My son graduated high school in June of this year and will be in a strong position to buy a house in our market within the next 12 months, despite the housing shortage and skyrocketing prices. How? We looked at all of the criteria lenders look for and ensured he would comfortably qualify for all of them. These criteria?
- Employment: 2 years of employment and 6 months at the same job.
- Credit: Minimum FICO score of 580
- Debt to Income Ratio: <43% on back end of mortgage
- Bank Statements: 2 months of bank statement
- Down Payment: At least 3.5% for an FHA loan
- Cash Reserves: 1 month Principal, Interest, Taxes, and Insurance for 1 to 2 unit properties and 3 months of Principal, Interest, Taxes, and Insurance for 3 to 4 unit properties.
Our son started work in June of 2021 and maintained his job through his senior year of high school averaging 20 hours per week. Now that school is out he has transitioned to full time with the same employer and is earning $16.32/hr and working 38 hours per week, which works out to an approximate $32,000 per year.
Lenders are looking for 2 years of W2s: He has W2s and tax returns from both 2021 and 2022, and can easily demonstrate why his income increased in 2022 and that its reasonable that it will stay the same. Although in the 24 month lookback period he was not employed for all of this time, the steady history of his job and that he was under 18 for that time period should alleviate any concern. Since the goal is for him to be ready to buy by next summer, this will be a non issue since he will hit 2 years in June of 2023.
About 18 months ago I added him as an authorized user to 2 of our credit cards. I just signed him up for Credit Karma and his VantageScore is 778! Obviously the accounts are paid on time every month and have low utilization, but he also got a bonus because the cards give him positive credit history for the entire length that I have had the cards as his length as well, so his credit history rather than being 18 months long for that card is almost 5 years!
This means you don’t have to do this well in advance! Parents can add their kids when they turn 18 or graduate from high school and within a month or two adding them as authorized users can give them several years of positive credit history and a high credit score! Of course only do this if the card has always been paid on time and carries a low credit utilization. Adding them as a user on a card with negatives will hurt them.
This process is used in the open market under the terms of buying and selling trade lines. People sell the ability to add people as Authorized Users on their accounts in order to repair the buyers credit. The buyer doesn’t receive a physical card, they are only given a bump based on the credit profile of the card owner and the attributes of that card (age, credit limit, payment history, issuer). Typically people will buy 2 to 3 tradelines at once ranging from $100 to $800 each. The normal relationship here is that they are added, remain on the account for a couple months, then are removed. This process is frowned upon by banks and credit card companies and selling an authorized user spot can result in losing your card. Adding your children is a legitimate use of the “authorized users” feature.
Debt To Income Ratio:
He has no debt and will not have any student loans, credit cards, or car notes. The above mentioned credit cards he is an authorized user on carry no revolving balance, therefore his debt to income ratio will solely be based on whatever mortgage he goes after. He is not seeking any further education at this time, and even if he was we would cover the expense. He does not have or need a credit card, and will likely be buying a car in the $1,000 to $2,500 range within the next year with cash.
He has had a bank account since he was a little kid, however he has also had a checking account since he started his job last summer. His bank statements show consistent deposits and an accumulating balance. Lenders look for balances trending downward and for large deposits in excess of 50% of the monthly reported income. These raise a red flag and need to be discussed. He does not have any such deposits. Gradual growth from his weekly paychecks will put lenders at ease.
His current cash savings between his checking and savings accounts is around $5,000. By the end of this year he should have closer to $10,000 and by June he should be north of $15,000. Having no expenses allows him to bank a ton of cash. The only bill he has is his cell phone, which runs around $50 a month. Since he is grossing almost $2,500 a month, he can save a ton of money. He already has enough money for a 3.5% down payment on any house the bank would issue a loan for.
Reserves (Retirement Accounts):
He puts 50% of his income (the maximum his employer allows) into his Roth 401K account. Between this, his Roth IRA, and his Stockpile account he should have north of $20,000 by the end of this calendar year. Banks count money in retirement accounts towards the reserves requirements for loans. This is especially useful if he went for a 3 to 4 unit property where reserve requirements are higher.
What House Can He Afford?
Obviously $32,000 a year isn’t a high salary, so realistically what type of house can he afford? At the most restrictive 28% debt to income ratio measurement, he can afford a monthly house payment of $750/mo. If we assume $100 per month for property taxes and $50/mo for home owners insurance, then this leaves roughly $600/mo for principal and interest.
This would be a $100,000 loan for a 30 year mortgage at 6% and a $76,000 loan for a 15 year mortgage at 5%.
By June of 2023 he would certainly have enough of a down payment for a 10% down $110,000 loan to maximize the $100,000 available loan he would have, so a $110,000 single family house is the absolute top of his budget. It may make more sense for him to get a 15 year loan and even a 3.5% FHA loan.
What can you get for $110,000 in our market?
These are sold prices, not list prices over the last 6 months:
What About A Multifamily Property?
Ideally he would actually buy a 2 to 4 unit property. Why? Because the expected rent from the property offsets the lending requirements and with 2 to 4 units he can still qualify for a 3.5% down FHA loan. For example if a 4 unit property that he lives in is expected to bring in $700/unit, then $2,100 of monthly income is used against the lending requirements. Note: This is typically discounted 10% to 20% to account for vacancies.
This 4 Unit building sold last summer for $137,000. It’s in a decent neighborhood (1 block from Mrs. C. and I’s first home!) and consists of 1 3 bedroom, 1 2 bedroom, and 2 1 bedroom apartments all with separate gas and electric meters. In our current market the rent for the 3 bedroom would be around $800, the 2 bedroom around $700, and the 1 bedrooms around $600. If he lived in a 1 bedroom, the rent from the other 3 units would be $2,100 per month.
If he got a 3.5% down FHA mortgage he would pay roughly $5,000 for a down payment and another $3,000 in closing costs, which he would easily be able to cover. Then his payment on a 30 year mortgage would be $794 per month. Add in the $100 in property taxes and increase the insurance to $150/mo and his rough costs are $1,050 for this building…while the building is making him $2,100. He has NO HOUSING COST AND is earning $1,000 a month!
OK, so subtract $200/mo for property management and $100/mo for maintenance and we get to $700 a month in net earnings, still WAY better than him renting an apartment in someone else’s building for $600 a month right?
4 units with 3 rented at $700 per month avg rent
- 2,100 Gross Rents
- -800 Principal and Interest payments
- -100 property taxes
- -150 insurance
- -100 maintenance
- -210 property management
740 net cashflow (and living for free)
From a lending standpoint, assuming this building would gross $2,100 per month, the bank would likely count around $1,800 of income as gross rent. His total monthly income would then be seen as $4,466, allowing for a mortgage of up to $1,250/mo, which would be a 30 year loan at 6% interest of $208,000.
A Step Further:
Then after 1 year if he continued to save what would be his house payment of $700/mo and the additional $700/mo in rental income he will have $16,800 saved up. Since 1 year has passed he can get a new FHA loan! He could buy a 2nd 4 plex to move into it as a primary residence with only 3.5% down. He could now rent out the fourth unit in building 1 and move into building 2, where the numbers would be similar.
Now rather than living for free and having $700 in net monthly rental income he will live for free and have around $2,000 in net monthly rental income.
(2 properties worth $270,000 with 3.5% down payments)
8 units with 7 rented at $700 per month avg rent
- 4,900 Gross Rents
- -1,600 Principal and Interest payments
- -200 property taxes
- -300 insurance
- -200 maintenance
- -560 property management
$2,040 Net Cashflow (Yes I know the principal part of the mortgage is not an expense and that I did not include the depreciation expense. These will roughly cancel each other out).
Could He Buy A House Now?
The only factor he is lacking is the 2 years of work history. 2 solid years isn’t a hard and fast requirement, they look at all the other factors to see if they compensate for that. Having a much higher credit score than required and having much higher reserves than required should make up for this. All though we are not actively looking for a place now, If a perfect property comes up he is already in a position where he should be able to make a move.
Why Are You Looking At Housing And Not College?
College for the vast majority of people ends up having a negative ROI, especially when you factor in the opportunity cost of 4 years of delaying work as a primary activity. My son has not excelled at school and attending traditional schooling for more time will be a detriment to him. He may pursue some skill training, however a full time 4 year college degree is not a good path for him. As an employee of Wal-Mart there are many no cost further education options available to him, and I would certainly cover virtually any skills training that he shows a legit interest and aptitude for that has a positive ROI.
For the vast majority of people having their housing costs fixed and becoming a home owner is a much stronger financial base than a 4 year college degree.
What are you doing to set your kids up to become home owners?