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Get Out of Debt Before Buying a Home

First-Time Home Owner

It’s a situation that many 20- and 30-somethings find themselves in: You’re married and have good jobs, and you’d like to buy a house… but you still have some debts left to pay off. So which should you do first — purchase a home or get out of debt?

Unfortunately, the status quo in America is for young people to carry large loads of student loans, credit cards and other debt into marriage, and most couples actually accumulate more debt as they go in life. This is a really bad thing, because debt is a form of financial slavery that costs us tons of money over the course of our lifetimes.

We believe that the best path to financial freedom is to pay off your debts as quickly as possible, which means holding off on buying a home until you’re debt-free. This isn’t a popular opinion in America today, but it makes a lot of financial sense.

Here are five reasons why you should get out of debt before purchasing a home:

1) Buying a home kills your financial focus.

If there’s one key to getting out of debt quickly, it’s focus. People who become debt-free are the ones who have focused all of their financial resources and energy on paying off debt, using every extra penny that they can come up with to pay their balances down.

Unfortunately, buying a home softens that focus and strips you of some of the resources that you have to pay our debts off. Most people stretch themselves financially to get as big a house as they can make the mortgage payments for, which leaves very little money for paying off debt. And even if you get a modest mortgage that is similar to what you pay in rent currently, you’re going to have to save some cash for a down payment, which is cash that you won’t be able to pay toward your debt balance.

If you can exercise the patience to wait on buying a home while you focus on your debts, you can pay your debts quickly, thereby reducing the overall amount that you pay in interest. If you carry those debts into home ownership, though, they’re likely to stick around for years or decades, costing you thousands of dollars in extra interest payments.

2) Home ownership creates additional risk.

One of the fundamental problems with debt is that it creates risk in your life: If you encounter a financial emergency, your ongoing debt payment obligations may leave you without enough cash to solve your problems. If things get too bad, this leads to bankruptcy, which can screw up your financial life for years.

If you already have the risk of debt in your life, you don’t need to increase your financial risk by buying a home. In the long-term, home ownership is a great financial decision, but it comes at a cost: Stuff breaks, appliances need replacing, and emergencies and disasters will require you to drop large amount of money on home repairs at inopportune times.

For people with no debt, the benefits of home ownership outweigh these risks. But if you already have the risk of the debt load that you’re carrying, adding the risk of home ownership to it can put you in a precarious financial position.

3) You’ll have a better down payment.

Though some lenders offer “zero-down” mortgages that finance the full value of the home that you buy, these are rarely a good idea — they often comes with high fees and interest rates, and can cost tens of thousands of extra dollars in interest over the life of the loan. The best way to buy a house is to save up enough cash for a down payment of at least 20 percent of the home’s value.

If you have a lot of debt payments right now, you probably aren’t able to save much money each month for a down payment, which means that you would go into your home purchase in a low-cash position. This isn’t a position you want to be in. Instead, focus on getting out of debt quickly, and then apply that same focus toward saving up enough cash to go into your home purchase with a big down payment.

4) You’ll get a better mortgage interest rate.

When you buy a house with a mortgage, you want to qualify for the best mortgage interest rate available at the time of your purchase. Interest on a mortgage will cost you tens of thousands of dollars over the life of your loan, and even a small increase in the interest rate equates to big increases in your interest payments. And the more you have to pay in interest each month, the less you can afford to really pay for a house.

If you go into a mortgage with no other debt, you’ll qualify for a better interest rate than if you’re also carrying a bunch of student loans and consumer debt. Why? Because the bankers know that you don’t have these other financial obligations pulling at your wallet, which makes you much more likely to pay them on time every month. They like that security, and they reward you for it with a lower interest rate.

5) You’ll pay the house off more quickly.

It’s an unfortunate fact that most American homeowners carry 30 year mortgages on their homes, and spend the full 30-year term paying their houses off. The best way to mortgage is with a 15-year loan, which saves you a ton of money in interest while only moderately increasing your monthly payments.

If you have to make payments on all of your other debts while also paying for your home, you’re probably going to get a 30-year mortgage instead of the ideal 15-year loan, and you’re probably going to spend the full 30 years paying it off. Over the life of that loan, this often equates to paying just as much in interest on the loan as you paid on the actual purchase price of the home.

If you don’t have any other debt, however, you can get a 15-year loan, and then focus your efforts on paying that loan off early. Each year that you cut off of your home mortgage saves you thousands of dollars in interest payments.

In the end, the goal of good financial management is to get debt-free as quickly as possible, and then to stay that way. Buying a home is a great thing to do, but it’s not worth doing if it’s going to be a roadblock on your path to debt freedom.

——

Photo by Andi Narvaez. Used under Creative Commons License.

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Comments

  1. Ricky Teachey says:

    I think this is good advice, but is it really always true?

    We bought in August despite not being out of debt. Here’s what our situation looked like:

    1. Cheapest decent, two-bedroom apartment we could find: about $950/month (Dayton OH is in the top 10 worst cities in the country for renting vs buying, according to Forbes mag; it’s just stupid expensive for some reason)
    2. ~$20k in student loans, 6.5% rate
    3. Loan interest rates were (are) going up – FAST
    4. Two kiddos: one here, one on the way, and more planned soon
    5. Four-bedroom houses in good areas for <$60k, and prices going UP
    6. $25k balance in my wife's rolled over IRA

    We found it to be impossible to put almost anything significant toward debt while renting, and we were already feeling the pinch in our small apartment with one baby.

    We decided to take $10k from the IRA (the IRS allows a one-time, penalty-free IRA distribution of up to $10k for the purpose of a first-time home purchase) and use it to buy our $63k house. Monthly payments are now $575.

    Also it appraised for $70k, so we are already at 20% equity and our $20/month PMI will be gone in May when the loan has seasoned. In addition the house will be reassessed and taxes will go down about $50/month or so, leaving a $500 monthly payment. Utilities are about the same as in the apartment (gas is much cheaper than electric). We have a one-year home warranty in place to cover any broken furnace or whatever.

    While this decision wasn't ideal, it would have taken us YEARS to pay the loan off AND save up 20% without touching the IRA; if I had had $10k in hand right now it most certainly would not have been put into the IRA, it would have been put onto debt. But putting it onto debt wasn't an option (without a major penalty at least), so instead we moved it into a house that would drastically reduce our monthly payments.

    I think this situation is pretty unique. What do you think we should have done?

  2. My wife and I just became debt free and saving up for our down payment. I agree with this article as well. Although I am interested in the answer to the other readers question.

    Risk seems to be one of the biggest factors. There are so many people losing their homes today. I think that if they had been debt free from the beginning they would have been able to adjust and sustain the increase on their loan payments.

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All content on this site is given on a general basis and is intended for informational use only. The content does not reflect any professional legal, investing, accounting or tax advice, and should not be used as the sole basis for making financial decisions. Always consult a certified financial professional before investing.
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