While it’s common for young, prospective homeowners to stay at home to save money for their down payment and future mortgage payments, banks and lenders consistently decline applicants without adequate rental history.
Though it makes perfect sense to live at home to save money on things such as rent, groceries, utilities and the like, it does little to prove you’ll be a sound borrower once you finally do move out.
Rental History Is Important to Predict Future Payment Behavior
Banks and mortgage lenders are very interested in your financial history, whether it’s in the form of credit cards, auto loans, or a previous lease. If you fail to provide these things, they’ll be hesitant to lend to you.
In short, if you want to qualify for a mortgage, it’s best to rent first so you have the ability to document that rent for at least a year. Doing so will also prepare you for the responsibility of homeownership.
Sure, you can ask mommy or daddy to co-sign for you, but if you don’t have that luxury, don’t assume you’ll get financing for that dream home you’ve got your eye on unless you can provide a VOR (Verification of Rent) or cancelled checks for the previous 12 months.
And no, providing a VOR from a family member won’t fly in most cases, even if you insist that you pay your parents rent each month. It really doesn’t make sense from the lender’s point of view. You’ll need cancelled checks or something that actually proves the rent was paid.
Living Rent-Free Prior to Applying for a Mortgage
If you don’t have a current housing payment and suddenly take on a mortgage payment of several thousand dollars a month, banks and mortgage lenders are going to bet you may struggle to make your mortgage payment each month.
In reality, they won’t really know without anything to go on, but they’ll err on the side of caution.
This theory is known as payment shock, and is generally defined as an increase in your monthly housing payment beyond 200%. In other words, if your payment more than doubles, you’re automatically labeled a risky borrower.
Let’s look at an example:
Current housing payment living at home: $0
Proposed mortgage payment: $2,500
Current housing payment: $1,500
Proposed mortgage payment: $2,750
As you can see, Borrower B will be favored for mortgage financing over Borrower A based on rental history alone.
If you insist upon living at home and/or rent-free prior to applying for a mortgage, it may not be a problem if you are otherwise qualified.
Most home loans, including those backed by Fannie Mae, Freddie Mac, the FHA, VA, and USDA, are pushed through automated underwriting systems these days. And rental history documentation may only be required if the system flags it.
This is typically the case if you have limited credit history or bad rental history that somehow shows up in your file.
For example, if you only have one credit card to your name, the system may want to know more about your rental history.
Conversely, if you’ve got excellent credit and deep credit history, the system may not ask for rental history. However, the underwriter could still ask for clarification or a letter of explanation.
You May Still Need to Explain Yourself
Ultimately, they’ll still want to know what you were doing before you made an offer on a piece of property, they just won’t scrutinize it as much. And that can be a good thing!
If you apply for an FHA loan and have been living with mom and dad, they’ll simply ask that you provide documentation from the property owner that you have in fact been living rent-free and the amount of time you’ve been doing so.
Assuming you pay a relative or friend rent each month, it might be advisable to pay via check so you can provide cancelled checks in the event they are required. It’s pretty difficult to prove you paid in cash.
Additionally, it’s important to have other credit tradelines, such as credit cards, auto loans, student loans, etc. to show lenders you have some credit history if you lack rental history.
Aside from potentially getting denied, you may be subject to stricter underwriting guidelines if you’re unable to document rental history, such as a lower maximum DTI ratio.
The good news is with more and more first-time home buyers living at home prior to applying for their first mortgage, this issue is becoming less of a roadblock.