In August 2023, Zillow’s Consumer Housing Trends Report revealed half of all homebuyers are purchasing their first homes, marking the highest share ever recorded by the real estate giant. This surge in first-time homebuyers is not only a significant increase from the previous year but also the highest level since 2010 when the first-time homebuyer tax credit was in effect. While this trend can be attributed to various factors, it is particularly driven by millennials, who are entering the housing market even in the face of rising interest rates.
Many families are grappling with how to assist their grown children as they enter the market as first-time homebuyers. It’s a different world than buying a home 30 years ago and the strategies are different for millennials. New buyers need to adapt to the following realities, which include addressing the misconception around down payments, credit repair and management tactics, rate buydowns, budgeting, and understanding the long-term benefits of homeownership.
1. Let’s First Get the Down Payment Argument Straight
One of the most common hurdles for first-time homebuyers is saving for a down payment. Many still believe that a hefty 20 percent down payment is required to purchase a home. However, it’s just not the case anymore. More and more real estate professionals are advocating for more attainable down payment options, such as a 5 percent down payment. For instance, on a $500,000 home, a 5% down payment amounts to $25,000.
Prospective buyers need to be made aware of the numerous down payment assistance programs available to help bridge the financial gap. These programs can significantly reduce the upfront cost of purchasing a home, allowing buyers to enter the market sooner rather than later. Moreover, by using first mortgage loan programs, buyers may also be eligible for CHFA assistance options to further ease the financial burden.
2. Speaking of Down Payments … Leveraging Generational Wealth
With the surge of first-time homebuyers primarily driven by younger generations, parents with available cash can play a pivotal role in helping their young adult children make their first foray into homeownership. This intergenerational approach not only assists the younger generation in benefiting from property appreciation but also reinforces the value of family financial planning.
By providing financial assistance or co-signing for a mortgage, parents can help their children enter the real estate market sooner, even in the face of rising interest rates. It’s important to note that this assistance doesn’t necessarily require gifting a large lump sum; it can be structured in various ways, including down payment assistance, co-ownership, or acting as a co-borrower.
One strategy is to act as your children’s “bank” and lend them the money, the so-called intra family loan. By serving as their lender, you help alleviate the block of them having to meet certain criterias and income requirements of banks. In order to avoid gift tax implications, parents should formalize the loan with a promissory note and charge a minimum interest rate called the applicable federal rate (AFR).
Once the note is signed, that same interest rate applies for the duration of the note even if the AFRs change thereafter. Therefore, instead of a 30-year fixed mortgage rate from the bank, a child can get the same loan from the parent and pay a significantly lower interest rate.
If parents don’t have available funds to lend their child for the entire purchase price, another way for a parent to assist is to act as guarantor or co-signer on a loan. This allows a parent to help a child who may not have established credit and, in some cases, may also help secure better terms on the loan. This type of indirect financial benefit (or direct benefit, should the parent end up paying) can have income and gift tax implications, and families should consult with their tax adviser before considering it.
3. Credit Repair and Management Tactics
A healthy credit score secures a favorable mortgage rate. First-time buyers should develop strategies for improving their credit scores and establishing a solid credit history. This may involve creating a credit repair plan, paying down outstanding debts, and managing credit responsibly.
Buyers should understand that a higher credit score can lead to a lower interest rate, resulting in more manageable monthly mortgage payments over the life of the loan. Additionally, rate buydowns can be negotiated in the contract, with sellers offering concessions to buyers.
4. The Power of Rate Buydowns and PHM
As mentioned, rate buydowns are a valuable tool, offering advantages to both buyers and sellers. A rate buydown involves a seller concession to the buyer for a predetermined amount, often referred to as “points.” These points can then be used by the buyer to reduce their mortgage interest rate, effectively lowering their monthly payments.
It’s worth noting that many sellers are now using rate buydowns as a strategic tool to attract buyers. This not only eases the immediate financial burden for first-time buyers but also makes long-term homeownership more affordable.
“Rate buy-downs are an excellent strategy for both buyers and sellers,” explains the Denver Prosperity Home Mortgage Regional Manager. “Buyers can secure a lower rate, reducing their monthly payment, and sellers can avoid large price reductions, bolstering prices in the neighborhood.”
5. Understanding Long-Term Benefits
To overcome the fears of first-time buyers in regards to high current mortgage rates, families and brokers need to help emphasize the long-term benefits of homeownership. If it’s your children, they really need to understand that current rates are not permanent and refinancing down the road is fairly typical. In addition to negotiating factors like pricing, inspection, and rate buydowns, highlight the advantages of homeownership.
These advantages include building equity, enjoying tax benefits, and the potential for property value appreciation. In markets like Denver, where historical appreciation rates have outpaced the national average, prospective buyers should understand that homeownership is a wise long-term investment.
The journey to homeownership is evolving, with first-time buyers facing unique challenges. However, there are numerous strategies and resources available to empower them on this step. The involvement of older generations in assisting younger family members underscores the importance of intergenerational wealth planning. By working together, families can make homeownership a reality for the next generation, allowing them to benefit from property appreciation and secure their financial future.
*Updated as of October 6, 2023