Managing debt when you’re just starting out is never easy, but it’s especially tough these days for first-time home buyers. For example, if you’re saving for a house, is it better to pay off student loans first or put everything toward a down payment?
My fiancé and I are recent graduates. We are saving for a down payment on a house and have $15,000 so far. We have around $14,000 in student loans. Would it be wiser to pay off our student loans now, or use our savings for a larger down payment and carry the student loan debt along with a mortgage?
— Katherine R., Montclair, N.J.
You’ve got two different decisions here, so you may be better off making them one at a time.
The first is whether to pay off your student loans. That depends a lot on the interest rate you’re paying: If you’re stuck with a high rate, you may be able to save faster by getting rid of that expense. On the other hand, if the rate on your loan is lower than what you’ll pay for a mortgage, that student loan is “cheaper” than a mortgage — so you may as well leave it alone. In general, when deciding which order to pay debts off go with the costliest first.
The other question is whether or not to buy a house — and how much to save before you do so. The answer to that one involves a different set of considerations. To make your decision, you’ll need to know 1) how big a down payment a lender will require for the loan you expect you’ll need 2) what kind of interest rate you’ll qualify for and 3) how big your monthly payments will be for the price range you’re considering.
Step No. 1 may be the biggest hurdle: These days lenders are demanding much bigger down payments than the no-money-down, go-go days of the housing boom. They may also want to see a bigger down payment to make up for any student loans outstanding. Or you may be able to consolidate your student loans with your mortgage. You won’t know until you sit down with a lender.
So start by shopping for a loan — before you start shopping for a house. This may seem like putting the cart before the horse, but you won’t know how much house you can afford until you find out how much mortgage you can handle. If your credit history is weak, you’ll pay a higher rate — if you can get a loan at all. If so, you may want to wait awhile to strengthen your credit, save a little more, and try again.
You’ll also want to write up a detailed budget to figure out how much of your monthly income you can realistically devote to mortgage payments. (Don’t forget to factor in the tax savings from deducting your mortgage interest.)
Only you can decide what’s affordable. During the craziness of the housing bubble, brokers were talking people into spending more than half of their paycheck. That’s just not sustainable — a third is probably about as high as you should go. But every situation is different. If you expect your salary to go up, you may want to stretch a little bit at first. If you’re worried about losing your job, you may want to play it safer.
No matter how much house you can afford, buying today is risky. It’s not clear whether we’re closer to the end of the housing slump than the beginning. (Your real estate agent will no doubt have an opinion on this, but that’s all it is. No one really knows.)
If the worst is over, you could be getting the bargain of a lifetime. But if house prices keep falling, you could easily see your hard earned savings wiped out as the drop in the value of your new house wipes out your down payment. Unless you plan on staying put long enough for the housing market to recover — which could take years — you may be better off renting.
My daughter is in college. Her credit score is a 458. Last year, she had no credit score. Unfortunately, she has had medical bills that are on her report. She had one credit card that she paid out and closed. Her other credit is local. How can she raise her score?
—Sandy F., Big Sandy, Tenn.
First thing is to get copies of her report form all three credit agencies. You can get one every year from annualcreditreport.com. Be sure to use this site only. There are a lot of pretenders who will figure out how to charge you. This one was set up by the three credit agencies as required by a 2005 federal law.
Check the reports and make sure the information is accurate. You may be surprised how bad these records are. (We’ve done this several times and found mistakes.) If you find errors, contact the agencies and have them corrected. You may have to provide them with a written statement or proof of the error. They’re supposed to follow up within 30 days.
It’s important to check all three reports because each agency works a little differently. They also score your credit history a little differently. To find out your score, you’ll have to pay a small fee — only the information in the credit report is free.
If the info is accurate and the score is still low, there aren’t a lot of short cuts — in spite of the pitches you may see from companies offering “credit repair.” While a legitimate financial advisor or credit counselor can help you get your finances back in shape and — over time — rebuild damaged credit, the “credit repair” business is riddled with scammers.
You’ll hear from folks who promise to raise your score — for a big fee — or give you your money back. When you read the fine print, you find you don’t get it all back (if you get any of it). Many of these companies count on finding inaccuracies in your report, which you can do yourself for free. For more on credit repair scams, check out the FTC’s Web site.
Ultimately, the only way to build a credit history is to take on a manageable level of credit, pay it off on time and before long your score will come up. But it takes time.
That’s why they call it a credit “history.”
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