The average personal debt in the U.S. in 2018 is up to $38,000.
This does NOT include mortgages.
The average student loan debt total per person is $31,172.
The average household’s credit card balance is $8,509.
The average down payment on a house is $17,419.
A Student Loan Hero study of 1,427 adults revealed 41 percent of people with student loans have postponed buying a home because of their debt.
So if you want to buy a house, you’re faced with the question of should you pay off debt or buy a house?
The decision of whether to pay off debt or save for a house is a complicated one, but you don’t necessarily have to choose one or the other.
The decision of whether to pay off debt or save for a house is a complicated one, but you don’t necessarily have to choose one or the other.
If you’re trying to decide if you should pay off debt or save for a house, we’re going to answer that exact question in this blog.
And we’re also going to cover some tips on how to save money for a house while still down some of your debts.
Should You Pay Off Debt OR Buy A House?
If you’re trying to buy a house, it’s important to know what kind of money we’re talking about.
This will give you an idea of what kind of savings goals you should have.
The average home price in America is $248,857.
7% of $248,857 is $17,419.
With your current amount of debts, can you afford to save up for a $17k down payment?
Let’s look at whether or not you can afford a down payment on a house with your current levels of debt.
Can you afford to buy a house with your debt?
One of the first steps to buying a house is pre-qualifying for a mortgage so that you know how much house you can actually afford.
Knowing how much house you can afford will allow you to see how much your mortgage down payment will be.
When you apply for a mortgage loan, the bank will look at your debt to income ratios.
The results of this application will answer whether or not you should pay off debt or save for a house.
You will know whether or not you even qualify for a mortgage with your current debts.
And if you do qualify for a loan, will this mortgage allow you to buy the house you even want?
It’s not a huge accomplishment to get pre-approved for a mortgage on a $100k house if you want a $250k house.
Lenders look at your debt to income ratio for a mortgage to determine if they will approve you for a first time home buyer loan.
Your debt to income ratio will not only affect whether you’re approved for a mortgage, but it can also influence what type of interest rate you’ll be offered.
Let’s look at the two Debt to Income Ratios that you will be judged during the mortgage pre-approval process.
There are two types of DTI ratios mortgage lenders consider:
The first one is the front end debt to income ratio.
front end debt to income ratio
This is also called the housing ratio formula.
This shows what percentage of your income would go toward your housing expenses
These expenses include your monthly mortgage payment, real estate taxes, insurance, and housing association dues.
The second one is the back end debt to income ratio.
back end debt to income ratio
This shows what portion of your income is needed to cover all of your monthly recurring debts.
This includes credit card bills, car loans, child support, student loans, and any other debt on your credit report that requires monthly payments.
It also includes your mortgage payments and other housing expenses.
To calculate your back end debt to income ratio, add up all of your monthly debt payments plus your housing payments.
Then divide this amount by your gross monthly income (before taxes and deductions).
Let’s look at an example.
If you have $500 in student loans, a $100 car payment, and $1,000in housing expenses, your total monthly debt payments are $1,600.
If your gross income before taxes is $4,000 per month, take $1,600 and divide it by $4,000.
Your back end debt to income ratio is 40 percent.
Typically, you want to make sure your DTI ratio is as low as possible and no higher than 43 percent.
This is important because most mortgage lenders have a maximum 43 percent DTI ratio for you to qualify.
If you’re thinking, “how much house can I qualify for?” you can just use an online debt to income ratio calculator.
If your revolving debt is close to this ratio and still really want to buy a home, it’s worth checking with a mortgage lender to find out if you qualify.
Should you buy a house if you have debt?
If you don’t have the money for a 20% down payment, you can still get an FHA loan.
An FHA loan only requires you to put down 3.5% as a down payment.
But if you do this, you’ll have to pay for private mortgage insurance, which is better known as PMI.
PMI is basically the banks telling you that you’re a risk to them.
So hey, let’s tack on another $125 a month to your mortgage payment just in case.
But, just because you can afford a home doesn’t necessarily mean you should buy a house with debt.
There are pros and cons of buying a house if you have debt.
The benefits of buying a house if you have debt include some of the following reasons.
build equity in your home
You can build equity in your home.
Equity is just the difference between what your home is worth and what you owe.
With the average home appreciation being 3.9%, every year that you own a home and pay down the mortgage, you’re gaining equity.
Slacker Shawn: But what if there’s a market crash!? Real estate prices tanked in 2008!
Slacker Shawn 2: My house has appreciated 11% every year since I bought it!
Yeah, I hear you guys. It’s important to note that real estate has appreciated an AVERAGE of 3.9% over the past 25 years.
That’s with the market crashes and the wildly competitive markets.
get more for your money
When you buy a house there is potential to get more bang for your buck.
In some areas, you may pay more in rent then you would if you just bought an equivalent house.
In this case, it’s a really good idea to go ahead and buy a house.
You would end up saving money by paying less for housing and you would be able to build your own equity and not your landlord’s.
start real estate investing
This can jump-start your real estate investing.
If you’re into the idea of real estate investing, you can think of your new home as an investment.
Buying a house can make money for you.
For example, when we bought our first house, my wife and I lived in the basement and rented out rooms to my co-workers and interns at my company.
With all of the rent coming in and splitting utilities, we actually made $200 per month to live in our house.
But there are also downsides to consider.
So, let’s touch on those.
less money to pay down debts
You have less money to put towards your debt.
This means that if you want to pay off debts fast, then it may not be a good idea to allocate money to buy a house vs pay off debt.
If debt payoff is more important to you, it may be better to create a debt payoff plan to get out of debt fast.
Then, you can use a debt snowball to pay off debt faster.
Once you are debt-free, you can allocate those savings towards saving for a down payment on a house.
Another downside is that you are increasing the debt that you have.
increasing your debt
When you have a lot of debt already, it’s usually a good idea to NOT add more debt to that.
Slacker Shawn: But I’m already paying for rent, so what’s the difference?
I know, but if you end up NOT being able to afford rent while paying off your other debts, then you can easily move into a cheaper rental property.
When you own a house, you’re just going to get behind on payments, rack up late fees, and potentially face foreclosure.
Most people will tell you that if a mortgage payment and rent are the same costs, then you should definitely go with buying a house.
What the fail to tell you is that you have other costs that can come out to be hundreds of extra dollars per month.
Things like insurance, landscaping, repairs, maintenance – you know… All of the things you don’t mess with when you’re a renter.
Ultimately, you have to do a little math and see if buying a house is truly feasible for you.
If you are riddled with debt, don’t have an emergency fund, and you’re already kind of struggling financially, then you’re not ready for homeownership.
But if you’ve already built some good money habits, you have at least $1,000 in an emergency fund, and you have some money going into savings already, then you are ready to consider homeownership.
So, let’s talk about how to save money for a house with debt.
How to save money for a house with debt
Many people dream of buying a house for the first time, but saving for a house downpayment becomes far more challenging when you are saddled with debt.
The more of your income you’re forced to give up each month to debts, the harder it will be for you to save up money for a home down payment.
And, if too much of your income is monopolized by debt, you might struggle to keep up with the costs of owning property once you actually buy.
On the other hand, the longer you continue paying rent, the longer you’ll be paying someone else’s mortgage instead of your own.
You may not want to let your debts prevent you from putting a down payment on a house sooner rather than later.
So should you be paying off debt before buying a house, or do the opposite?
Most of the time, paying off debt before buying a house first makes the most sense.
By carrying that debt, you’ll continue to rack up costly interest charges that eat away at your earnings.
This makes saving for other important goals, like home ownership, very difficult.
Next, let’s look at WHY we should be paying off debt before buying a house.
After that, we will look at why we should be buying a house without paying off debt.
Here’s the case for knocking out your debts first.
The case for knocking out your student debt first
The sooner you pay off your debts, the less interest that you’ll pay.
pay less in interest
Since the average debt for an American is $38k, we’re going to use that for this example.
If your debts are lower or higher, just bear with me.
Also, depending on what kind of debt you have, your interest rates will vary.
For this example, I’m going to use $38k and a 6% interest rate on our debts.
We’re also going to say that it’s going to take 5 years to pay off our debts whether that’s a car, credit card, or a student loan.
I’ll put any numbers I talk about up on the screen so that you can easily follow along.
If you stick to the 5-year schedule, you’ll end up spending just about $6,000 on interest alone.
Now let’s say you work a side job for a year that puts $5,000 in your pocket.
You can use that money for either a home down payment or to pay off your debts.
If you apply this $5,000 as a one-time payment on your debt, you’ll save yourself a good $1,500 in interest.
Keep in mind that other debts, like credit cards, charge far more than 6% interest.
So if you’re able to pay off the debt faster, you stand to save even more.
Another point to consider is that having these debts could make it difficult to afford your home once you buy it.
Remember, when you own property, it’s not just your mortgage payment, property taxes, and insurance you’ll need to worry about.
You’ll also have to cover the cost of maintenance and repairs.
This means that if you buy a $300,000 home, you could be looking at $1,000 a month, or $12,000 a year.
So, if you’re currently paying, say, $700 a month in debts, buying a house after paying off debt will give you that much extra money for homeownership costs.
Also, you may have an easier time qualifying for a mortgage if you pay off your debts first.
qualifying for a loan
That’s because a large amount of debt can drive up your debt-to-income ratio.
This makes lenders more hesitant to give you a loan.
Meaning, a lender might be more willing to lend you $200,000 to buy a house when you’re not already coming in $38,000 in the hole.
Also, spending some time paying off your debt before buying a house could help your credit score by boosting your payment history.
Your payment history shows how likely you are to pay your bills on time.
And it’s the single most important factor in determining a credit score.
If you do a good job of keeping up with your debt payments, your credit score will increase.
And if you then apply for a mortgage after that, you’re more likely to not only get approved but snag a more favorable interest rate in the process.
There’s also the stress factor to consider.
less financial stress
Having a nagging monthly debt is stressful enough in its own right.
But adding a mortgage payment to the mix could be enough to send you over the edge.
Being on the hook for several debt payments also leaves you with fewer options in the event that a financial emergency strikes.
Therefore, it really helps to go into homeownership without a pile of debt in your name.
Which is why it often makes more sense paying off your debt before buying a house
But let’s play devil’s advocate and say that you should be buying a house without paying off debt.
buying a house without paying off debt
I gotta say, it’s generally a better idea to pay off your debt before buying a house.
But, there are some scenarios where buying a house without paying off debt can make sense.
located in a major city
Let’s say that you’re located in a major city.
Major cities are usually where renting is growing increasingly unaffordable.
In this case, buying a home might actually help lower your housing costs in the long run.
And that, in turn, makes the idea of buying less risky when you still have debt hanging over your head.
Also, if you’re planning to make money with your house.
use the house to make money
I’m not talking about the profit you would make if you sold your house in 15 years and made $100k on it.
This is if you use the house as another income source by house hacking and renting out rooms.
If you house hack, you’re going to basically be living for free.
So, this would put you in a much better financial position now and in the future.
This is because your tenants are going to be paying for your mortgage, which frees up another $1,000 to $1,500 per month for you.
And that money could be used to pay off debt faster.
Owning a home also buys you stability, which is something renting does not.
If you have children, moving to another neighborhood could mean having to switch school districts.
And when you rent, there’s always the possibility that you’ll be forced to leave your home.
When you own a home, no one can kick you out.
Unless you stop making mortgage payments, at which point the bank can reclaim your property.
And the last benefit is tax breaks.
There are also some tax breaks available to homeowners.
These come in the form of deducting your mortgage interest and property taxes.
But, to be honest, the savings you get from these tax breaks will probably come out to be less than the savings you’ll get by paying off your debt early.
This is especially true if your loans have a high-interest rate attached to them.
So, if you’re still interested in buying a home, let’s look at how to save for a down payment on a house with debt.
saving for a home while paying off debt
Most of us feel forced to choose between paying off debts OR saving for a down payment.
Sometimes, it doesn’t really feel realistic to be able to save a down payment for a house when we have so much debt.
But there is hope. Saving for a house, even on a low income, is not as hard as we might believe.
In reality, there’s always the option to pay off your loans and save for a home simultaneously.
This doesn’t mean that you’ll have the down payment ready in 3 months, but it does mean that you’re chipping away at that goal.
A good start is to see how much you need to save each month and figure out what excess spending you need to cut out to save for a down payment.
how much should you be saving?
If you want a $200,000 and you’re going to put 3.5% down on your FHA loan, then you only need to save up $7,000 for a down payment.
Now, there are other costs associated with buying a house, but we’re ignoring that at the moment.
If you wanted to move into a new house in 2 years, you would divide $7,000 by 24 months.
This tells us that we need to save $291 per month to have a down payment for our house in two years.
Use the mortgage down payment calculator from Zillow and figure out what the down payment would be on the type of house that you’d like to buy.
Then, figure out how many months from now you want to buy a house.
Just divide the down payment amount by the number of months and you’ll know exactly how much you need to save to reach your down payment goals.
With that being said, if you’re going to buy a home before getting out of debt, make sure to keep your housing costs affordable.
This means making sure that your mortgage, property taxes, and insurance don’t exceed 30% of your income.
Most likely, your lender won’t let you go much higher than 30%, but it’s a good rule of thumb to not go over that threshold.
Until your student debt is paid off, you may not have much financial wiggle room on a monthly basis.
And the last thing you want is to risk falling behind on your mortgage because too much of your income is tied up in debt.