Mrs C. and I bought our first home in August of 2006, 3 months after I turned 20. At the time most people thought I was either lying about buying a house or was getting a really run down unliveable house, neither of these were the case. I bought my first home with income I made from a minimum wage job. As long as you have a solid plan, it is possible to be a homeowner just a couple years into the real world, even if you aren’t making a ton of money.
What You Need To Buy A House At Age 20:
Stable Work History: Lenders want to know that you will be able to pay them back, and your income and work history are the two factors used to determine your ability to pay back the loan. You need to have two years of W2s with no employment gaps.
Down Payment, Closing Costs, and Cash: To get a loan with favorable terms a 20% down payment is a must. This also helps greatly if you are lacking in any other area. If we didn’t have the cash for a 20% down payment we would have paid more in closing costs, had a higher interest rate, and had to pay private mortgage insurance (PMI).
Established Credit: Even if you have a steady job and some money for a down payment lenders really want to know if you have the integrity to actually pay back money you borrow. They want to see a track record of this and if you don’t have it you might not be able to get a loan.
Are all of these steps possible to achieve by age 20? Absolutely.
Shopping For A House At Age 20:
Affordable: Obviously your late teens are not going to be high income years. This means that any house you buy will have to be an inexpensive one in an inexpensive area. Many young adults will try to stretch into a more expensive home based on assumed increases in income, when they should really be trying to get into a less expensive home. Lenders will typically only allow you to get a loan in which the house payment, taxes and insurance are no more than 33% of your gross income.
As an example, someone who earns $10 per hour for 40 hours per week, which is $20,800 per year, this would limit the total mortgage payment to $572. For a house in this range taxes and insurance can be estimated at around $100 per month, leaving $472 for the principal and interest.
A $472 principal and interest payment would be:
A $96,000 loan on a 30 year 4.25% loan, assuming a 20% down payment the home value would be $120,000.
A $78,000 loan on a 20 year mortgage at 4.0%, assuming a 20% down payment the home value would be $97,500
A $66,000 loan on a 15 year mortgage at 3.5%, assuming a 20% down payment the home value would be $82,500.
Remember this the absolute most a bank would consider lending. keeping the home price well below these values would make the bank much more comfortable with loaning you money. I would recommend shooting for around 75% of what these values are. For example if seeking a 15 year loan, the buyer would be looking for a home valued at around $62,000.
Lenders may also charge a higher interest rate for a young buyer because it simply isn’t possible to have a high credit score established in under 2 years of being an adult. Prepare for your interest rate to be 2% higher than prevailing interest rates. This is another reason to look at lower cost homes, the lower the price of the home, the less the interest rate matters.
Insurable: Lenders will require you to buy a years worth of property insurance and to provide proof of this at closing. This is to protect their investment if the house has any damage done to it. If a house is dilapidated, insurance companies will not insure it. Broken windows, patched roofs, missing furnaces, and even missing railings around decks will keep an insurance company from underwriting the house.
How I Bought A House At Age 20:
I got my first real job when I was 17 in 2004. I stayed at that job for the next 2.5 years. For the first year I lived at home with my parents while going to school. I saved the majority of my income and put about half my savings into cash and half into my Roth IRA. The next year I moved into an apartment with Mrs. C. We were both working a job that paid just above minimum wage and we were extremely careful with our expenses. All in all we were saving at a rate of around $400 per month. After a year of this we had saved up around $8,000 and moved into Mrs. C’s mom’s house in order to not sign another year long lease while shopping for a house. That same month I worked my first nuclear plant outage and earned $5,000. This was a major boost to our cash position and put us at around $11,000 total. Most of the houses we were looking at were around $50,000 and working the outage gave us enough for a 20% down payment. I was 19 when we started shopping for our home and we closed 3 months after I turned 20.
Mrs. C. and I went to get a loan as first time home buyers by talking to a local mortgage company. Mrs. C and I had no credit scores, which made getting a loan more difficult and more costly. Because of a lack of credit scores the lender manually underwrote the loan and processed the loan through their mortgage company instead of through a big bank for a referral fee, which was their usual practice. The big bank would not lend to us because we did not have established credit histories. Since they did not normally underwrite loans themselves, this loan came with a catch, we had to establish credit and refinance in 1 year. We did not actively compare different lenders, and there were no major online loan brokers like Lending Tree which will have banks compete for your business.
We only had two of the three major items needed to buy a home; solid work history and a large down payment. Lacking credit scores we were still able to make it happen, but if we had been focused on developing credit scores earlier the process would have been much less difficult and much less costly.
Details of the House:
We purchased a 5 Bedroom 2 1/2 Bath 2,200 square foot home in Benton Harbor, MI for a total price of $48,500. The down payment was $9,700 and we had $1,739 in closing costs, including $600 for property insurance. Our total cash out of pocket at the closing table was $11,439. Our interest rate ended up being 9.25% instead of 7% because of the lack of credit history. On a $38,800 loan this doesn’t make a huge difference though; our principal and interest payment was $319, which was around $200 less per month than what our rent had been for a tiny 2 bedroom apartment.
Income requirements: Our maximum loan amount was determined off of our 2005 income. In 2005 Mrs. C. and I both earned around $12,000. Combined, a $24,000 income would have allowed us a total house payment of $660. After $100 for taxes and insurance, this would mean our mortgage could be no more than $560 per month. At the time we were looking at an interest rate of 7%, which would have allowed us a mortgage of $84,000. Using a 20% down payment we could have bought a house of $105,000. Our cash position did not have us in a place where we could put 20% down on a $105,000 loan, but we could put 20% down a $50,000 loan. This is why we were searching mainly for a house between $45,000 and $55,0000. Our lender was willing to give us a mortgage with a lower down payment (3.5% FHA), however we wanted to be conservative and ensure we would not be upside down in the house, we also did not want to be forced into escrowing our property taxes and insurance and paying PMI.
What I Could Have Done Better:
Essentially we stumbled in to buying a house and made several mistakes along the way. This was years before I turned into a finance geek, so I had to learn many of these lessons the hard way.
1. Focus: When I was 17 and 18 I didn’t have a set goal to buy a house. Had I spent those two years planning and taking action to put myself in the position to purchase a home I’m sure I could have made it happen a year earlier. I very easily could have worked more hours during those two years and had a larger savings account.
2. Establish Credit: I avoided credit, because I had no need for it. I was aware of the dangers of credit card debt and car debt and stayed away from credit. Had I known it would be such a large factor in determining my interest rate I would have made sure to get a credit card at 18 and paid it off in full every month. I would then have 2 years of established credit history, which would have made getting a loan easier, and drastically reduced my interest rate.
3. Negotiate: We originally offered $42,000 for the house. The home was a foreclosed bank owned property than had been on the market for over a year. The realtor called us back after our offer was in and told us there had been another offer made and that if we wanted to house we had to increase our offer. We instantly increased our offer to the full ask price of $48,800, and the bank accepted. If we had not been so nervous about the whole process we would have negotiated better and been willing to walk away. I am sure if we had stuck to it we could have got that house or a similar one at a discounted price. That difference of $6,800 doesn’t make a big difference in the monthly mortgage payment, but it does make a big difference in your equity position when you go to sell the house.
4. Got a 15 year mortgage or 10 year mortgage: Our original loan was for a 30 year, and then we had to refinance to a 15 year a year later. When we did this I made some mistakes, and once again did not compare lenders. I took cash out and paid way more in closing costs than I should have. Had I originally gotten a 15 year loan with a 20% down payment I would have avoided those costs and built equity much faster.
5. Eliminated Future Down Payments: Saving up a down payment for a home is extremely difficult. Coming off of 20% of a home price is most likely the largest check you will ever write. When I upgraded in home 5 years after buying this house, I had to save up another down payment because we had not sold our home yet. Think about this: Even at a 5.5% interest rate (2% higher than the current going rate) a 15 year $38,800 mortgage 5 years in would only have $29,000 left on the mortgage. Since the home was worth $50,000 at purchase, even if it didn’t increase in value over 5 years, I would still walk away from the closing table with around $20,000, enough for a 20% down payment on a $100,000 house.
6. Pay Extra on Principal: My original mortgage was a 30 year at 9.25%, even for 2006 this was quite high. Paying extra principal payments is most effective on the early years of the loan, and effectively you get a rate of return equal to the interest rate AND greatly reduce how long you will be paying on the house. It didn’t even enter my mind to make extra principal payments because I was only concerned with the fact that my monthly payment was so much lower than the rent I was paying. I actually felt like I was winning financially with my mortgage.
Was It Worth It?
Even with all the mistakes I am so thankful that Mrs. C. and I decided to buy a home as young adults. Yes we overpaid for the house, overpaid for the loan, and didn’t build equity as fast as we should have, but we were still making forward progress and owning a home gave us a solid base to continue building our net worth.
Buying a house reduced our monthly housing cost and gave us a better standard of living. Our mortgage payment, house insurance, and property taxes combined was still $100 less per month than what we were paying for an apartment. We had over twice the area in total square footage plus a yard, plus a 2 1/2 car garage, and plus an 800 square foot basement. Our apartment was around 900 square feet and had neighbors directly above us and on two sides.
I loved having space. We had 2200 square feet of living space and another 1400 square feet of unfinished space between the oversize garage and the basement. I loved having a yard that was ours. I loved being able to make changes to our environment. Being able to paint rooms, open up a doorway and run new electric lines is an amazing feeling when moving from being in an apartment where you have to worry that a scratch on the wall will cost you your security deposit.
Deciding to buy a house is a big life decision and shouldn’t be made lightly. Most people in their late teens and early twenties are not ready to buy a home, like everything in life, it depends on your individual circumstances. My older sister moved literally a dozen times between Age 18 and 25. Had she purchased a home in her early 20s, moving to take advantage of excellent job opportunities would have been much more difficult. If you know where you want to live and spend a bit of time planning, buying a home at a young age can be done and is a major step towards building wealth.
Did You buy a house at a young age? What did you do to prepare for the purchase?