I Want A House But I’m In Debt: 4 Steps To Take To Get The Best Of Both Worlds

Updated: December 23, 2020

You made the decision to buy a house, but you have debt. How in the world do you become debt free and a homeowner before your 40s? Millennials who are burdened with student loan debt, car loans, and credit card debt are faced with this exact challenge.

And while we dream of Pinterest-worthy living rooms and a two-stall garage, don’t forget that homeownership is a major expense. The U.S. Department of Housing and Urban Development estimates 12 million households spend more than 50% of their annual income on housing alone

How can you save up for a down payment when you are trying to clean up your debt? It’s not easy but there is a way to get the best of both worlds by implementing these four steps.

Step one: Have an emergency fund

First, do you have an emergency fund? Regardless if you rent or own, you should have one. An emergency fund covers any unexpected expenses that might pop up. This is crucial to have in place prior to buying a house.

Imagine buying a home and then realizing the washing machine floods every time you turn it on. Your emergency fund can cover the cost of repairs and help you avoid going into debt. In fact, a study by LendingTree found that 43% of Americans listed unexpected expenses as their top financial concern.

Todd Riedel, a 31-year-old from Fort Worth, had a hefty emergency fund built up before buying his first home. “It gave me peace of mind knowing I had money set aside for emergencies,” he shared with The Money Manual.  

While tackling debt, he was able to save $12,000 in an emergency fund. The extra funds also helped cover any closing costs. “You never know the final cash-to-close amount until the end so it’s nice to have the extra cash set aside,” he said. 

Instead of taking out a larger mortgage or adding emergency costs to your credit card, start building an emergency fund. Open a separate savings account and contribute to it on a regular basis. 

Step two: Have a debt payoff plan

Are you current on all of your debt payments? It is crucial to have a debt payoff plan before you start house hunting. Why? Because buying a house is one of the biggest purchases of your life, so debt needs to have structure.

A good idea to get your debts organized is by writing them down in one spot. List out the company name, outstanding balance, interest rate, and the minimum payment. Then make a plan to pay it off according to the highest interest rate or the lowest total balance owed. This is popularly called the debt avalanche and debt snowball methods respectively.

I’ve heard of a debt-to-income ratio. What is it?

If you are planning on applying for a mortgage, the mortgage lender will most likely look at your debt-to-income ratio, or DTI. According to the Consumer Financial Protection Bureau, your DTI is all of your monthly debt obligations divided by your gross monthly income. Your gross monthly income is the amount of money you earn before taxes and deductions.

Once you have a debt plan in place, take a look at your DTI. In most cases, borrowers can get a qualified mortgage with a DTI up to 43%. Borrowers with higher DTIs are more likely to have trouble making their monthly payments. If your DTI is high, take action to reduce your debt quickly.

Step three: Avoid burnout

It’s perfectly okay to start saving for your new place while you are in debt, but understand that if you try to slap a ton of cash towards both goals—debt and down payment—you could quickly burn out.

Instead, prioritize your financial goals. The debt should be tackled first. If you slack here, the lackluster momentum leaves room for fast-growing interest. Especially if you have credit card debt.

Make your goals fun by creating milestones. Track your debt progress with a debt free chart. Set due dates for how much you want to save for your down payment. Then you can build in contribution amounts inside of your budget so you stay on track.

Step four: Set up a separate savings account

A great way to build your down payment is with a high-yield savings account. Research how to pick the right savings account so you can maximize interest earnings.

Sharana Cook, a 28-year-old from Philadelphia, balances both goals by keeping her house goal funds separate. “I’m trying to pay off all of my debt first, but I already opened a separate savings account for my future house,” she told The Money Manual.

Cook said she’s starting small by transferring $50 to $100 each paycheck. When asked why she decided to keep her house savings separate, she chalks it up to motivation. “I can rename my savings account which helps me know I am 100% dedicating that money to something specific,” she said. You are also less likely to dip into the funds when it’s labeled for a specific goal. 

Final thoughts on debt and down payments

While having a place to call your own can be a measurement of adulthood, it can be a burden if you get in over your head. There are several costs that go into purchasing a home aside from the down payment. For instance, you want to aim to have a 20% down payment so you can avoid private mortgage insurance which can be another added cost. Be sure to take these factors into consideration:

  • Closing costs: Typically, you should allocate between 2-5% of the purchase price towards closing costs.
  • Proof of income: Bring your W-2 with you when meeting with mortgage lenders.
  • Debt-to-income ratio: Make sure your DTI is no more than 43%.
  • Credit score: Aim for a credit score above 670, which is considered a good credit score.

If this all sounds a bit overwhelming, focus on getting the debt down first, then stashing cash for your down payment in a savings account. Once the debt is under control, you can make better headway towards homeownership.

Justine Nelson is the founder of Debt Free Millennials, an online community to help millennials get out of debt. Justine enjoys writing and speaking about all things personal finance. This Midwest millennial paid off $35k in student loan debt and now resides in San Diego with her husband living the DINK life (Dual Income, No Kids).

Feature Illustration: Laura Caseley For The Money Manual