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If buying a home is a rite of passage, so is talking about how challenging it was to buy said home — and it can get even trickier if you have debt. But that doesn’t mean you have to put your dreams of homeownership on hold until you’re completely debt-free. Here’s what to know about buying a home when you’re still paying off debt.
Make Sure You’ve Got the Financial Basics Covered
When Jennifer S., 29, received an inheritance of $150,000, she immediately began looking for apartments on Zillow in her Hoboken, New Jersey, neighborhood. “I had about $20,000 in consumer debt and was making about $75,000 at the time,” she says. “In my mind, I thought I could put the entire $150,000 on a home and then be set.”
When she sat down with a financial advisor, however, she learned she needed to prioritize building her emergency fund and paying off her debt over buying a home — even if she had a large sum she could put down. So instead, she created a budget, moved in with roommates and saved up for two more years.
“It’s important to really see your whole financial picture, because you want to be in good financial shape before you buy a house,” says Brian Frederick, CFP®. “Taking control of your consumer debt and addressing any red flags or spending patterns can be an important first step.”
That’s not to say that you have to reach a $0 balance in order to start saving for a home. Make living within your means, putting money toward debt, saving for a down payment and having enough to cover a monthly mortgage a part of your everyday budget so you can “practice” what it feels like, financially, to own a home. Otherwise, windfall or not, unhealthy spending habits could keep you in a debt cycle.
Get to Know Your Debt
You’ve likely heard of good and bad debt. Good debt can be considered an investment in your future, like taking out student loans to attend college to potentially land a higher-paying job. Additionally, student loans tend to have lower or fixed interest rates.
Bad debt, like consumer debt, may have high or variable interest rates, and lowers your net worth without building anything of potential value for you in the future. In general, you’ll want to prioritize paying off your consumer debt faster than student loans so you pay less in interest and fees over time.
But even if you have some consumer debt, you may still be able to purchase a home, says Louise Phillips Forbes, an associate real estate broker for Halstead Property in New York City. “What’s important is to keep your debt-to-income ratio in mind,” she adds. Your DTI is the percentage of your gross income that goes toward paying debts like student loans, credit card bills or car payments.
You generally want to keep your DTI to 36% or lower, otherwise a lender may be wary of approving you for a loan, as Jennifer found out when she was denied for a pre-approval. When she asked why, she learned the rejection was partially due to her high DTI. “To me, that was a wakeup call that I just wasn’t in the right position to buy a house,” she says. “But it was pretty shocking, since plugging in numbers in online calculators made me think I was way more ready for homeownership than I was in actuality.”
Hannah Rinaldi, 33, and her husband, Tom, 34, decided to move forward with buying a house in Naples, Florida, even though they had a collective six figures in student loans, but stuck to the lower end of what they could afford. “Where we live is expensive, and when we ran the numbers, it made more sense for us to buy,” Hannah says. Because they were committed to simultaneously buying a house and paying down their student loans, they looked at smaller houses that would allow them to work toward both goals.
Consider All the Expenses of Homeownership
While crunching the numbers on what you can afford, you have to consider all the expenses that come with being your own landlord. Beyond the down payment, mortgage and closing costs, also consider renovations, furnishings and homeowners association fees, as well as funds for general upkeep (like snow removal) and one-time repairs.
If your down payment is lower than a certain threshold, typically 20%, you may have to pay for private mortgage insurance, or PMI — an added fee Tom regrets. “It was just throwing away money,” he says. “I wish we had been able to put down more as our down payment.”
It’s also crucial to understand that the loan you get approved for and what you can comfortably afford to pay each month can be two different numbers. To avoid buying too much house, Tom asked his lender to write a pre-approval letter for less than the actual amount he was pre-approved for, so he wouldn’t be pressured by a real estate agent to look outside their budget.
Finally, unexpected expenses will happen. “A couple of weeks after buying our first house, we had to buy a new air conditioner,” Hannah recalls. “We were really happy that we bought a house that was under our budget, because it wasn't a hard cost to swallow.”
Ask Yourself: Why Do I *Really* Want to Buy a House?
Many people see buying a home as a strategic move — to avoid rising housing costs, to stop spending money on rent, to invest in property, to future-proof a growing family. But when emotions get involved, things can get tricky.
“Sometimes the emotions and the numbers just aren’t in line,” Frederick says. Recognize whether an emotional pull to own a home is overshadowing your actual ability to afford one.
For Jennifer, homeownership was a sign of success she saw in her friends and wanted to emulate. But after working with her advisor, she realized it was a major step she wasn’t ready to take until she got her financial life in order.
“I would advise someone that it’s not about owning a house — it’s about feeling financially stable, which may mean renting,” she says. Now that she’s debt-free, she is currently looking to buy an apartment. “Buying isn’t something you should rush or do just because everyone else is doing it.”
Certified Financial Planner Board of Standards Inc. owns the certification marks CFP®, CERTIFIED FINANCIAL PLANNER™, CFP® (with plaque design) and CFP® (with flame design) in the U.S., which it awards to individuals who successfully complete CFP Board’s initial and ongoing certification requirements.