As home prices have continued to trickle upward, many millennials are finding it difficult to purchase their first home.
Millennials Want Homes
As millennials are growing older, they are now active members of the housing market. In fact, the national homeownership rate rose by 0.20% from the rate in the fourth quarter 2019 (65.1%) to the current rate in the first quarter of 2020, (65.3%), according to the U.S. Census Bureau.
But as home prices have continued to trickle upward, many millennials are finding it difficult to purchase their first home, especially in this turbulent market. Other factors like the ongoing pandemic are also forcing them to push off this milestone. In fact, a recent Quicken survey revealed 23% are putting off buying a house anytime soon.
There are a number of factors that make home-buying challenging for millennials, but these are three of the major factors:
1. Rising home prices mean larger mortgage payments, straining monthly budgets
The rise in home prices has two effects—a larger upfront cost and increased monthly payments, which compared to renting, may not be worth the price.
2. Restrictive lending standards make approval a very cumbersome process
Lenders have a number of requirements that bar many millennials from approval or they fail to provide low enough rates to make home buying an affordable option.
Credit score is a major factor in bank approval and in preventing millennial home buying—according to a LendingTree survey, more than 4 in 10 (44%) homebuyers are more worried about qualifying for a mortgage because of the pandemic, with first-time buyers (58%) and millennials (52%) especially anxious. This anxiety is justified, with many lenders requiring a higher credit score, often at a minimum of 700, in order to qualify for a mortgage.
3. Limited savings result in an inability to put a 20% down payment
This is a major hurdle that most can’t cross—even those millennials with high incomes simply have not had the time to save enough.
While there are first-time homebuyer programs that lower the down payment amount, these often use insurance fees and other mechanisms to increase monthly costs and reduce how much of the principal is paid down. Additionally, just as banks are becoming stricter about their credit standards, many are demanding higher down payments as they try to dampen their risks. So even if you have saved and believe that you have enough for a down payment, that amount of savings may no longer be enough for a down payment.
Parents are Millennials’ Only Option
With banks increasing their standards for lending or scaling back on lending options, millennials have no choice but to turn to their parents for a loan and a chance at homeownership. According to a 2020 Loan Depot survey, 77% of Millennial and Gen Z respondents are turning to their parents for help to become first-time homebuyers. However, this often means that parents will have to shoulder part of the expensive down payment costs. Though parents may be more financially stable, that doesn’t make it any less expensive for them.
There are a few different options available to parents who are helping their children with the purchase of a home:
- Utilize your savings and/or retirement accounts (401k, IRA)
- Procure financing by leveraging your untapped home equity wealth
- Sell unused assets (such as land) to generate cash
All of these options have various advantages and disadvantages depending on parents’ financial situation. Tapping into home equity may be an increasingly attractive option, as parents who opt to make a low-interest loan to the child, becoming in effect the mortgage lender, can enjoy a bit of income from the monthly payments. This trend is growing, especially as home prices have risen substantially in the past five years and home equity levels have recovered. Below, we’ve created available options for you to tap into your home’s equity to determine which option may be best for your situation.
Home Equity Solutions
There are two traditional home equity financial mechanisms available to parents:
- You can cash-out equity from the home with a negative amortizing loan, which means that the bank buys equity month-by-month.
- A reverse mortgage allows you to keep living in your home as long as you keep up with property taxes, maintenance, and insurance.
- Taking out a reverse mortgage means spending a significant amount of the equity you’ve accumulated on interest and loan fees
- If you pick a payment plan that doesn’t provide a lifetime income, such as a lump sum or term plan, or if you take out a line of credit and use it all up, you might not have any money left when you need it.
- Reverse mortgages limit the ability to pull out further equity and/or pass on the home to family members.
Home equity line of credit (HELOC):
- Homeowners can pull cash over a period of time and make required monthly payments.
- Lender may offer the flexibility of interest-only payments during the draw period.
- Rising interest rates can increase your payment.
- Without discipline, you might overspend, tapping out the equity in your home and finding yourself saddled with large principal and interest payments during the repayment period.
- HELOCs are often difficult for parents to get, due to restrictive bank standards on loan-to-value (LTV) and income requirements. Interest rates on HELOCs can also be quite high.
Neither option is perfect and both are quite limiting. More importantly, both of the above options can place additional debt burden on parents at a later stage of life with minimal tax benefits.
A Better Home Equity Option
A modern alternative, home equity sharing, allows parents to tap into the existing equity they have in their current home. This means that they get cash on hand in exchange for a share of the upside or downside of their home’s future value. There is no added debt, monthly payments, or interest for this funding. As such, instead of occurring more debt finance, an effective partner can help you meet you and your children’s financial needs.
A few benefits of home equity sharing include:
- A fast, straightforward approval/funding process
- No monthly payments, additional debt, or interest accrual
- Flexible underwriting standards that look at your financial profile holistically
- A shared partnership model that accounts for fluctuating home values and minimizes your risk
- No prepayment penalties
- Potential tax benefits, as compared to a HELOC or home equity loan
Armed with research and comprehensive information about the advantages and disadvantages of the financing options available to you, including tapping into your own home equity, you may be able to help your children achieve the American dream: buying a home.