Is buying a house with debt a smart decision?
Buying a house with debt isn't ideal — then again, life rarely is. Find out when it's a good financial move to buy a home, even with debt.
How important is it to get your "financial house" in order before you consider buying a real house?
Of course, you should know whether you have the basics of what it takes to pay for a home — a steady job, cash for a down payment, a good credit score. While you want to at least have your debt load under control, waiting to pay off all your loans before you sign on the dotted line could delay your home purchase timeline by years.
So, is buying a house with debt a good decision? Here's a look at the not-so-simple answer.
The pros and cons of debt and homeownership
Depending on your unique financial situation, buying a house with debt can do you some serious financial good, or it can cause your wallet to take a hit in the long run.
On the plus side, you might be able to:
- Build equity: the sooner you purchase a home, the sooner you'll stop paying rent and start building equity. If you take the time to pay off your debt before purchasing a home, you could miss out on years of equity building and hurt your total net worth.
- Get into a hot market: home prices are increasing rapidly in competitive real estate markets such as Toronto. If you live in one of these areas, you might only have a short window to purchase a home before you're priced out of the market.
- Make a prudent purchase: if you have the opportunity to make a smart buy, say if you spot a property at a great price or receive an inheritance with a time limit, then purchasing a home now could well be worth it, even if you have debt.
At the same time, this move could set you up to:
- Be house poor: if you purchase a home while you're still in debt, your minimum payments could leave you with little or no money left over to save for retirement or other life necessities.
- Receive a smaller loan: when you apply for mortgage pre-approval, your lender will use your minimum debt payments in a formula called your debt-to-income ratio. This compares your total debt to your gross income. The more debt you have, the smaller your mortgage pre-approval will be.
- Manage split priorities: if you buy a home while you still have debt, you'll need to balance your priorities carefully. Debt repayment doesn't become less important just because a mortgage has entered the mix, and if the addition of a new loan is too much to handle then you might be putting your other financial goals, like saving for retirement, at risk.
Advice for buying a house with debt
There are times when it just doesn't make sense to pay off all your debt before buying a home. If this is your situation, have no fear! Here's what you need to do.
Manage your debt
Make sure that any debt you have is manageable. A little student loan debt or a car loan is one thing, but if you're consistently spending beyond your means every month, that's a sign you have some financial soul-searching to do. Tracking your spending and sticking to a budget is a good start.
Transfer your debt
If you have high-interest debt, such as credit card or payday loan debt, transfer it to a line of credit. Lines of credit have much lower interest rates, making them easier to pay off. Be mindful not to let a balance creep back up on your credit card. If you're not good about keeping your balance down yourself, call your lender and have them lower your credit limit.
Maximize your down payment
If you have debt weighing you down, you'll want to save the biggest down payment possible. Your debt will limit the size of your mortgage pre-approval, but a larger down payment will help offset this limitation.
Earn more money
Easier said than done, right? Just keep an eye out for opportunities: if you're due for a raise or promotion at your current employer, now is the time to ask. A higher income will make homeownership easier, help you save for a bigger down payment and qualify you for a larger mortgage pre-approval.
Plan for all possible costs
Buying a house isn't just about the mortgage and down payment. Closing costs can add up to 5% of the home's purchase price to your final total cost. After the purchase, remember that homeownership comes with many additional costs beyond the mortgage. Budget for utilities, insurance, property taxes, and annual maintenance. Run the numbers alongside your minimum debt payments to check that you can afford all of these costs.
In an ideal world, you would wait until your debt is completely paid off before purchasing a home. But life isn't ideal. Student loans and car loans are a nearly inevitable fact of life. You may not be able to pay them off before leaping into homeownership — and that's OK! With a strong strategy in hand, you can buy a home and enjoy homeownership while working toward debt freedom.