You’re in your 20s or 30s and saddled with student loan debt. Maybe you’re not yet earning what you expected this far out from graduation, and now you’re wondering how to save for a down payment on a starter home.
Plenty of Millennials feel as if they’ll never see the end of their student loan debt much less amass enough money to make a down payment on their first home. The average student loan debt for the class of 2015 climbed to $35,000, but all is not necessarily lost for young home buyers.
Your debt-to-income ratio, your credit history and how much you have in hand for a down payment all come into play when applying for a mortgage. However, if you have considerably more debt and/or less income than lenders find desirable or if your credit history has a few bumps that need ironing out, you may need some serious motivation to reduce your debt, improve your credit worthiness and save for a down payment.
Despite the challenges, plenty of Millennial buyers have managed to make the down payments and secure mortgages. Realtor.com reports that 30% of all existing home buyers at the end of 2015 were 25 to 34 years old, and Bloomberg Business reports that 37% of mortgage borrowers were Millennials. How did they do it?
5 tips for first time home buyers short on down payment and deep in debt
Successful first time home buyers used strategies that may have included one or more of these:
1. They bought a home in a less expensive market. You may want to live in hip cities like New York or San Francisco, but Millennials who purchased with a mortgage made up the largest number of home buyers in cities such as Des Moines, Pittsburgh and New Orleans, according to Bloomberg.
2. They made smaller down payments than the conventional 20 percent. Many first time home buyers find the down payment one of the biggest challenges to home ownership. If you qualify for an FHA-insured mortgage, you can put down as little as 3.5%. Veterans may be eligible for ‘no down payment’ programs. State and local programs offer grants for first time home buyers to help with down payments. You can get more information from HUD.gov.
3. They paid down debts while starting to save. If your debt-to-income ratio is higher than 43%, you may need to pay down your debts before a lender can approve you for a mortgage. With a graduated savings plan, you aggressively pay down debt while gradually putting away savings. At the outset, you put the bulk of your discretionary income toward student loan repayment and a smaller percentage into savings for your down payment. As your loans get paid down, you gradually put more into savings and less toward the loans, but continue paying the debt until it’s gone.
4. They saved every bit of ‘found money’ and tapped less obvious sources for down payment funds. If you have an IRA, you and your spouse can each take up to $10,000 toward the purchase of a first home without paying the 10 percent penalty for early distribution, but you may still owe taxes on the withdrawal. For Roth IRAs, you must have had the account for over five years to withdraw without penalty, but the money is tax-free for buying a first home. Prior to five years, you may also owe taxes on the withdrawal. Putting money and checks you receive as gifts, bonuses, rebates — any unexpected windfall — into a low-risk, interest-bearing account like Certificates of Deposit or a credit union or online savings account helps grow your down payment savings fund faster.
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5. Compelling reasons for buying a house motivated them to save. Clarify why you want to save for your starter home. Freedom to renovate and decorate as you please may not be as compelling as seeking relief from living with relatives or inconsiderate housemates. Needing more space to start or raise your family may motivate you more than having more room to entertain. Your monthly rent may be costing as much or more than a mortgage, and it’s making your landlord rich — but it’s not building you any equity. Your reason to buy your first house should be important enough that when you’re torn between putting money into savings and spending it for a night out on the town, your starter home fund wins out.
If your debts are manageable, focus on savings. You may have opportunities you hadn’t thought of:
- Look for bargains when you shop, and instead of spending the money you saved on something else, transfer the amount saved into your savings account.
- Do a crash budget — don’t spend any disposable income at all for a week each month.
- Bank loose change and coupon savings.
- Make your lunches and give up or cut back on not-so-healthy habits that cost you money.
You may have to live a no-frills, minimalist existence for a while, but there’s usually a way to squeeze out some savings. No doubt the practice can come in very handy, too, after you’ve become a home owner.