Many of my friends with college aged kids have asked if we're going to have him rent a place after this year or if we're going to have him buy a house. I have been a mortgage lender for fifteen years and a real estate investor for twelve so I have a unique understanding of finances and housing. They're curious about whether I feel buying is worth it for such a short term.
Will MYCollege Student Rent Or Buy?
So...knowing what I know about the industry, will I have my college student buy or rent?
Buy. We definitely plan on having him buy. Because he will only be living in the home for a short period, though, we will be strategic with his buying. Here are the key pieces to make this work.
Making the Student The Buyer
Our family is anti-debt but I've seen enough young people who want to buy a home but can't qualify or get good terms because they didn't build the necessary credit history. To keep that from happening here, Jacob opened a credit card the week after his eighteenth birthday and another about six months later. He barely uses them (gas only, paid off each month) but now, at nineteen, he has a solid credit score which will help him qualify for a mortgage.
Why does this matter? Two reasons. First, if he can qualify as the primary buyer, the terms of the loan will be better. He can put less down (as low as 3% sometimes) and the interest rate and mortgage insurance cost will be less because he is an owner-occupant.
If the parent buys a home for the student to live in and the student is not on the loan, the house is viewed as in investment property for the parents. Investment properties require a 20% down payment and have a higher interest rate than an owner-occupant loan has.
The second reason that it's good to have the student on the loan is because of the way property taxes work. In our state, property taxes are lower for an owner-occupant than they are for an investor. They tend to be about double for investors which increases the housing cost.
But wait...what about income? Many students have little to no income so they wouldn't qualify for a mortgage, would they?
That's where the parents come in. There are many loan options today that would allow the student to buy as the primary borrower with the parent(s) as a non-occupying co-borrower. The student has to qualify credit wise (that's why building that credit score was important) but the actual approval is based on the parent's income, not the student's.
Consider the Sale When You Buy
Even with the lower monthly payment that comes with an owner-occupant, it still may not make sense to buy and sell in a short period of time though. When a person gets a mortgage to buy a house, there are costs involved which are referred to as closing costs. Those costs are different in different places but tend to run around $2,000 in my market.
Those closing costs need covered upfront. When the time comes to sell the house, there will be even more costs that need covered. Jacob will likely have $1,000ish of closing costs at the time of sale and a 6% Realtor commission that needs paid from his profits.
People get burned when they buy a house for a short period of time and don't take these costs into consideration upfront. It's important to make sure you're buying in an area that appreciates at a rate that lets you cover those costs without losing money.
In Jacob's case, he should be ok. If he bought a house for $150,000 and it went up in value 3.5% each year (a normal appreciation level in his college town), the house should be worth $166,000 after three years. If it cost 8% of the price to cover his Realtor and closing costs, he would net $153,000 at sale time so he would come out slightly ahead.
Another option would be to arrange for lender paid costs at the front end to further reduce the fixed costs. Lenders sometimes have the ability to charge a buyer a slightly higher interest rate over the life of the loan and, in exchange, cover the upfront closing costs. Seeing this is going to be a relatively short-term loan, that option likely will make good financial sense.
Living Rent Free
If our student is going to buy a house and potentially make no money when he sells it, though, why would we even bother? The advantage of owning during college is typically not in the profit at sale. The advantage is in the monthly cost for housing.
Here is what we're planning on for Jake. He is looking for a three bedroom house near campus. He will take one bedroom and rent out the two others to other students. If he bought a $150,000 home and put 5% down, his monthly payment would likely be around $1,000 per month with taxes and insurance included. If he charged $500 per room per month, that would cover the full mortgage, essentially letting him live rent free.
Plus...Loan Amortization!
Another important piece to consider is that the mortgage loan is getting paid down each month with that payment. If Jacob used a 30 year loan and borrowed $142,500 upfront (95% of the $150,000 price), his balance would be about $135,000 when he went to sell the house three years later. This extra $7,500 cushion will either cover him if the market didn't appreciate as well as expected or it will be a profit for him at sale time.
What I Would Tweak
So...does it make sense to buy? Yes, in our case it does. If your student hasn't been able to build a credit score, if your market has higher costs at the front or back end, if you don't think you can find good roommates to cover the payment, yada yada then maybe it wouldn't for you. For Jacob though, it makes financial sense.
There is one thing we're going to tweak though. Jacob will not be having a 30 year mortgage. Instead, he'll be having a 15 year one.
The Beauty Of The 15 Year Mortgage
A 15 year term is a better option for three reasons. First, the interest rate is lower. Right now, the interest rate is about 0.5% lower when you choose the shorter term. Secondly, the mortgage insurance is cheaper. Mortgage insurance is something you typically pay as part of your loan payment if you don't put 20% down. With a shorter term, the cost for it drops.
Lastly, the loan gets paid down ALOT faster with a 15 year term. While I estimated the balance owed at $135,000 after three years with a 30 year loan, it's only $120,800 with a 15 year loan. That's over $14,000 more that will go in our student's pocket when he sells the house.
But won't a 15 year term make the payment higher? Yes, it will. In this scenario, the mortgage payment will be about $300 more per month. That adds up to less than the increased profit at sales time though ($300 per month x 36 months=$10,800) so it financially just makes sense.
Again, buying makes financial sense in our situation. It may not in yours. How do you know if you don't check though? If you're considering your options in Indiana or Michigan, I'd be happy to help you crunch the numbers. Just give me a call or drop me a line at lori.hiscock@ruoff.com.
Lori Hiscock is a Sr. Loan Officer at Ruoff Home Mortgage‘s South Bend office. One of Michiana’s top mortgage loan officers, Lori started her lending career in 1995 after obtaining her bachelor’s degree in Finance from Western Michigan University. You can connect with Lori Hiscock or apply online here. NMLS#404320.
Ruoff Mortgage Company, Inc. is an Indiana corporation licensed by the Indiana Department of Financial Institutions (DFI) and operates with the following licenses:
Indiana-DFI First Lien Mortgage Lending License #10994;
IL Residential Mortgage Licensee #MB.6760734;
Michigan 1st Mortgage Broker/Lender License #FL0017496.
Indiana-DFI First Lien Mortgage Lending License #10994;
IL Residential Mortgage Licensee #MB.6760734;
Michigan 1st Mortgage Broker/Lender License #FL0017496.
Ohio Mortgage Broker Act License #MBMB.850220.000
The Florida Office of Financial Regulation License #MLD1182
