Why Banks Don't Use This Important Factor as Proof You Can Afford a Home

Rent payments and mortgage payments are different.

I have been a renter for most of my adult life. It can be frustrating to talk about housing costs with others and hear how little they spend on mortgage payments compared to how much I spend on my rent every month. Thankfully, I have also spent all of my adult life renting in areas with a lower cost of living than average, and I have always been able to afford my rent.

But it does make you wonder: If a monthly mortgage payment costs less than a monthly rent payment, why don't banks and other mortgage lenders consider on-time and in-full rent payments as proof that you can afford to buy a house? A major reason for this is the difference between rent and mortgage payments, and the real amount of money required to become a homeowner. However, there's a bright spot for some aspiring homeowners, thanks to a big recent change in how Fannie Mae underwrites home loans.

What does a mortgage payment cover?

While rent and mortgage payments both serve the same basic function of ensuring that you have a roof over your head, they are not the same thing. A mortgage payment consists of not just the payment used to pay down the mortgage loan you secured to purchase the house, but also interest on that loan. It can also include homeowners insurance, property taxes, and potentially even homeowners association (HOA) fees.

The size of your mortgage payment will depend on the cost of your house, of course, as well as the interest rate and the length of your mortgage term (for example, 30 years). And if you got an adjustable-rate mortgage, your mortgage payment will likely change over time due to the tendency of the interest rate to fluctuate up or down based on market conditions.

Your homeowners insurance is a must-pay if you purchased your home using a mortgage, as lenders require it. And even if you bought in cash, it's generally not advisable to go without homeowners insurance. If you made a down payment of less than 20% on a conventional mortgage loan, you'll also need to pay private mortgage insurance, or PMI. PMI doesn't protect the homeowner, but rather, the mortgage lender; if you default on your mortgage and your lender forecloses, it ensures that the lender can recoup costs from seizing and selling a house with little equity.

You will also be required to pay property taxes, which are based on the assessed value of your home. These can either be paid yearly or divided into monthly payments as part of your mortgage loan.

Homeownership also comes with many ongoing and sometimes unanticipated costs, as routine and emergency home maintenance is the financial responsibility of the homeowner. Need a new roof? That's on you and your wallet.

What does a rent payment cover?

Now let's contrast mortgage costs with what it takes to rent. A major difference between buying and renting is the deposit requirement. Landlords vary, of course, and most of my rental experience has been with either individuals who own and rent out homes or with very small property management companies. I have always been required to pay a refundable deposit (usually equal to one month's rent) on a rental, and occasionally a smaller nonrefundable amount for cleaning and maintenance after my lease ends and I move out. I've also always been required to give the first month's rent upon signing a lease.

This is different from buying a house, which usually requires a larger down payment that is applied to the total cost of your home, and your mortgage is used to finance the rest of that cost. While there are programs offering mortgages for no down payment or a very small down payment (including FHA loans), you will have to pay for additional mortgage insurance (such as the PMI mentioned above) to protect your lender, rather than you.

Ideally, home maintenance and repair costs should be paid by your landlord. The higher amount of your rent payment compared to a mortgage payment reflects this. And while it is highly recommended that renters carry renters insurance, the cost of it (which only covers your personal belongings in the case of an accident, such as a fire in your apartment) is much lower than homeowners insurance, which insures the entire property, inside and outside.

Credit reporting

Another huge difference between mortgage and rent payments is that mortgage payments are reported to credit bureaus, and will therefore appear on your credit report and be reflected in your credit score. This has not traditionally been the case with rent payments (fewer than 5% of U.S. renters have their payments reported). And if you think about it, this makes some sense. Since I have rented from private individuals most of the time, I have either mailed a check every month or sent rent payments through an online tenant portal or through a payment service like PayPal. There's no credit reporting involved, unlike when you make a payment on, say, a credit card.

However, in September 2021, there was a positive change that should make it easier for some renters to qualify for a mortgage.

The change to Fannie Mae and what it means for aspiring homeowners

The Federal National Mortgage Association, more commonly known as Fannie Mae, is a GSE (government-sponsored enterprise) that buys conventional mortgage loans on the secondary market. Last year, it announced that the automated loan underwriting service it uses can now take the previous 12 months' of rent payments by aspiring homeowners into consideration when deciding if they can qualify for a mortgage.

The process involves using bank statement data (with the applicant's consent) to show those consistent on-time payments as proof that the applicant can also repay a mortgage, and will only be used to improve an applicant's chances for approval. Fannie Mae's data showed that 17% of applicants turned down could have been approved for a mortgage loan had rent payments been taken into consideration.

This exciting change will make homeownership more possible for those Americans with lower credit and perhaps a weaker financial background. Americans who have been kept from homeownership are more likely to be Black or Hispanic than white or Asian, so this change by Fannie Mae is a move toward much-needed racial justice and support for all Americans.