You have student loan debt. You would like to buy a house. Is it better to pay off your student loans before you start saving for a down payment on your home?
This is a common question for US home buyers. On the one hand, paying off your student loans before saving for a down payment could help you qualify for a better home loan because you’ll have less debt. It might also give you the psychological benefit of knowing you’re officially free of monthly student loan payments.
On the other hand, waiting to save for a home means you’ll be stuck as a renter for longer. Plus, home prices, already high in most of the United States, will have time to rise even before you’re ready to buy.
It’s no secret that student debt can be a barrier to achieving other financial goals. A study by the National Association of Realtors found that among first-time homebuyers who struggled to raise a down payment, nearly half said student debt delayed them from saving for a home.
It already takes longer than ever to save up for a down payment. In June 2001, the average first-time home buyer needed about six years to save up for a 20 percent down payment, according to home-buying start-up Tomo. Now, homeowners regularly take nearly a decade, Zillow reports.
Couple this growing challenge with rising average student debt and longer loan repayment terms, and you have a perfect storm of competing financial challenges: Saving a down payment to buy a home or paying off student loans? To understand which one suits your personal financial situation, answer the following three questions:
What are your other financial priorities?
Can you buy a house before paying off your student loans? The answer, according to many financial advisors, is “it depends”. Everyone says that an outstanding student loan balance doesn’t have to kill your homeownership dreams.
But the decision to focus on saving for a house before paying off student loans is a decision you should make in the context of your larger financial plan. Two or three financial goals are the most anyone can work on at one time, says Kristi Sullivan, a financial planner in Denver, so make sure you’ve built a solid financial foundation before you start saving for a house.
You’ll want to pay off any credit card debt. This debt almost certainly carries a higher interest rate than student loans or a mortgage, so get it out sooner. Then compare the rates on other types of debt you may have, such as personal loans or auto loans, to your student debt.
Build an emergency fund, which should contain about six months of your major expenses. This money could help you get through a period of unemployment, cushion an unexpected expense, or even help you take advantage of a sudden opportunity. Put money in a high-yield 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 put away while you’re young, the more years your investments will have to harness 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. This is free money and gives you a 100% rate of return, even if you never earn another penny.
How much debt do you have and how much does it cost you?
Once you have secured a solid financial footing, you should evaluate the specifics of your student debt balance.
In the United States, the average college graduate has more than $29,000 in debt. That number jumps to $53,920 for master’s degrees overall, and tops out at $132,740 for law school and a whopping $191,920 for medical school, according to the National Center for Education Statistics.
Interest rates on student debt also vary. Rates on federally backed debt for college degrees are the lowest and can range from 2.75% to 5.5%, depending on the year you took them out. Graduate school debt carries interest between 5.3% and 6.8%, and PLUS loans can be as low as 8%. Interest rates on private loans are generally higher, often reaching double digits.
Where your debt falls within those ranges will help you determine the best option for you. A difference of a couple of percentage points in the interest rate equates to a lot of money over a period of years. For example, at 3%, a total loan of $29,000 will 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 increases to $7,900 on the smallest balance and $67,100 on the largest.
Simply put: If your interest rate is low, then there’s less harm in paying the minimum on your student debt by pushing more money into your down payment fund. But the more you owe and the higher the interest rate, the better it is for you to pay off your balance ahead of schedule, even if that means it takes you longer to save up for a down payment.
Can you afford a house?
A faster student debt repayment plan means you’ll pay less interest, but it may also be what you need to do to qualify for a home mortgage.
If your student loan balance is large 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. If so, a lender will make this decision for you: You won’t be able to buy a home without paying off your student loans, Sullivan points out.
Mortgage lenders typically prefer borrowers with a debt-to-income ratio of 36% or less. You may be approved if your ratio is higher, but likely with a higher mortgage interest rate. (To calculate the ratio, use The one about money debt-to-income ratio calculator.)
Keep in mind that when you buy a home, you’ll have more freedom than you have as a renter, but you’ll also take on more risk. When you own a home, you’re dealing with insurance, taxes, utilities, and what can seem like endless maintenance expenses. This can include anything from cleaning gutters to putting on a new roof. Given other time commitments and expenses, including student loan payments, can you afford to buy a place and take care of it?
“A house is a big thing and shouldn’t be taken lightly,” says Logan Murray, a financial planner in Tempe, Arizona. But, he adds, “You don’t need to let student loans run your life just yet.”
This story was originally reported and published in 2021. It has been republished with updated data on student debt and down payments.
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