First home or student loans?

first home Should you buy your first home or pay off your student debt?

This is part two of the response to a question from Alison, who wanted to know if she should first pay off her student loans before saving for a house. You can read part one here.

Hi Alison,

I like the idea of power-saving for the foreseeable future – as much as possible. And pay the minimum on your student loan each month of $500. I like a balanced approach – if you simply focus on paying off your debt first, you might have to wait five or six years before it’s gone, (9.5 if you stuck to the minimum payment plan) and only then you begin to save your down payment.

And you would miss out on the opportunity to leverage a small down payment into generous capital gains which may accrue from a real estate investment.

Here are some steps that will get you from paying down your student debt to buying your first home:

1) If you do not actually have a credit card, ask your bank for one – with a limit of at least $2,000. Ideally, I’d like to see you with two such cards. The reason is to ensure you have an amazing credit score when the time comes to buy.

2) As my original article suggested, I am a fan of first-time buyers buying a property and renting out as much of it as possible while living there also. This approach allows you to consider a small (as little as 5%) down payment; gets you into the market sooner rather than later, and can really defray your monthly outlay for accommodation. Plus if you live in the property, it’s your principal residence, and any profits on future sale I would hope are tax-free – this is not the case if it is a pure investment property that you do not live in.

I understand $1,600 a month does not get you a lot in the Toronto rental market, AND it is a lot of after-tax dollars. I have a few young professional clients who have bought two-bedroom condos in the past few years, and rented out the second room and lowered their monthly housing expense below yours.

That said, I am not a big fan of condo investment – I prefer houses or duplexes or triplexes. And I am not averse to having a partner to share a load of buying the property – ideally a life partner, but could be an old classmate or trusted friend. (If that ever seems possible, come back and ask me how to structure it wisely)[/notice]

3) Technically it would be very difficult to qualify for a mortgage until your employment situation is more stable. Your income is good, but lenders are looking for permanent full-time employment, without a probation period.

4) Anything you can do in the interim to reduce your monthly living expenses and increase your monthly savings rate will pay off in the future – so look for ways to be more aggressive in the realm of savings

5) Saving money in a Tax Free Savings Account is always preferable to a regular savings account or non-registered GIC. It can be a good place to hold money pending decisions on making RRSP contributions.

6) If you decide to follow my advice and save for the down payment, it may make sense to plan to use the first time homebuyers’ RRSP plan. Your marginal tax rate is around 30 to 35%, so you may generate a healthy refund which can be plowed back into your savings, and when you are ready to buy, your RRSP can be a source of a large portion of your down payment. (You might want to research this plan online)

Before you do that you should speak with your tax preparer. You likely have a chunk of tuition/education deductions carried forward which could lower your marginal tax rate.

There is more to home buying than just this. There are various programs and credits available to first time home buyers to reduce the financial sting, but this response at least addresses your fundamental question.

I hope this helps Alison – it’s been a pleasure answering your questions – keep me in mind as you progress through your journey.

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