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   ARTICLE   |   From Scotsman Guide Residential Edition   |   May 2017

Smaller Is Mightier

Independent mortgage companies can better capture millennials

r_2017-05_Phillips_spotMillennials have had a complicated relationship with homeownership. They are the nation’s largest living generation with a population of approximately 75 million, but the homeownership rate for those under 35 — the age group encompassing millennials — is at an all-time low. On the other hand, more than 90 percent of millennial renters say they want to be homeowners.

Unfortunately, the dream of homeownership is often dashed by the harsh economic reality that most millennials are worse off financially than their parents were at their age because of slow wage growth and student-loan debt. When asked if they want to purchase now, two-thirds of non-homeowners who have student debt say they are uncomfortable borrowing for a mortgage and also less likely to believe they could even qualify for a mortgage, according to a 2016 National Association of Realtors consumer survey.

The financial website The College Investor estimates that the graduating class of 2016 started their professional lives with an average of $37,172 in student-loan debt, more than double the debt accrued by the class of 2003 ($18,271). Considering these figures, it’s clear how the financial and emotional toll of repaying student-loan debt is contributing to a delay in millennials purchasing a home.

Underwriting barriers

Changes in mortgage underwriting have not been favorable to millennial borrowers who are saddled with student debt. To start with, there have been recent shifts in how underwriters could treat student debt. Previously, student loans that were in deferment for at least a year were excluded from debt-to-income (DTI) ratio calculations.

The change led the Federal Housing Administration (FHA), Fannie Mae and Freddie Mac to require 1 percent of an applicant’s outstanding student-debt balance to be calculated as part of DTI for loans underwritten to the agencies’ guidelines — even if those loans are in deferment. Freddie Mac allowed for a more lenient treatment of student loans, clearing the way for other options for qualification — including using projected monthly repayment amounts on deferred loans in calculating the borrower’s DTI ratio. The bottom line, however, is that the DTI ratio can essentially make or break a borrower’s loan approval.

Too high of a DTI, above 43 percent to 45 percent, can pose a high risk for default. Borrowers with $60,000 in student-loan debt whose payments are currently deferred for 18 months, for example, could reduce their buying power by as much as $122,000 by using 1 percent of the outstanding debt total. Thus, underwriting guidelines can force applicants to purchase “less house” because they can only qualify for a smaller mortgage.

Repayment costs

Even for millennials on sound financial footing, the process of paying back student loans can create challenges when it comes to qualifying for a mortgage. Income-based repayment (IBR) plans, which are designed to reduce student-loan bills to a manageable percentage of monthly income, became popular as millennials began landing their first jobs. These plans, however, also placed them in a conundrum of extending the life of the loan and paying more in cumulative interest.

Millennials seeking customized loans have access to a breadth of products from independent mortgage companies.

All student loans — whether deferred, in forbearance, or in repayment — must be included in a borrower’s recurring monthly debt obligation when qualifying for a home loan. Freddie Mac and U.S. Department of Veterans Affairs (VA) loans will accept the monthly payment as reported on the credit report, and VA will allow for deferments over 12 months not to be included DTI calculations.

For loans following Fannie Mae or FHA guidelines, however, a lender must use one of the following options to calculate the debt payment for DTI:

  • 1 percent of the outstanding balance, which is typically higher than the projected monthly repayment amount;
  • The monthly repayment amount reported on the credit report, assuming it fully amortizes the loan; or
  • A calculated payment that will fully amortize the loan over the repayment period, which calls for calculating a payment with no forgiveness after 20 or 25 years.

If the loan is amortized over 20 or 25 years, and the existing monthly payment will pay it off, then it is fully amortized. For millennials on income-based student-debt repayment plans, however, their current payment will not pay off the debt in that time frame, so it won’t be considered to be amortized, which can prevent them from getting the mortgage they desire.

Filling the void

All is not lost for millennials who wish to purchase a home, despite mounting student-loan debt. Independent mortgage companies can make it easier for millennials to buy their first home.

According to the Federal Reserve, the percentage of home loans issued by independent companies not affiliated with banks has climbed sharply in recent years, reaching 47 percent in 2014. This figure could increase as more millennials seek to make the leap to homeownership because these independent mortgage companies can be more flexible.

Independent mortgage companies don’t carry the burden of having to be one of many business lines, which, in the case of larger banks, can create legal and reputational risk for the entire organization. Independent mortgage companies can leverage individual agency guidelines to provide increased flexibility. They don’t have to play it conservatively or rely on internal credit overlays that impose stricter lending standards than the various agencies require.

A large bank may take Fannie Mae guidelines and Freddie Mac guidelines, for example, see where they overlap and where they differ, and then take the more conservative of the two approaches. This creates a barrier for millennials who might actually be eligible for financing under one or the other of the two sets of guidelines.

Millennials seeking customized loans have access to a breadth of products from independent mortgage companies. For example, a nonbank can make a decision to use Freddie Mac guidelines that enable the use of student-loan payments per the credit report — and avoid the issue of a monthly payment that does not fully amortize the student loan because of an income-based payment adjustment.

Independent mortgage companies also can work with dozens of investors that have a variety of loan programs that are not underwritten to standard Fannie Mae or Freddie Mac guidelines. These programs include loans that are customized to deal with medical professionals or self-employed individuals who are good credit risks but perhaps structure their businesses for tax purposes in ways that do not align with traditional underwriting guidelines.

•  •  •

There is a reason that independent mortgage companies are taking a larger share of the market. Their more customized approaches to underwriting and the breadth of mortgage loan products they can offer are exactly what many millennials need if they want to repay student-debt obligations while simultaneously investing in a home as part of a plan for future financial stability. 


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