72% of Gen-Z plan to buy a home in under 6 years. Do they know what it takes?

A survey from Rocket Mortgage found that many Gen Zers plan to get a mortgage in a few years.

It’s tough out there for first-time homebuyers. They’re facing multiple challenges, including rising mortgage rates, high home prices and limited inventory. However, that doesn’t seem to scare off young Americans — in fact, 71.5% of Gen Zers plan to buy their first home in the next one to six years, according to a Rocket Mortgage survey from earlier this year.

At the same time, not every Gen Zer knows what mortgage lenders are looking at when evaluating a home loan application. On average, 33.9% of Gen-Z were wrong about the factors lenders consider when deciding whether to approve a mortgage, according to the survey.

What most mortgage lenders look at when considering your application

CNBC Select explains what factors influence mortgage approval and what young people can do to increase their chances of qualifying for a home loan.

Credit score

Most Gen Zers know that their credit score can impact their ability to secure a mortgage (73.2%). And while they’ve had less time to establish a credit history, Gen Zers have an average FICO score of 679 according to the latest data from Experian. That’s lower than that of older generations but still considered good.

The minimum credit score to qualify for a conventional mortgage is 620. Government-backed mortgages have more relaxed credit requirements. The minimum credit score for an FHA loan is 580 with a down payment of 3.5% or as low as 500 if you can put at least 10% down. USDA and VA loans don’t have set credit requirements, but lenders that offer them might.

Besides approval chances, a homebuyer’s credit affects the interest rate on the loan. A small difference in interest rates can add hundreds of dollars to a monthly mortgage payment.

It’s best to work on building credit before applying for a mortgage. Free credit monitoring services such as CreditWise® from Capital One and Experian free credit monitoring can be helpful in tracking progress and finding opportunities to improve.

Note that the scores credit monitoring services offer differ slightly from the scores mortgage lenders use when making their decisions. That said, they should be pretty close and provide a good idea of your overall credit health.

Debt-to-income ratio (DTI)

Almost one-third of Gen-Z didn’t name the debt-to-income ratio (DTI) as one of the factors affecting mortgage approval (32.8%). In reality, lenders evaluate this closely when determining whether to approve a mortgage and what the terms of the loan will be.

DTI is the amount of debt relative to income. To qualify for a conventional mortgage, you don’t want a DTI any higher than 43%. For USDA and VA loans, the DTI limit is typically 41%, while the FHA might allow you to go up to 50%. Remember, these are guidelines — it’s up to individual lenders to determine the cutoff for what’s an acceptable number.

Down payment

When a homebuyer makes a sizeable down payment, the lender may consider them a less risky borrower. Having more money to put down increases the chance of mortgage approval and can lower the monthly mortgage payment.

According to the survey, 10.1% of Gen-Z plan to put down 20% of their home price. If they do, they’ll start off with a good amount of equity in their home and won’t have to worry about private mortgage insurance (PMI). PMI is a monthly fee rolled into the mortgage payment, designed to protect the lender if the borrower can’t pay their home loan.

That said, it’s possible to secure a mortgage without a 20% down payment. In fact, FHA loans require as little as 3.5% down with a credit score of at least 580. Qualified first-time homebuyers can also put 3% down with conventional mortgages, such as HomeReady and Home Possible. USDA and VA loans have no down payment requirement at all.

Saving up for a down payment can take some time — often, several years. Putting the funds in a high-yield savings account can help them grow a little faster. Some of CNBC Select’s favorite accounts include LendingClub High-Yield Savings and the Western Alliance Bank Savings Account for their high APYs and ease of use.

Employment

Current employment, as well as work history, are also factors in mortgage lending decisions. It’s not uncommon for a lender to require two years of consistent employment history. Note that it doesn’t necessarily mean working for the same company. More likely, the lender will be looking to see whether the borrower has been employed in the same line of work or career field and if there are any lengthy gaps without a job.

Showing this kind of consistency can be tricky for Gen Zers who have only just started building their careers. However, as long as the homebuyer can prove they have a stable income and are a responsible borrower, the lack of two years of work history might be something a lender can live with.

How Gen-Z can prepare for a mortgage application

While mortgage lenders generally examine the same things when evaluating an application, they might not always agree on what’s an acceptable risk. Individual lenders also may offer different types of home loans, work with different down payment assistance programs or even have their own unique offers for first-time homebuyers.

For that reason, it’s wise to speak to several lenders before choosing one. Plus, this will also allow for interest rate shopping, which is essential to securing the best possible mortgage terms.

CNBC Select picked PNC Bank as one of the best lenders for first-time homebuyers, thanks to the variety of home loan options they can offer. Rocket Mortgage can be a good choice for borrowers with lower credit scores, and Ally Bank Mortgage can help new homebuyers save on lender fees.

Bottom line

Gen-Z are entering a challenging housing market, but many feel up for the task and plan to buy a home in the next few years. Homeownership can be an excellent way to build wealth, but before springing into action, it’s a good idea to educate yourself on what impacts mortgage lending decisions and get your financial ducks in order based on what you’ve learned.

Source: https://www.cnbc.com/select/how-gen-z-can-qualify-for-a-mortgage/