Coile, chairman of Rockville-based multiple-listing service MRIS, offers analysis and writes commentary on the Washington-area housing market.
When I was growing up, my friends and I couldn’t wait to move out of our parents’ house. Today with the high unemployment rate, rising student loan debt and increasing social acceptance of multi-generational households, many adults 18 to 34 have opted to move back in with their parents.
This emerging group has been dubbed the “Boomerang Generation” and makes up 39 percent of young adults, according to a recent study by the Pew Research Center.
There are an estimated 3 million boomerangers living in their parents’ basement, who in better economic times would have created their own households. As they get back on their feet and start conceptualizing the idea of buying their own home, they may be hit with some unanticipated problems when applying for a mortgage.
I’m not saying all boomerangers need to move out from their parents’ home right this minute — they can enjoy the perks for as long as the situation works. But anyone planning to move out and buy a home within the next few years needs to know some game changing information to ensure they qualify for a home loan when the time comes. Here are my top three tips:
Establish a rental history
Lenders are already adjusting to the Consumer Financial Protection Bureau’s (CFPB) Ability to Repay and Qualified Mortgage rules that become effective on Jan. 10, 2014. One impact has been that lenders are very focused on the home buyer’s past housing payment history. Many home buyers will need to show a 12 to 24 month rental payment history even if they are living with a family member. Only about 48 percent of boomerangers report they pay rent to their parents, and in most cases it is sporadic and lower than an average mortgage payment.
To create a verifiable “rental history,” boomerangers must give an actual check, not cash, to be deposited into their parents’ bank accounts each month. It is also helpful if the amount of money the young adults pay their parents is in line with what they expect their mortgage payment to be in the future. Otherwise, the home buyer may encounter “payment shock” which can impede a loan approval since the lender may have a concern about the customer’s ability to repay the loan.
Parents must act like real landlords and require formal and consistent payments from their tenants. Same amount, same day of the month. Don’t cut any slack near the holidays and let the boomeranger skip a monthly payment because it will come back to bite them in the long run.
While parents can’t give the money back to their child immediately, they can always save the money in their own account and, depending on the loan type, may be able to gift it back to the kids when they are ready to buy a home.
Be mindful of credit file dings
As with anyone applying for a home loan, boomerangers should work to build up their credit score as high as possible. As we move into a tighter lending market, tiny credit dings could have a larger impact. In the past, minor credit dings could be easily explained with a letter to the lender, but unfortunately this will no longer suffice.
The new Qualified Residential Mortgage guidelines have total debt ratio limits of 43 percent of a borrower’s income that can go to all their payments, including home, car, credit card and student loans. But that ratio is for borrowers with good credit. If there are disputes or significant dings, that ratio drops to 36 percent in the new Ability-to-Repay guideline, and that translates into a 15 percent cheaper house for the boomeranger. There is a big difference between say a $400,000 home and one that sells for $340,000. That’s why you must protect your good credit so you have options when you go house hunting.
Talk to a professional early
The time when borrowers simply needed to be employed and have okay credit to qualify for a home mortgage loan is over. We are in a new era of finance reform with the Dodd-Frank legislation and the CFPB’s new underwriting standards.
With these new rules and regulations, there are many changes coming down the pike. Boomerangers can still buy a home; they just need to prepare in advance. The best way to do this is to find an experienced real estate agent who can help you evaluate your housing needs and create an action plan. A real estate professional can also help you select a qualified mortgage loan officer to determine what you personally need to do now so you can buy later. So start early, learn the rules, and plan for your future.
The bottom line is sometimes we don’t know what we will want — or where we will be living — in two years, but it is better to have options. Boomerangers who want to get out of the basement some day, need to start preparing now.