Down payment vs student loans: where to put your money


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You have student loan debt. You would like to buy a house. Is it better to pay off student loans before you start saving for a down payment on the home?

This is a common question for American buyers. On the one hand, paying off your student loans before saving for a down payment could qualify you for a larger mortgage because you will have less debt. It might also give you the psychological advantage of knowing that you are officially excluded from these college loans.

On the other hand, waiting to start saving for housing means being locked out longer as a tenant. Plus, home prices, already high in most of the United States, will have time to rise further before you’re ready to buy.

It’s no secret that student debt can be a barrier to achieving other financial goals. A recent National Association of Realtors study found that first-time homebuyers struggled to put down a down payment, nearly half said student debt held them back in saving for a home.

Saving for a down payment is already taking longer now than before the pandemic. It is already taking longer to save a down payment now than before the pandemic. According to an analysis by home-buying startup Tomo, in August, a first-time home buyer would need about seven years and 11 months to save a 20% down payment on a mid-priced home. In January 2020, the same buyer would have needed seven years and a month.

It is not just a pandemic trend. The time required to save for a down payment has also increased over the past 20 years. In June 2001, the average first-time home buyer needed about six years to save on a 20% down payment.

Pair this growing challenge with increasing average student debt and longer loan repayment terms, and you’ve got a perfect storm of competing financial challenges: prioritize paying off student debt or saving for a down payment? To find out what’s right for you, answer these three questions:

What are your other financial priorities?

Can you buy a house before you pay off your student loans? The answer, according to many financial planners, is “it depends”. Everyone says that a bad student loan balance doesn’t have to kill your dreams of home ownership.

But the decision to focus on saving for a home before paying off your student loans is a decision you should make in the context of your total financial life. Two to three financial goals is the most everyone can work on at the same time, says Kristi Sullivan, a financial planner from Denver, so make sure you’ve built a solid financial foundation before you start saving for a home.

You will want to pay off any credit card debt. This debt almost certainly carries a higher interest rate than your student loans or a mortgage, so pay it off first.

Build an emergency fund, which should contain about six months of your basic expenses. This money could help you get through a period of unemployment, write off an unexpected expense, or even help you take advantage of a sudden opportunity. Put the money in a savings account or certificate of deposit where you know you can easily access it if needed.

Finally, start or continue saving for retirement. The more you can set aside while you’re young, the more years your investments will have to take advantage of the multiplier power of compound interest. You should at least save an amount that allows you to take full advantage of your employer’s matching funds, if offered. It’s free money and gives you a 100% rate of return, even if it never earns another dime.

How much debt do you have and how much is it costing you?

Once you have secured a solid financial foundation, you need to weigh the details of your student debt balance.

In the United States, the average borrower owes about $ 29,000 on bachelor’s student loan debt, that number jumps to $ 66,000 for master’s degrees in general, and it rises to $ 145,500 for law school. , $ 202,400 for degrees in health sciences like dentistry and pharmacy and a whopping $ 246,000 for medical school, according to the National Center for Education Statistics. From bottom to top, it’s a difference of $ 217,000.

Interest rates on student debt also vary. The rates on federally guaranteed debt for undergraduate degrees are the lowest and range from 2.75% to 4.66%, depending on the year you took them out. Graduate debt bears interest between 5.3% and 6.6%, and PLUS loans can be as high as 7.6%. Interest rates on private loans are generally higher, ranging from 3.34% to 12.99%.

Where your debt falls within these ranges will help you determine the best option for you. A difference of a few percentage points in your interest rate is a lot of money over a period of several years. For example, at 3%, a total loan of $ 29,000 would cost you $ 4,860 in interest over 10 years, while a loan balance of $ 246,000 would cost $ 39,050.

But at 5%, the amount you spend on interest drops to $ 7,900 on the smaller balance and $ 67,100 on the larger.

Simply put: if your interest rate is low, it’s easier to pay the minimum on your student debt while putting more money into your down payment. But the more you owe and the higher your interest rate, the better off you pay off the balance before the due date, even if that means it will take you longer to save a down payment.

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Refinancing your student loan could allow you to pay off your student loan debt sooner.

Lower your interest rate or lower your monthly payment.

Refinance my student loan

Can you afford a house?

A faster repayment plan means you’ll pay less interest, but that might also be what you need to do to qualify for a mortgage.

If your student loan balance is high relative to your salary, your debt-to-income ratio may be too high to qualify for a mortgage, even if you’ve spent years saving for a down payment. In that case, a lender will make that decision for you: You can’t buy a house without paying off your student loans, Sullivan points out.

Mortgage lenders generally prefer borrowers with a debt-to-income ratio of 36% or less. You can be approved if your ratio is higher, but probably with a higher mortgage interest rate. (To calculate your ratio, use Money debt ratio calculator.)

Keep in mind that when you buy a home you will have more freedom than you have as a tenant, but you will also take a greater risk. When you own a home, you have to pay for insurance, taxes, utilities, and what can seem like endless maintenance expenses. This can include everything from cleaning gutters to installing a new roof. With your other time commitments and expenses, including your student loan payments, can you afford to buy a seat and take good care of it?

“A home is important and it shouldn’t be taken lightly,” says Logan Murray, a financial planner in Tempe, Arizona. But, he adds, “You still don’t need to let student loans rule your life.”

More money :

7 tips for getting a mortgage when you have a student loan

A housing economist did the math on how long it takes to save for a down payment – and that’s not pretty

How to prepare for the next student loan repayment

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About Matthew R. Dailey

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