September 21, 2020

Help for first time homebuyers

Making sure the next generation of homeowners has the resources to buy a first home is going to play a big role in any sustained economic recovery.

Having persisted far longer than anyone anticipated, the pandemic crisis accelerated what was already a healthy housing market. And despite ultra-low mortgage interest rates, home prices have skyrocketed without enough supply to meet demand. For countless families and individuals, it's pushing the American Dream of homeownership further out of reach.

To help, newly proposed legislation in the House of Representatives would allow first-time homebuyers to withdraw up to $25,000 of from their retirement savings tax-exempt and penalty-free if the distributions are put toward a down payment.

The First Time Homebuyer Pandemic Savings Act builds on current CARES Act provisions for new and repeat homebuyers that allow them to withdraw up to $100,000 of their 401(k) balance penalty-free until the end of 2020.

In the Senate, the American Dream Down Payment Act of 2020 would allow states to establish and manage down payment savings accounts for homebuyers. Family and friends can contribute to the account, which can be used for a down payment or other related housing costs without penalty.

Although homebuyers can pay as low as 3.5% down with FHA loans, the coronavirus and the ensuing unemployment crisis has pushed lenders to raise minimum credit scores, require greater down payments, and evidence of a six-month savings reserve — a hard task for many first-time buyers, regardless of age.

Even absent the economic problems of the pandemic, many prospective homebuyers younger than 40 say student loan debt holds them back. The latest Federal Reserve data finds that the average college graduate has an average of $30,000 in student loan debt, diminishing the ability to save for a down payment or make monthly payments.

Legislative help could make a tremendous difference, but there are several other steps potential homeowners can take to improve their own financial foundations. One of the most important is improving debt-to-income ratio (DTI).

Whether carrying debt for a student loan, a car, or credit cards, lenders expect borrowers are managing a varied mix of expenses.

On the “front end,” lenders don’t want borrowers paying more than 28% of total gross (pre-tax) income for housing expenses - including mortgage payment (consisting of principal plus interest), property taxes, and insurance.

Second is the “back end.” Lenders don’t want a housing payment combined with other debts to exceed a certain proportion of gross income. Depending on the lending environment, loan type, credit score and down payment, the back end is typically 36%, but can stretch as high as 50% with other factors considered.

Ultimately, finding ways to bring debt levels down to satisfy the ratios may be the fastest way to get borrowers into a home and a solid financial future.