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The Three Biggest Financial Challenges First-Time Homebuyers Face

When Nicole and Olivia McKinney decided that they wanted to buy a home, they initially hoped to stay close to the Navy Yard neighborhood in Southeast Washington where they had been renting.

“We found out pretty quickly that we had to open up the search to different neighborhoods because there was so little available that we could afford near the Navy Yard,” says Nicole, 32, who works in fundraising for a nonprofit organization.

Olivia, a 32-year-old high school counselor, says that they both work in Northern Virginia and find their reverse commute manageable, so they wanted to stay in a convenient city neighborhood. The married couple moved to their newly constructed condominium in Eckington in early September, compromising on their preferred community but buying a larger home than they had anticipated.

The McKinneys were able to accomplish something many millennials aspire to: homeownership. The TD Bank Renter Survey in September found that 76 percent of millennials rank homeownership as extremely or very important to them.

According to the September Campbell/Inside Mortgage Finance HousingPulse Tracking Survey, the first-time homebuyer share was 38.3 percent in May, the highest level since 2010. However, higher home prices and seasonal home-buying patterns pushed down the first-time buyer share to 36.4 percent in August.

The peak of first-time homebuyer activity, according to this survey that has been conducted for the past five years, was 40 percent in August 2010.

“We’ll look back at 2015 and see that this is the beginning of the trend of millennials buying homes,” says Jonathan Smoke, chief economist for in Washington. “Two or three years ago we saw the impact on the rental market of increasing household formations, and now those renters are becoming homeowners.”

Smoke says that 13 percent of the national population are millennials (age 24 to 34) and that share rises to 15 percent in the D.C. metro area, which has one of the highest proportions of people in that age group.

While not all first-time buyers are millennials, traditionally the largest share of initial homebuyers are in the 24 to 34 age bracket, Smoke says. He says that according to the mortgage data he reviews, 36.3 percent of all purchase loans between January and August 2015 in the D.C. real estate market have been issued to millennials.

While some millennials are managing to buy their first home, almost no one considers the process to be easy. For the McKinneys, the challenge was finding something desirable in their price range.

“We used WalkScore to look for neighborhoods with walkable amenities and input our commutes on that site to narrow down areas and then looked at listings within our price range in those communities,” Olivia says. “We lived in the Navy Yard before it was developed as much as it is, so we’re fine with being in an area that is still developing now. We spent a lot of weekends looking at places, so we got to know a lot of different neighborhoods, but this place has a great shared rooftop deck, a private deck, a parking space and the layout that we like, even though it’s not in the Navy Yard.”

The McKinneys financed their purchase with an FHA loan with a 3.5 percent down payment so that they could use their accumulated savings to pay for moving and closing costs. Among prospective first-time buyers surveyed by TD Bank, 64 percent of millennials said that they need to save for a down payment, and 45 percent said that they need to pay down debt before they can buy their first home.

Financial Challenges:

Here are three big financial challenges that affect millennials who want to buy their first home, particularly in high-cost housing markets such as Washington, New York City and San Francisco.

• Expensive Rent: According to, the average rent for a two-bedroom unit in Washington was $3,000 in September, which makes saving a challenge.

“It’s hard to save for a down payment when rents are high and require a large share of your income,” says Svenja Gudell, chief economist for Zillow in Seattle.

• Tight credit: “We’re seeing a little bit of a window opening in looser underwriting guidelines,” says Jonathan Corr, chief executive of Ellie Mae, a loan software company and provider of mortgage data in Pleasanton, Calif. “The average FICO score for approved loans dipped to 723 in September, the lowest number since we started reporting back in August 2011.”

However, Ellie Mae’s data for purchase loans, not including refinance loans, shows that the average credit score remained the same as the 2014 average at 755 for approved conventional loans, as did the average debt-to-income ratio at 34 percent. Approved FHA loans also stayed the same, with an average debt-to-income ratio of 41 percent. The average FICO score for FHA loans actually rose slightly to 689 from an average of 684 in 2014.

“Establishing your credit is a key part of becoming a homeowner,” Corr says. “A few years ago, average credit scores for approved loans were in the 750s and the 760s, so we’ve improved somewhat over that.”

• Student Loans: Zillow recently researched the effect of student loan debt on millennials and homeownership and found that the impact was smaller than expected, at least for borrowers who had graduated with a degree or, better yet, an advanced degree, Gudell says.

“If you don’t finish your degree you won’t have the higher income needed to repay your loan,” Gudell says. “Paying down your student loan debt could delay homeownership a little, but many people can still meet the debt-to-income ratio requirement even with a loan payment.”

The typical debt-to-income ratio requirement means that the minimum monthly payment on all your debts, including your housing payment, should be a maximum of 43 percent of your gross monthly income.

“While loan requirements generally call for a hard stop at 43 percent, there can be a little gray area for borrowers with excellent credit or other compensating factors,” says Chris Copley, regional mortgage sales manager for TD Bank in Philadelphia. “To improve that ratio you have to buy a less expensive home, make a bigger down payment so you borrow less, pay down debt or find a way to increase your income.”

Borrowers with student loans tend to have less credit card or auto loan debt, Smoke says, which is why they can often qualify for a mortgage even while repaying their education debt. Smoke says that student loans make saving for a down payment more difficult and may be one reason for lower down payments by millennial buyers. He says 69 percent of millennial buyers year-to-date in 2015 have made a down payment of 5 percent or less.

Gudell says, “It’s still hard to get a mortgage because credit standards are tight, particularly if you have student loan debt and a shorter credit history.”

“And even if you have the credit qualifications and down payment funds,” he says, “it’s hard to find an affordable, entry-level home in high cost markets.”

Aid for Homebuyers…

A variety of programs are available to first-time buyers that can make their purchase more affordable.

“A real game-changer in D.C. is the DC Open Doors program,” says Connie Fisichello McCollister, a realty agent with DC Home Buzz in Washington who represented the McKinneys. “The program gives buyers 3 percent for their down payment on a home priced up to $430,000. The income cap is just under $125,000 for borrowers. And you can usually negotiate with your realtor to have the closing costs covered by the seller, so you can get into a house with almost no cash at all.”

For example, McCollister says, if a home is listed at $300,000 you can ask for the seller to pay your closing costs of approximately $9,000 and negotiate the sales price to $309,000. Adding the $9,000 to the loan balance will add only a minimal amount to the monthly payment on a 30-year loan.

In addition to DC Open Doors, buyers can find out about other local and state down payment assistance programs at . Various mortgage options can also reduce your cash needs for your home purchase, such as:

•FHA loans, which require a low 3.5 percent down payment, typically have more lenient credit standards, although lenders set their own guidelines for borrowers and generally require a credit score of 620, 640 or higher. Mortgage insurance that lasts for the life of the loan is added to the monthly payment.

•TD Bank offers a Right Step loan with a minimum credit score of 660, a down payment of 3 percent and no private mortgage insurance. The interest rate will be slightly higher than other loan products.

•Conventional loans available from lenders and backed by Fannie Mae and Freddie Mac require a down payment of 3 percent and require private mortgage insurance to be paid until the loan-to-value reaches 80 percent. Lenders establish a minimum credit score for these loans, but the lowest interest rates are available to borrowers with a credit score of 740 or above.

Many first-time buyers rely on assistance from their parents for down payment funds. According to research by loanDepot, a national lender, the number of parents who anticipate helping their millennial-age children buy a home in the future has increased to 17 percent from 13 percent over the past five years.

Gift funds are allowed for some or all of your down payment depending on the loan program you choose, but keep in mind that you’ll also need money for closing costs, moving expenses and cash reserves.
In addition to relying on gifts, millennials are finding other ways to save for a down payment.

“Our research found that 16 percent of millennials plan to move home for a while to save money for a down payment,” says Julie Reynolds, a spokeswoman for loanDepot in Irvine, Calif.

Other methods for saving include sharing housing costs with a roommate, cutting down on entertainment and meals out, working extra hours or two jobs, selling personal items or asking for money instead of wedding and holiday gifts.

Compromise part of the homeownership equation…

When you think you’re ready to buy a home, Tim Steffen, director of financial planning for Baird’s wealth management firm in Milwaukee, says you need to determine how much you can afford to pay, including your down payment, monthly borrowing costs and cash reserves. Next, he says, you should think about where you want to live, and then find out what you can afford in your ideal neighborhood.

“You’ll likely need to compromise and decide if you’re willing or able to pay more for your preferred neighborhood or move someplace else that’s not as trendy or not right at the Metro stop but is more affordable,” Steffen says.

McCollister says most first-time buyers today are aware of the high cost of housing in the D.C. market or quickly understand reality once they start looking at listings. She says most try to stay within their budget and adjust their expectations of what they will buy.

“I send listings to buyers to look at themselves, because it’s important for them to feel confident that they’re educated about the current housing market,” McCollister says.

When you can’t find your dream home at a price you can afford in the neighborhood you want, you’ll need to widen your perspective to look at other locations, homes that are in less-than-perfect condition or other home types such as a condo instead of a single-family house.

Still, switching to a less expensive property could usually require a monthly condo fee or homeowner’s association fee that could make your monthly payment higher.

McCollister also suggests waiting for a different season to buy.

“While there’s more on the market in the spring, there’s also more competition,” she says. “If you wait until December to look for a home, it’s possible that your offer will be the only one and that the sellers are motivated to accept it.”

Narrowing your priorities to a maximum of two or three can make it easier to get what you want than if you have a long list needs and wants, McCollister says. She says buyers need to be flexible and patient yet ready to move fast while they look .

“A big lesson we learned was not to idealize anything,” Olivia McKinney says. “There’s always something else you can find if your dream place isn’t available, and you can always adapt to other places.”

Tips for buying your first home…

•Know your budget and your comfort level with a particular monthly payment so you don’t overspend.

•Get a loan preapproval as early as possible so you know your financing limit.

•Find ways to save for a down payment. The median home price in the D.C. metro area in September, according to RealEstate Business Intelligence (RBI), a subsidiary of multiple-listing service MRIS in Rockville, was $400,000, which means even a low 3 percent down payment is $12,000.

•Establish a systematic savings plan and reduce as many expenses as possible.

•Be aware that you can finance a home with a down payment as low as 3 percent. A 20 percent down payment or a 10 percent down payment keeps the payment lower and builds equity faster, but is not required.

•Understand the other costs of homeownership, including property taxes, homeowner’s insurance, utility bills, condo or HOA fees and maintenance costs.

•Improve your credit score and reduce your debt to qualify for the lowest mortgage rates.

•Do your own research about neighborhoods and planned development in different communities.

•Be open to different property types and neighborhoods.

•Plan to live in your home for the next five to seven years.