With the Denver metro area consistently ranking among heavy-hitters like San Francisco, New York, and Washington, D.C. as one of the most popular cities for millennials, it comes as no surprise that rental prices have grown exponentially in recent years.
The cutthroat nature of the rental market coupled with increasing rates have many residents of the Mile High City wondering if they should continue to hemorrhage money on rent, or if its time to commit to buying a home. TRELORA is here to help first-time homebuyers make informed buying decisions while saving their future equity.
A prospective buyer has to take many things into consideration when contemplating their first home purchase. Where does a person even begin?
The Most Important Aspect of the Entire Buying Process Is, Without a Doubt, Researching the Financial Implications of Having a Mortgage.
While this may seem like a no-brainer, many first-time homebuyers overzealously begin shopping for houses before they know what kind of mortgage they can qualify for. Buyers oftentimes make the mistake of falling in love with their $500,000 dream home and then discover that they can only afford a $200,000 mortgage. It is essential to initiate a conversation with a lender in order to ascertain where you qualify.
So "How Much House" Can the Average Denver Renter Afford?
The average 2-bedroom rental rate in the Denver metro area is nearly $1,600 – skyrocketing 13% from last year’s median. This implies that most renters in the metro area are paying about $800 a month to live in our desirable city. Let’s say that someone dishing out $800 a month in rent alone is ready to buy his or her first home and (for simplicity’s sake) they qualify for a loan amount of $150,000. Here’s a breakdown of what that buyer can expect:
On a $150,000 30-year fixed loan at 4% interest in today’s market, expect a monthly payment of approximately $716 for principal and interest, in addition to fees for homeowner’s insurance and property taxes, resulting in a payment of around $896 per month.
The Down Payment
On a $150,000 home purchase, a buyer would be advised to put down 20% if he or she wanted to avoid paying mortgage insurance. This means that the buyer would ideally have $30,000 at their disposal at the time of purchase to avoid higher monthly payments.
Personally speaking, I find that the majority of the millennials I know are not walking around with $30,000 in their bank account. This lack of capital is what makes getting into a home such a financially daunting process for many 20-34 year-olds. Even though a person may have excellent credit and be able to afford a reasonable mortgage payment, it can be difficult to see a solution to their cash-poor problem.
The great thing is that a few different solutions exist. Down payment assistance programs, such as those offered by the Colorado Housing and Finance Authority (CHFA), are available to Colorado homebuyers. Closing costs and other fees can be included in down payment assistance programs as a “silent” loan. However, if a person makes more than a certain amount, they may not qualify for one of CHFA's programs.
A buyer could also take out a second mortgage at a ratio of 10% second mortgage to 90% CLTV (combined loan to value = amount of loans you have toward the value of the home). On our $150,000 home, a 10% CLTV would be $15,000, and would cover half of the 20% down payment needed. Effectively, then, the buyer would need to bring $15,000 cash plus closing costs to the table instead of the full $30,000 required by most lenders to avoid mortgage insurance.
If paying 20%, or in our case $30,000, up front is simply not an option, the required FHA minimum down payment is only 3.5%, which is equivalent to only $5,250 on a $150,000 home. Not too shabby.
Conventional loans such as Fannie Mae and Freddie Mac usually require 5% down (or $7,500). In early 2015, a few low down-payment programs that require just 3% down became available through Fannie and Freddie.
Additionally, if you are a veteran, you can take advantage of VA loans, which require 0% down and do not necessitate mortgage insurance.
Buyers can Expect to Pay Around 4% Interest on a 30 - Year Fixed Loan - As of October 2015.
Luckily for homeowners, private mortgage interest is tax-deductible (at least for now). The buyer of a $150,000 home pays roughly $6,000 in interest during the first year of ownership, and would subsequently receive 25% of their interest payments (if they are in the 25% tax bracket) back when tax returns roll around – equating $1,500. Cha-ching.
$1,500 in tax returns divided between 12 months translates into $125 that can be deducted from monthly mortgage payments. Therefore, an $896 monthly payment, less $125 in tax-deductible interest, comes out to roughly $771 a month in mortgage payments when you factor in your tax return retroactively. (That's $29 less than a renter would spend on their $800 monthly rent.)
Do Your Research
The $150,000 example used above is clearly a very brief, generalized overview but should give prospective buyers an idea of what the initial financing process looks like. Owning a home is a long-term investment, and it may be unfathomable for someone who desires immediate results to see the benefit of purchasing a property.
Building long-term equity may not seem worth it to someone who is nervous about maintaining a residence, doesn’t want extra responsibility, or is unsure of whether or not they will stay in Denver for the next 5-10 years.
Remember, when a homeowner makes their mortgage payment every month, they pay down the balance they owe on the home. In the end, the buyer gets to keep an asset, rather than simply paying a landlord to sleep under his or her roof. Considering the financials of the home buying journey is just the first step that a potential buyer must take – many other factors go into buying a home.