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Don’t Let Your Student Loans Stop You From Buying A House—How To Afford Your Dream Home When You’re Still In Debt

Crappy pay. Student loans. No savings. Think homeownership is out of reach? You might be wrong. Not that you should, but here's how many millennials buy houses while still in debt.

Whenever a study is released about millennials and money, the findings are usually depressing.

But one recent study caught my eye because it contained some good news for once.

Despite their well-publicized economic challenges, millennials represent the largest percentage of recent home buyers, according to the National Association of Realtors 2015 Home Buyer and Seller Generational Trends study.

Now, if you and all of your friends have debt and aren’t making a lot money, you may be tempted to call B.S. on this study.

But I promise – it’s true. Homeownership isn’t just for “adults” in their 40s.

Here’s how you can stop paying rent and start paying a mortgage, if you so choose:

Consolidate your credit card debt and student loan payments

You can buy a house while in debt. It all depends on what portion of your monthly gross income goes towards paying the minimum amounts due on recurring debts like credit card bills, student loans, car loans, etc.

Your debt-to-income ratio matters a lot to lenders. Simply put, your DTI ratio is a measurement that compares your debt to your income and determines how much you can really afford in mortgage payments.

Most lenders will not approve you for a mortgage if your DTI ratio exceeds 43%.

So let’s say you make $46,000 per year, the average full-time salary of college grads in 2012. And let’s say that like four in ten millennials, you spend half of your paycheck paying off your debts.

That means your gross monthly income is $3,833. $1,916 goes towards debt.

So your debt-to-income ratio is 50%. Learn more about how to calculator your debt-to-income ratio here.

Banks won’t approve you for a home loan, unless you do one of two things:

  1. Start making more money
  2. Lower your monthly recurring debt payments

Getting a higher paying job may seem like the obvious solution. But that could take a long time (and just think of all of those interviews). And it may actually hurt your chances for getting a bank loan, as some lenders are reluctant to provide loans to people with new jobs.

A better solution is to consolidate your debts.

“The number one thing to do to reduce the debt-to-income ratio without paying off the obligation is to consolidate debts,” says Scott Sheldon, a senior loan officer with Sonoma County Mortgages. “Consolidating credit cards or consolidating student loans will reduce the minimum monthly payment, which will lower the debt-to-income ratio and improve borrowing power.”

In other words, rather than paying off six credit cards each month, consolidate those balances into one, lower monthly payment. A growing market for personal loans makes this easier. For example, if you have good credit, you can get a personal loan of up to ,000 to consolidate your credit cards — sometimes at interest rates that are better than the cards themselves.

Consolidate your student loans too. “Student loans have the same effect as a car loan or credit card,” Scott says.

Now recalculate your debt-to-income ratio. Is the number lower? If so, a bank may give you a home loan.

You only need a small down payment

When I started thinking about buying a house, I assumed I would need a 20% down payment. Given that I had very little savings, I assumed I’d be dealing with landlords for the rest of my life.

But I didn’t need anywhere near 20%.

“20% down is what people paid 20 years ago,” Scott says. “The minimum you need today is 3.5% down for an FHA loan or 5% down for a conventional loan.”

Of course, the more you put down, the less you pay each month, and the better interest rate you’ll get.

But I only put 5% down and my interest rate is just shy of 5%.

Your retirement account can provide you with your down payment (but we strongly advise against that)

Yes, you can use up to $10,000 of an IRA, penalty-free, to purchase your first primary residence. If you have a 401(k), you may be able to borrow money from your account and pay it back over time.

You’re probably thinking that it’s terrible for a personal finance site to recommend this, but the fact is, people do it whether we tell them it’s a bad idea or not. 17% of millennials have already taken a loan from their retirement plan.

Again, we recommend against taking a loan from your retirement account. But if you really want to buy a home and are going to pretend you skimmed over that part of this article—there are a few things you should know.

Like most loans, make sure you can pay it back in a short amount of time

If buying a home is worth losing a little bit (sometimes a lot) from your retirement savings, you can do it.

But, since you’re already paying student loans, you don’t want to spend your life also paying back a 401 (k) loan. Make sure you have a set time to pay back the loan, with monthly payments taken out of your paycheck.

Avoid penalties

You’ll want to avoid any penalties for withdrawing money early from your account. Luckily, a study by the Employee Benefit Research Institute, shows that 87% of 401(k) plans offer loan options.

This differs from traditional IRAs, which only allow early withdrawals made before age 59 ½, and charge a 10% penalty tax.

However, there are a few exceptions to the penalty tax for withdrawals from traditional IRAs. One of which is if you’re withdrawing up to $10,000 to buy a first-time, primary home. This is a much smaller amount than the loans you can take from your 401(k).

Consider your overall personal finance health

Just because you have debt (i.e. student loans) doesn’t mean you have bad credit, which is another big factor in buying a home.

When you’re ready to buy a house, you’ll need to consider all your debt, your credit, and your job security.

If you do consolidate your debts and get lower monthly payments (and pay them off in full each month), your job is fairly secure and well-paying, and you’ve got a stellar credit history, there’s no reason you should let your debt sway you away from your dream home.

Again, just because you can get a loan doesn’t mean you should

Let’s say you take all this advice and qualify for a home loan.

Before you become addicted to Zillow or, spend some time mulling over if you’re really ready to commit, and how much house you want to commit to.

“Stretching your debt-to-income ratio to the maximum 45% allowance is a risky proposition unless your income is poised to rise in the future or any other consumer obligations you have are poised to be paid off,” Scott says.

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