasing number of millennials are now purchasing their first houses. Typically, the debt-to-income (DTI) ratio and the sum of interest negotiated on the mortgage determines the loan duration. For homebuyers, a longer contract means a lower payment, but a longer time to pay off that debt.
Some lenders may offer an interest-only mortgage, meaning the borrowers’ monthly fees will cover only the interest. As a result, it’s best to have a strategy in place to ensure that you can have enough money to return the entire sum borrowed at the end of the period.
Interest-only loans may be appealing since your monthly are low. But, unless you have a strong strategy to reimburse the capital, at some point, a fixed loan could be the better option.
Pro: Interest-only mortgages allow the borrower to place their capital elsewhere, such as in dividend stocks, a rental property, or other investments.
Con: Borrowers who aren’t careful with their budget may find themselves never being able to pay off the loan.
FHA loans and VA loans are mortgage loans that the government insures and are available for potential homebuyers. Further, FHA loans are available to lower-income borrowers and typically require a very low down payment. Also, borrowers get competitive interest rates and loan costs.
The government does not directly grant Federal Housing Administration (FHA) loans. FHA loans can be issued by participating lenders, and the FHA guarantees the loans. FHA mortgages might be a viable option for those who have a high debt-to-income ratio or a bad credit score.
Pro: FHA loans need a smaller down payment and credit score requirements are lower than conventional loans. Moreover, FHA loans may enable applicants to use a non-resident co-signer to assist them to be qualified.
Con: Unless a borrower puts down 10%, the monthly mortgage insurance will remain a part of the payment for the loan’s life. If a borrower ever wants to remove the monthly mortgage insurance, they must qualify and refinance into a conventional loan.
Read more: How to Improve Your Credit Score
FHA 203(k) loan
An FHA 203(k) loan is a government-insured mortgage allowing funding borrowers with one loan for both home renovation and house purchase. Current homeowners may also be eligible for an FHA 203(k) loan to help pay for the repairs of their current house.
Pro: Borrowers can use an FHA 203(k) loan to purchase and renovate a home that would otherwise be ineligible for a traditional FHA loan. It just takes a 3.5% down payment.
Con: You must be eligible for the full property value, as well as the price of anticipated improvements, with these loans. It’s possible that the rate will be greater than on a normal FHA loan. You’ll also have to pay both a one-time, and monthly mortgage premium insurance payments.
VA (Veterans Affairs) loan
The US Department of Veteran Affairs backs home loans for veterans, reservists, and military or National Guard members, as well as qualified surviving married partners.
In fact, nearly 90% of all VA-backed home loans are made without a down payment.
Pro: You won’t have to put any money down, or deal with PMI payments on a monthly basis.
Con: On purchase loans, a one-time VA “funding charge” varies from 1.4% to 3.6%.
Fannie Mae homestyle loan
The Fannie Mae homestyle mortgage needs just 3%–5% down, but a credit score of 620 is an option for fixer-uppers.
Pro: You don’t have to pay for mortgage insurance beforehand, and you can terminate it after twelve years or when you have 20% equity on your house. The rate is frequently cheaper than an FHA 203(k) loan.
Con: Credit score requirements must be met.
Reverse mortgage loan
Homeowners aged 62 and above can use a reverse mortgage to convert some of their property value into cash. The age of the youngest homeowner, the loan rate and fees, the heir’s wishes, and payout type are all aspects for the lender to consider.
Pro: There are no monthly payments required, and the homeowner can select between a one-time balloon payout, a monthly payout, a line of credit, or a combination of the three.
Con: The interest rate may be greater than that of a typical mortgage. The homeowner usually pays the mortgage insurance, a direct charge, an initiation fee, and third-party expenses.
What is the primary reason a millennial would want a mortgage?
For the majority of individuals, purchasing a home without a mortgage is difficult. Putting down hundreds of thousands of dollars in one lump payment is a luxury afforded to a select few.
Millennials are starting to take notice of the importance of a mortgage. They’re realizing that financing a home purchase enables them to choose where to live, what to do with their income, and how to invest their extra cash. But before determining whether or not to take out a mortgage, a millennial should consider the following five factors.
Clearing and paying off student loans and other debt
What is the most difficult aspect of buying a home for millennials? Student loans are a form of debt. A nationwide student loan debt is being paid off by almost 44 million Americans.
Millennials are often regarded as the most well-educated generation. They have some of the greatest levels of debt in history from school loans and large credit card loads. During the Great Recession, many millennials graduated and entered the labor market.
Since student loans affect both a borrowers debt-to-income ratio and credit score, Borrowers should be free of student debt before purchasing a home. Otherwise, the student loan payment will significantly eat into the potential borrowing power.
Read more: 12 GREAT Ways Not To Get Student Loans
Putting money aside for the down payment
The majority of us do not purchase our first house with cash. In reality, millennials buy with a mortgage in 97% of cases. That’s why a large down payment is critical—not only to decrease your interest rate but to help in paying off your mortgage faster. It is suggested that borrowers put down 10% to 20%.
Making a difference in a competitive market
They go on to the next phase, which is to enter the property market after paying off student loans and saving for a down payment.
Because Gen-Xers prefer to buy detached homes rather than condos, you’ll be up against other millennials and older people.
Buyers that participate in bidding wars have a larger budget and greater home-buying expertise. These tips will help you stay in the game:
- Before you make an offer, be preapproved for a mortgage. A preapproved loan indicates that your lender has reviewed your financial situation and determined that you can afford the down payment and monthly mortgage payments.
- Second, take decisive action. They go to great lengths to keep the process going forward. If you can have a home inspection done in days, it’s preferable not to keep an interested seller waiting for weeks.
- Finally, establish a relationship with the vendor. Most homeowners get emotional when selling their house, so you never know how far a personal letter may go.
In a seller’s market, finding an affordable home might be difficult
Another issue that millennials face is the growing cost of housing. Rising housing costs can be particularly aggravating for people who have just paid off college loans and secured solid employment.
On the brighter side, mortgage rates are quite cheap. The regular interest rate on a 15-year fixed-rate mortgage fell to 2.15% in August 2021, the lowest it’s ever been.
Not succumbing to the need to stretch your budget and purchase a property that is out of your price range is important. No home is worth putting other financial ambitions on hold for.
As a result, millennials are more likely to opt for a 15-year fixed-rate mortgage, which is the lowest and the only one that is generally recommended for them.
Getting used to the purchasing process
As a first-time homebuyer, acquainting yourself with the buying procedure is one of the smarter things you can do. The more you know, the better you will be as a homeowner. There is no greater feeling than making that first mortgage payment and all your hard work today will pay off for tomorrow.
That’s why working with professionals who know what they’re doing is especially crucial for millennials. Looking for a real estate agent with a lot of expertise and who understands the market well enough to locate a great bargain on the perfect home?
Work with a real estate agent who makes the time to advise and to pay attention to your needs and wants.
When it comes to picking a mortgage company, what do millennials generally look for?
Millennials have benefited from, and embraced technology. Aside from reasonable rates, these are some of the most important characteristics this demographic looks for in a mortgage company:
- Morals and principals — Millennials, for starters, have a conscience. The Oklahoma City explosion, the 9/11 attacks, long and damaging wars, and financial instability shaped their early years, instilling in them a desire to work with companies that are committed to the greater good. They go out of their way to find businesses that give back to the community.
- A powerful online and social media existence — Millennials are more comfortable with computers and cell phones than previous generations. Millennials will judge which mortgage firm is worthy through a variety of websites and social media sources. They play a major role in their decision-making.
- Constructive peer thoughts and reviews — What their friends and family think is also important. Millennials have perfected the knack of collecting info and developing opinions from peers and acquaintances. Positive testimonials and social recommendations of mortgage firms have a significant impact on consumers’ purchasing decisions.
- Brand credibility — Millennials have an incredible capacity to sniff out a parasite in the blink of an eye. They must believe in your brand before they can believe in your mortgage firm. They will not buy in if they don’t trust your brand.
- Engagement — This demographic looks for mortgage firms that are willing to interact with them. Only when they feel at ease and trust your mortgage company will they be willing to enter into a commercial partnership with you.
- Calculators — The majority of millennials will be cautious to call your bank for information. Consider creating calculators so that the ordinary individual can easily understand how much a mortgage would cost, what their rates will be, and how much they can manage to pay.
Mortgage loans are given to those who have enough income and assets in relation to their debt. Mortgages also aid in the development of credit. They enable homeowners to invest in a home, with the advantage of having a forced-savings component. However, like with any loan, borrowers should be responsible when taking out a mortgage. It’s easy to get carried away and buy more than is necessary (and become house-poor).