How to Keep Your Credit Strong During Economic Shifts and Know If You’re Ready to Buy a Home
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Sean, I know you're headed to the UK soon, and as a London girl, it would be wrong for me not to give you recommendations.

So here are some must-see spots. You must go to Kew Gardens because you're a gardener. Shortage for a bohemian hipster vibe. You got to go to Camden for top-tier markets, cafes, and coffee shops. South Back Center for an artsy, eclectic experience. And then you have to see the London Eye because you're a tourist, and why not? And of course, you have to take a pic in front of Buckingham Palace, or the trip never happened. ♪

Wow. Okay. Thank you, Elizabeth. I will definitely check every single one of those things out. And now you're indebted to me and have to bring me back a keychain and Kit Kats because I gave you those excellent tips. Okay. Well, that's a debt I'm happy to be in, unlike some of the debt that we're going to be talking about in this episode. Thank you.

Welcome to NerdWallet's Smart Money Podcast, where you send us your money questions and we answer them with the help of our genius nerds. I'm Sean Piles. And I'm Elizabeth Ayola. This episode, we're answering a listener's question about some home buying basics. But first, our weekly money news roundup.

where we break down the latest in the world of finance to help you be smarter with your money. We're always keeping an eye on economic indicators, and there's been a pattern lately that's not looking too good. Recent data shows that debt delinquencies are trending upwards.

And that's all kinds of debt. We're talking mortgages, credit cards, auto loans, and student loans. Our news colleague, Anna Hilhoski, is here with more details. Hey, Anna. Hey, Sean. Hey, Elizabeth. And after I run down what's happening with debt payments right now, I'm hoping, Sean, that you can put on your CFP hat to dispense some wisdom.

Oh, you know I will. It is big and shaped like a dollar sign for some reason. But first, let's talk about what's happening with debt right now. Can you give us some context, Donna? As Elizabeth mentioned, it's a bit grim for debt holders right now. Keep in mind that there's always a lag when it comes to economic data, including consumer trends.

With that said, the Federal Reserve Bank of New York's most recent household debt report shows that total household debt increased by $93 billion in the last quarter of 2024 to a total of...

$18.04 trillion. Wow. That's a lot. So we know that there's more debt, and when prices rise for goods, homes, services, etc., then debt continues to rise. The higher the debt, the more difficult it is to repay. What are you seeing with payments? It seems like borrowers are missing payments more often. Those with less disposable income or lower credit tend to be the borrowers who have more difficulty meeting payments.

Delinquency payments tend to rise when people take on more debt than they can repay, when lenders loosen credit standards and extend credit to riskier borrowers, when inflation is high, and during economic downturns. Again, since there are delays in data reporting, it's difficult to pinpoint exactly why delinquencies are happening, but usually it's due to a perfect storm situation.

One of the most common types of debt is home loans. What's the story there? Recent data from the Mortgage Bankers Association shows that delinquency rates on government housing loans — that's federal housing administration or FHA loans, as well as Department of Veteran Affair loans — outpace late payments on conventional mortgages in the fourth quarter of last year.

The report showed that delinquencies on conventional mortgages remained near historic lows. Now, government loans like VA and FHA loans are available for people who most need it, including first-time homebuyers, seniors who own their homes, and people who are buying manufactured homes. All of those borrowers tend to have lower incomes or little savings for a down payment, and that means that they're less insulated from financial shocks.

The NBA report also says that more serious delinquencies, those at risk of default, are rising more with government loans than conventional as well. Did the report detail any of the reasons why late payments are increasing? It did. The NBA cited, once again, a perfect storm of pressures from inflation, lower personal savings, consumer debt, and higher taxes and insurance, among other factors.

Speaking of government loans and default, let's talk about what's happening with student loans right now. There have been some recent developments that may concern borrowers. Yeah, there have been some developments indeed, Sean. Student loan borrowers had a five-year respite from penalties if they didn't make payments. But now the federal government is ready to collect. Now, let's back up.

In March 2020, student loan payments went on hiatus and didn't restart until October 2023. But the government continued to pause collections on unpaid bills. But beginning in January of this year, federal student loan servicers, those are the companies that manage federal student loans, began reporting late payments to credit bureaus. The Education Department says that more than 5 million borrowers are in default, while 4 million are in late-stage delinquency.

The Federal Reserve Bank of New York projects that more than 9 million people will be reported to credit bureaus for late payments by the end of June. Now, here's the most recent bad news. Beginning May 5th, the Education Department is going to start involuntary collection, which means student loan borrowers in default will see tax refunds and even Social Security payments reduced or withheld.

And beginning the summer, could see their wages garnished if they don't catch up with past payments due. That is rough. It sounds like anyone who thinks this could affect them should contact their loan servicer right away to find out their options for pausing or maybe lowering payments. Now, cars have been expensive in recent years and prices are only going up due to auto tariffs. But how are borrowers doing with their auto loans?

Some recent data from Fitch Ratings shows auto loan delinquencies are up to their highest rate in decades. And as we might expect, those with prime borrower scores are doing better than subprime. Now, that means that borrowers with higher credit scores aren't delinquent on their debts as much as those with lower scores. That's a pretty common trend when delinquencies rise.

One last one, Ana. Credit card debt. What is going on there? The Federal Reserve reports that credit card delinquencies fell to record lows at the start of the pandemic, but quickly returned to pre-pandemic levels by the start of 2023. And it's been rising pretty steadily ever since. And the Fed expects that to continue.

All right. We covered a lot of ground, but it pretty much all adds up to a bleak outlook for borrowers with financial insecurity. Conditions could also be exacerbated, and even more borrowers could be at risk of delinquencies if prices rise due to tariffs, which economists expect. Now, I'll be keeping an eye on consumer behavior data as it trickles out in the next six months to a year, and we can circle back when the picture is clearer. Now for some advice. Sean.

Sean, have you got that CFP hat at the ready? Putting it on? Okay. My imaginary dollar sign hat is firmly on my head.

So we know that delinquencies are rising. What are some of the potential consequences of delinquencies? The two big threats of delinquencies are damage to your credit and eventually debt collectors knocking at your door. A delinquent payment, which just means a missed payment, won't immediately harm your credit. Damage typically begins to set in after a payment is more than 30 days late. And then the longer you're delinquent, the worse the consequences.

So when a payment is more than 30 days late, that's typically when a creditor will mark the payment as officially late, and that mark could stay on your credit report for seven years. That can make it harder to get approved for new lines of credit or rent an apartment, the kinds of things that you need good credit to do easily. Then that can drag down your credit score too, and how much depends on where your credit is now. The higher your score, the further it may fall.

On the debt collection side, you may find yourself bombarded with calls from debt collectors seeking payments, and this can eventually lead to legal action or your wages being garnished. When someone starts falling behind on payments, what should they do first?

Picking up the phone is one of the best things that you can do. Call your creditors and let them know that you're having trouble paying your bills. They may offer hardship programs that can help you stay current with your bills. Is it ever a good idea to use savings or retirement accounts to catch up on debt payments? Savings, yes. Retirement, almost never.

When it comes to savings, be cautious there. It's not a great idea to completely deplete your savings to pay off your debt because you could end up going deeper into debt if and when the next financial emergency pops up and you don't have savings to pull on to pay it off.

Now, when it comes to using your retirement savings to pay off debt, I don't want to say it's never, ever a good idea because there's always some exception to the rules out there. But I am typically strongly opposed to using your retirement funds to pay off debt. There are a number of reasons why, but I'll give you two big ones. First, you'll often be hit with taxes and penalties for taking money out of your retirement account, particularly if you're tapping your 401k.

And the bigger reason is that you are robbing your future self of a comfortable retirement to solve an immediate problem.

Taking out $10,000 now to pay off debt could mean that you have a retirement savings gap of much more than $10,000 later due to lost compounding interest over time. And Sean, how should people generally prioritize which debt to pay off first if they can't make all of their payments on time? I recommend people go back to their hierarchy of needs. If cash is really tight, pay the bills that keep the lights on and the water running and a roof over your head.

Then start making those calls to other creditors to see which might offer hardship programs so you can try to stay on top of payments. Whenever people are in a tricky spot with their finances, they may get desperate, and that's when predatory lending and scammers seem to appear. Any advice for spotting the warning signs for those? Be wary of anyone that's offering a quick fix to your debt. You likely didn't get into the situation overnight, and resolving it can take some time too.

I know this situation can feel really stressful and you just want it to be over with, but take a little time to find the best solution. And what should people who are in financial distress who may be considering taking out a higher interest loan to get creditors off their back do instead? Are there any good options? Again, take a moment to pause. Realize that high interest loans can just make a bad situation worse.

If you're feeling really overwhelmed by your debt, reach out to a nonprofit credit counseling agency. These organizations are squarely focused on helping consumers navigate their debt, particularly credit card debt, in a way that's affordable. They may even be able to help you slash your credit card interest rates. Work to find a solution that keeps your head above water and moving toward resolving your debt. Thanks for that, Sean. And thank you, Anna.

Up next, we answer a listener's question about home buying considerations. But before we get into that, a reminder, listener, to send us your money questions. Do you want to know how to diversify your stock portfolio? Have you been wondering about how to budget effectively to reach a new financial goal? Leave us a voicemail or text us on the Nerd Hotline at 901-730-6373. That's 901-730-NERD.

or email us at podcast at nerdwallet.com. Now let's get to this episode's money question. That's coming up next. Stay with us.

We're back and answering your money questions to help you make smarter financial decisions. This episode's question comes from Nikki, who sent us an email. Here it is. Good morning. I am tired of renting and want to buy a house. I feel like renting is throwing money away. I've never bought a house before. Where do I begin? How much did I put down for a deposit? What are closing costs and how expensive can that get? I've heard that there is a loan for first-time homebuyers, but I'm not sure how that works.

And is it smart to use my 401k toward the cost? Thank you for your time, Nikki. To help us answer Nikki's question on this episode of the podcast, we are joined by mortgage nerd, Abby Baydack-Doyle. Thank you for having me.

Abby, our listener Nikki would like to buy a house, but they don't know where to begin. So let's start with that. Where should Nikki start? The very first step is to understand what monthly mortgage payment you can afford. And NerdWallet's Home Affordability Calculator is a really helpful first step here. So another general rule of thumb is the 2836 rule. That says to spend no more than 28% of your pre-tax income on housing costs.

And then no more than 36% on all debts. So that includes your mortgage, your car payment, student loans, things like that. So once you have that comfortable monthly payment, you can play with different down payment amounts to see which home prices would be affordable, which prices are a stretch, and what's out of your price range entirely.

Abby, so I have a question for you. I am in a mom's group and I see a lot of people asking questions about how they can get into buying a home, even though they're on an extremely tight budget. So some people say they're barely making ends meet, but they're still looking for a way to buy a house. So what would your kind of thoughts be on that? So there's two ways.

kind of prongs to this, right? First is the financial readiness, but then there's also, you know, the emotional readiness of, are you ready to settle down? Are you ready to stay in the same place for a while? So that 2836 rule is a really useful percentage guideline because you can back into your budget based on like what your household budget and the numbers that you're working with right now. So

You definitely don't want to stretch your budget more than what's comfortably affordable. You know that term house poor. But if you're able to make the numbers work with what you know about your cash flow, it is possible even with home prices being what they are.

Okay, that's helpful. So Abby, let's talk about down payment a little bit. Can you outline how much Nikki or anyone else looking to buy a house might need to put down? I think some people are still believing that you have to put down 20%. But that's not exactly the case anymore, right?

That is such a myth, Sean, that it's like the most popular home buying myth that we encounter on the team. So you don't need to put 20% down to buy a house. And actually, the median down payment for first-time homebuyers, according to the National Association of Realtors, is only 9%.

And even below that, some loans have a minimum of 3% for conventional loans. 3.5% is the minimum for FHA loans. And some loans, like USDA and VA mortgages, don't require a down payment at all. So definitely don't need 20% down to buy a house. To share a personal story, when we bought our house last year, we expected to make a larger down payment, but we bought a house that we wanted to do some renovations right away.

So we only put down 5% so that we would have more money in the bank for those renovations. So we tackled a minor kitchen remodel. We remediated some knob and tube wiring. And having that cash in the bank was super helpful. So the rule of thumb with down payments is larger down payment means a smaller monthly payment. But a smaller down payment leaves more cash in the bank for other stuff. So it's really about what's most comfortable for you.

That's a really good point, too, because when I was buying my house years ago, I put down 3% and that was really the only way I could afford to buy a house. And so, sure, my monthly payment is greater than it would be if I had put down 20%, but it got me in the door and my monthly payment is still manageable. So that's just an individual calculation that everyone will have to make for themselves. For sure. And then you're in there, your foot's in the door, and you're building that equity. And what about

people who are worried about PMI because I hear that all the time as well that, well, if you don't put 20%, you're going to have to pay that PMI. Is that a myth to you? PMI or private mortgage insurance is what protects the lender if you make a down payment less than 20%. So that is a real thing, but it's an additional fee that's tacked onto your loan and it drops off once you hit that 20% equity. So you're

mortgage broker or your loan officer can help run the numbers at different down payment amounts so that you're able to understand how much PMI you would be paying and how that would impact your monthly payment. - My PMI was a bit of a PIA, if I can say so. And so once I hit 20% equity, I requested that my PMI drop off 'cause it happened less than two years after I closed on my house due to the surging home prices and the immediate aftermath of the pandemic.

And I was able to shave off about $150 of my monthly payment just by getting rid of that. So if you are paying PMI, know that you can eventually get rid of it. And it, again, is worth it just to get you in the door.

Well, let's turn to closing costs because those are also a bit pricey. Abby, can you give us the rundown of those? Closing costs are those miscellaneous fees that complete the transfer of ownership of the property. So that's something that you pay at the very end of the line on closing day when you're handing over the keys.

and they run 2-6% of the loan amount. So you typically pay for those in cash or a wire transfer or a cashier's check. So the important thing to keep in mind when you're budgeting for a house is it's not just the down payment. You do want to have some wiggle room for the closing costs, as well as all of those cash expenses that you'll pay along the way, like a home inspection, things like that, moving costs. So it's not just the down payment.

Definitely account for a wiggle room for closing costs and other miscellaneous expenses, too. So now that we've discussed down payments and closing costs, Abby, how can we actually fund buying this home? What are the options? To tackle those larger questions about loans and financing, I know Nikki asked about a first-time homebuyer loan. But there's not just one type of loan for first-time homebuyers. There's definitely a lot of options.

And this is where someone like a mortgage broker can really be helpful in explaining your options and helping you shop around. So common options for first-time homebuyers include conventional loans, as the name suggests, that's the most common type. Conventional loans allow for lower down payments, that 3% figure that I mentioned before. Another popular option for first-time homebuyers is FHA loans, which are guaranteed by the Federal Housing Administration.

Those can be easier to qualify for if you've had credit challenges, if you're building your credit, if you have a lower credit score. So typically conventional and FHA loans are the most common options for first-time homebuyers.

One thing Nikki didn't ask about in their question was credit. Are there any general guidelines that you think Nikki should keep in mind around what credit score they might want to have before they go shopping around for mortgages? For credit score in general, just like everything else, the higher the better. You're going to have a more competitive interest rate. You're going to have more options if you have a stronger credit score.

Most borrowers have scores in the high 600s to low 700s, and each lender is going to set their own minimum credit score by loan type.

Okay. And I've heard that the best rates go to those with a credit score 740 or above. Is that still true? Yep, that's correct. Okay. In that case, do you think it's worth people waiting, maybe if they have a lower credit score, waiting and improving their credit score before trying to apply for financing? I love that you brought that up because that can be such a useful first step and that can really make a difference if you're able to get a lower interest rate with a better credit score. Bill,

Building that credit as a first step in home buying readiness overall is a really smart place to start.

All right. So the listener also wanted to know about borrowing from your 401k to buy a house. So what are your thoughts on that? That's an option if you don't have a lot of cash saved up, but it is risky and I'd consider that to be a last resort. And Sean, I know you have some thoughts and experience on this topic too. I do have thoughts on this topic. I am generally not a fan of using retirement funds to pay for a down payment on a house.

401k loans, which Nikki asked about, can be particularly risky. If you quit your job or are fired, you will have to repay that loan in short order. Plus, borrowing from your 401k can result in a hit to your retirement savings, which can make it just that much more difficult to save enough for your golden years.

Now, beyond 401ks, traditional and Roth IRAs allow you to pull up to $10,000 of funds from your account penalty-free for a first-time home purchase if your account has been open for at least five years. But you may owe income tax on the earnings portion of what you take out, depending on the type of account that you have. Now, you can take your contributions from an IRA at any time, but here's my gripe with that. This is a retirement account IRA.

I don't like to view it as a savings account. I think it's important to have some psychological separation between what's a savings account in your bank and what's a retirement account so that people aren't using a retirement account like a piggy bank.

And, you know, it's also technically possible to take a withdrawal from your 401k and use that money for a down payment. But that's also not a great idea because it generally comes with taxes and penalties. So, again, I'm not a big fan of this route to homeownership. If the issue is that you don't have a lot of cash saved up, I'd recommend looking into down payment and closing cost assistance instead of tapping your 401k.

Down payment assistance. That is something I am not a homeowner like you two, but there was a time during the pandemic when I was looking into buying a home and I did look at the down payment assistance programs. So can you break those down for us, Abby? What is it and how does it work? So most down payment assistance programs, also closing cost assistance programs,

Most options are available to first-time buyers with low to moderate incomes, but there are some options out there that include higher income or repeat buyers.

Down payment assistance, it can come in the form of a grant. So that's, you know, free money that you don't have to pay back. A forgivable loan. So if you stay in the house for five or 10 years, then the loan is forgiven. Or a low interest loan with, you know, good repayment terms. So sources for down payment assistance. The big one is state housing finance agencies. But you can also find grants and assistance through local nonprofits, nonprofits,

local governments, so, you know, your city, your county, and different mortgage lenders. So credit unions, banks, a non-bank mortgage lender, even some employers have first-time homebuyer assistance to incentivize employees to buy in their HQ city.

Abby, when I was researching all of these options, one thing that I felt was overwhelmed because there were so many options and so much information. Do you have any tips for how people can maybe start the process without feeling overwhelmed of researching? Definitely assemble your home buying squad so you don't have to go all of this alone. Find a good buyer's agent who's experienced working with down payment and closing cost assistance programs online.

Again, a good mortgage broker, a loan officer, someone who's really experienced and like does this day in, day out for a living. It can be really overwhelming to like run an online search and just be inundated with information. So, you know, assemble your squad, surround yourself with people who are experienced and that you trust and can steer you in the right direction of stuff that works for you.

Another resource people may not be aware of are first-time homebuyer classes, which can help make homebuying more affordable, too. Can you talk us through that? Before you can receive down payment assistance, some loans and programs require you to complete a first-time homebuyer class. But

Honestly, even if it's not a requirement, it's a great first step to learn and understand the process and feel really confident about what you're getting into. So a first-time homebuyer class covers all the basics, all the stuff that we're talking about now. Many are available for free online at a self-study pace. You can also find a class online or in real life if that's your speed. But there's a lot of options to just kind of like check all the boxes, understand the steps, and

And it's a really good place to start if you're feeling a little overwhelmed. And even if someone thinks that they know everything about buying a house, if you haven't done it before, there are going to be things that you don't know. And this is likely the biggest purchase you will ever make in your life. So it's worth doing a bit of homework. And if folks want to learn more about first-time homebuyer classes, we have an article on the NerdWallet website, and we will link to that in the episode description.

I'm with you on that. You guys know I love a Facebook group. The Facebook groups that I've poked around in as well, lots of people express regret over not realizing how expensive it was going to be to own a home. So I second that in terms of doing the class. And I think this is a good segue into the rent versus buy question that the listener had. So what are your thoughts on that, Sean? What are your thoughts on renting versus buying? Yeah, when Nikki said in their question that they feel like

renting is throwing money away. I thought to myself, I don't think so, Nikki, I disagree with you because there's nothing wrong with renting. It's not really throwing your money away. You are buying a roof over your head every month and you have so much more freedom when you're renting. Also, let's just be honest, renting can be so much more affordable for many people.

When you are renting, your monthly rent payment is the most that you are going to pay for your housing each month. And Abby, as I'm sure you know well, when you are a homeowner, your mortgage could be just the minimum you pay for housing that month because you might have to repair something in your house or have some other...

Home-related expense. You're giving me flashbacks, Sean. Yes, that's very true. Okay. Please go on. Tell me. I love our house, but I do miss the simplicity of renting sometimes. Like in the first year of homeownership, we're fixing toilets, we're painting, we are...

redoing drywall. We are replacing ceiling fans. I had no idea there were so many different types of ceiling fans. I've spent so much time and money at the local hardware store and no regrets because it's really worthwhile and there's a sense of pride and ownership and, you know, making things exactly the way that we want them to be. But it is a lot of work and you have to be like up for that. And what they say is true that owning a home is a lot of work.

And it may not be as glamorous as it's made out to be on all of these social media pages where people are DIYing their home improvements and make these beautiful white kitchens. Sometimes you're just replacing the pipes in your walls. Exactly. That is not sexy. I personally prefer the idea of renting during this phase of my life, and I am focused on maximizing my retirement savings. So all the things you guys said, it just reaffirms my decision right now to not want to own a home.

I love calling up my landlord. The other day, actually, my water heater broke and I was without hot water for, I don't know, maybe a week or two. But the point is, I didn't have to replace that. And I know that was expensive. So my landlord was in charge of that. You don't need to own a home to be an adult.

No, absolutely not. It really is a matter of priorities, Elizabeth. You're prioritizing saving for retirement right now. And you also recently moved to where you're living. So I feel like you're still settling in, in a way. And you don't really want to buy a place unless you're going to be there for at least five years so you can come out ahead. How did you know? That was one of the things, too, because I was like, I might not like Texas and I might need to move and I don't want to be stuck with a house. So that was part of my reasoning, too.

So Abby, do you have any final thoughts on how Nikki or anyone else who's looking to buy their first home might be able to do so when everything is so expensive right now? I know that there's a lot that feels scary in today's housing market. There's, you know, high prices and mortgage rates are really unpredictable. But at the end of the day, if you are ready to settle down and you're ready to put some roots down and create a space and design a space that facilitates the life that's meaningful to you, it is still totally possible to buy a house and it

might sound simple, but having that positive attitude and planning ahead can really be a power move to help you reach that goal. Well, Abby, thank you so much for coming on and sharing your insights. Happy to be here.

And that's all we have for this episode. Remember, listener, that we are here to answer your money questions. So turn to the nerds and call or text us your questions at 901-730-6373. That's 901-730-NERD. You can also email us at podcast at nerdwallet.com. Or if you're listening on Spotify, drop us a comment to let us know what questions you have or even just what you think of the episode.

Don't forget to follow Smart Money on your favorite podcast app, including Spotify, Apple Podcasts, and iHeartRadio to automatically download new episodes. And tune in next week to hear about how to manage the financial side of wedding planning, something I am in the middle of for my own wedding. And here's our brief disclaimer. We are not your financial or investment advisors. This nerdy information is provided for general educational and entertainment purposes, and it may not apply to your specific circumstances.

This episode was produced by Hilary Georgie and Anna Helhosky. Hilary also helps with editing. Nick Karistamy mixed our audio and a big thank you to NerdWallet's editors for all their help. And with that said, until next time, turn to the nerds.