Pay off my student loans or make a large downpayment on a home?

December 31, 2010 2:44 PM

Should I pay off my student loans or put a down payment on a house?

I have $35,000 saved up to put a down payment on my home. My student loans also total around $35,000, I have no other debt. My parents are adamant that I pay off my student loans, then think about saving up and buying a house. I currently pay $450 a month in student loans, it would take around six and a half years to earn back the money spent on the loans. I also get tax breaks on the loan interest and assuming the economy doesn't stay in the tank, in five years I'll still be paying the same amount but earning more.

With a house I'd also be buying in a down market with the opportunity to actually get a return on my investment. Housing prices could continue to drop, but I think with the area I'm in, they'd at least stay stagnant. There's some risk involved, as with any investment, I think the upside is much more lucrative.

My parents and my girlfriend, on the other hand, think I'm crazy and should pay one debt down before taking on a mortgage. They don't pay my rent or my student loans and will be contributing nothing to my house purchase, so their opinion doesn't really matter, but I'm willing to at least take it into consideration. I really don't see why they're so uneasy with the concept of multiple debts, especially when one is an asset with growth potential, unlike student loans or a car payment.

Is my reasoning correct or am I missing something? Is my family just being a bunch of hardcore no-debtors? Considering they come from the school of thought that 5-year car loans are okay, I don't take financial advice from them, but the fact they're being so conservative has given me pause.

posted by anonymous to work & money (29 answers total)

I agree with your parents and girlfriend: Pay off the student loans before you take out more loans.
posted by dfriedman at 2:57 PM on December 31, 2010 [1 favorite]

You'll need to do the calculations, but I strongly suspect you'll find that your student loan interest is much, much lower than the substantial compound interest you'll pay over the term of a home mortgage.

I would try to reduce the principal you would borrow to buy a home, if you want to reduce how much interest you pay overall. This could mean buying a less expensive home, as well as putting more money into a down payment.
posted by Blazecock Pileon at 3:06 PM on December 31, 2010 [2 favorites]

Financial decisions should be made with data. There isn't enough data here to help you. What is the interest rate on your student loans? How much of that do you get back in taxes? How much does a house that you might buy cost in your area? What do you pay in rent now? How sure are you that you want to stay in your area?

On the face of it, there is no specific reason to avoid having two debts (mortgage and student loan), but without knowing more about your particular situation, it is impossible for anyone to provide you with useful advice here.
posted by ssg at 3:07 PM on December 31, 2010 [5 favorites]

Did your parents co-sign on the loans?
posted by bq at 3:10 PM on December 31, 2010

I'd first evaluate whether or not you want to buy a house, completely independent of the student loan issue. That's a decision that depends on the housing market in which you live, the affordability of monthly payments, the length of time you plan to keep the house, and all sorts of other considerations.

If you decide to buy, keep whatever debt is the cheaper one. Without knowing the particulars of your situation, it seems to me that the student loan debt will usually be a less expensive burden than a mortgage on a house that you've bought with less than 20% down. Not only will you have a larger monthly payment, but you'll be paying PMI and possibly be subject to a higher fixed rate, since the bank is taking on a higher risk that you'll go underwater on the mortgage. Since (i) you have no credit card debt, (ii) the loan balance is relatively small and (iii) you're reasonably confident about your earning potential, I don't see why you'd need to be in a hurry to pay down student loans.
posted by Saucy Intruder at 3:10 PM on December 31, 2010 [1 favorite]

What's the interest rate on the loans? How does it compare to the interest rate you might pay on a mortgage? Would you be spending all $35k on a downpayment, or leaving yourself some savings too (for house repairs etc)? Are you looking at a price range where your downpayment would cover at least 10%, preferably 20%?

I tend towards saying you should keep the loans and buy a house, but only if the loan interest is very low, if you have enough to make a 20% downpayment, PLUS leaving yourself savings in case of emergency repairs (roof replacement etc). The tax break on the loans and the tax break on the mortgage, plus your "rent" money goes into your investment instead of someone else's pocket seems like a good idea.

If you don't have enough saved for the 20% down plus repair buffer, then keep saving until you do. If your student loan rate is high, then pay that off first.
posted by Joh at 3:11 PM on December 31, 2010

It is a mistake to think of a house as an investment. You should only buy a home as a lifestyle preference, that is, you don't like renting and like the idea of home maintenance, a yard, etc. And only buy a home if you are sure you will be living there for at least 5 to 7 years.

A home is a risky, undiversified investment. It is like betting all your money on one spin of the roulette wheel. If you want to invest, use low cost index funds, e.g. Vanguard. In this way you own thousands of diversified stocks and no one failure will hurt you.

Whether you should try to pay off your loans more quickly with additional payments depends on the interest rate, whether the interest is deductible and whether you have already maxed out your retirement investment accounts.

If the interest rate is high, pay off the loan as quickly as possible. If the interest rate is low, max out your retirement accounts first, then dedicate whatever is left to the loan.
posted by JackFlash at 3:15 PM on December 31, 2010 [8 favorites]

Stop thinking of the house as an investment. It just isn't. It might not depreciate as much as a car, but it is a place to live, and a purchase that should only be made if (a) you can afford it, and (b) it is cheaper over the long term than renting a comparable place. Romanticizing house-buying, or thinking of it as an investment, is what causes housing bubbles.

That said, the interest on the student loans should only be considered an additional expense involved in buying the house, so if the math works out in your favor, and you're certain about sticking around, go for it. (A note about the math: you will get a better interest rate with more income and less debt. That's another marginal cost.)

When in doubt, talk to a financial planner.
posted by supercres at 3:17 PM on December 31, 2010

I think real estate is still overpriced in most markets. Some references: Calculated Risk, patrick.net.
posted by monstrouspudding at 3:18 PM on December 31, 2010

There are a lot of details that would factor into this decision that aren't listed, namely: How old are you, are your long term earning prospects solid, do you have a healthy emergency cash-pad already, what does your retirement picture look like, what's the interest rate on your student loans and how much houses cost in your area. If you don't have 3-6 months worth of expenses stashed away, do that first. If you don't have a retirement account (Roth IRA and/or 401k), you can't back-fill if you miss a year, so max it out for 2010. Buying a house can be a big risk, so make sure you have some cash stocked away for possible repairs or unforeseen expenses.

The housing market is a tricky thing right now. On one hand there can be good deals, but on the other hand there are plenty of people saying that prices are still inflated and will eventually drop. If I were you I'd keep the money close and liquid and bide my time for the next year. Feel out the housing market, if it really rebounds you'll know and will hopefully catch it on the up-swing. If it double-dips, maybe there will be great bargains to be had.

There's nothing wrong with paying things off over time, especially if the interest rate is low and you have steady, bankable income.
posted by jeffkramer at 3:18 PM on December 31, 2010

How long would it take you to save up that 35k again, including saving that extra $450 you are currently putting toward the loans? Is the the 6 and a half years you mentioned, or something else? If you can save $800 a month, and even without earning interest, you'll have over 38k 4 years. That's not a lot of time! Pay off the loans, redirect that money toward savings. Good luck!
posted by two lights above the sea at 3:20 PM on December 31, 2010

IANYREA, but my associates in the real estate bizness say the common knowledge is that for an amateur to plunge into housing investment for the purposes of speculation is like gambling with really big-sized poker-chips.

It is worth buying a house if you really need one and intend on living there yourself for many years, but playing the market just for gain always carries a risk factor.

Now I can't factor in how good your tax breaks are, but the interest on $35K over several years should be a pretty good chunk of cash. So if you were able to pay it off quickly you would be making a decent investment right there.

So from a bottom line view your family is right. And if gambling is in your blood there will always be Vegas.
posted by ovvl at 3:25 PM on December 31, 2010

How about paying some of the loan off whilst continuing to save?
posted by freya_lamb at 3:25 PM on December 31, 2010

You have 35K saved up and you're paying interest on student loans?

Dude, that is nuts.

You should never have gotten into this position. Interest on the loan means you're paying a little money today for the privilege of paying money tomorrow. But you already have the money today, so why are you paying for it?

This is like having a pool with a leak. You have the leak-fixer in your hand, but instead, you're just dumping more water into the pool to keep it filled.

Pay off your debt today.
posted by Cool Papa Bell at 4:09 PM on December 31, 2010 [10 favorites]

If you don't pay off your loans and you use the money as a down payment on the house, you are compounding the interest problem. Suddenly, you're not only paying interest on the $35K, you're also paying interest on the whole house. It would be absolutely throwing away money. It may take you six years to pay off the loan, but you're also throwing away all the money you're paying in interest and could be making on interest elsewhere. It is absolutely insane to buy a house instead of paying off the student loans.
posted by stoneweaver at 4:19 PM on December 31, 2010

You should never have gotten into this position. Interest on the loan means you're paying a little money today for the privilege of paying money tomorrow. But you already have the money today, so why are you paying for it?

If your student loan interest is lower than what you can earn by investing, then paying off a student loan is a losing proposition.

My student loan interest rate is less than 1% right now - it's like 0.2%. It makes much more sense to invest my savings at even 1% - that gives me an effective profit of 0.8%.
posted by muddgirl at 4:26 PM on December 31, 2010

What's your interest rate on your student loan? If it's super low, then I don't see the rush to pay it off--and I do think buying a house can be a very sensible thing. Student loans aren't typically like credit card debt, with high interest rates. There can be such a thing as good debt. Paying that student loan regularly can be helping you build good credit.

If you are planning to live in the house at least a few years, then I do think buying a house can be a good move--especially since you are probably paying rent right now.
posted by bluedaisy at 4:49 PM on December 31, 2010

How long have you been paying your student loans? Student loans are typically amortized such that the early years are spent paying off most of the interest and principle isn't paid until the later years. If you've already paid off most of the interest, you gain no economic advantage from paying off the principle immediately.
posted by mr_roboto at 4:59 PM on December 31, 2010

Stop thinking of the house as an investment. It just isn't.
... and ...
Pay off your debt today.

These are... misguided. A home is not only an investment, sure, but it's also a considerable investment, and you should be prepared to go into that sort of long term, eggs-in-one-basket investment with an unsentimental outlook and ready to make some difficult decisions.

Your goal here should be positive net worth, which doesn't necessarily mean zero debt. If you are fully committed to buying a house, and are considering whether or not to put that $35k against the house or the student loan, then compare the cost of maintaining the student loan debt against the savings to the total cost of your mortgage over the same period.

If your mortgage costs are that much higher than your student loan costs, then putting the $35k towards the house instead of the student loan effectively means you get to maintain that part of your debt at student loan costs, rather than mortgage costs. Having said that, I understand student loans need to be repaid in a certain time period, and there are other elements at play like the fact that you can't declare bankruptcy to escape them. In any case, run the numbers and see what debt will cost you less and assuming you're prepared to assume that risk then go that route.

If, on the other hand, you have not committed to buying a house yet, then it would be a good idea to start putting some, maybe not all, of that money towards your student loans.
posted by mhoye at 5:10 PM on December 31, 2010

As noted above, more data would help. Your job history, income, job stability, emergency fund, retirement fund, cost of current housing, total cost of a house, mortgage rate, loan rate and so on would really help us give better advice.

You haven't indicated whether you have an emergency fund. Before you even think about buying a home, you should have 6-9 months of expenses set aside -- above and beyond your downpayment. You should also have contingency funds for emergency-like non-emergencies, like the washer breaking, the furnace breaking down, etc. And then some small funds for things like the furniture and home improvements you will inevitably need.

Kudos to you for saving $35k. But it's hard to say where that will take you. Where I live, that would be less than 10% down on a 1BR condo, and you'd still have about $1800 a month to pay for mortgage/strata/taxes....and then eat, pay utilities, get to work, etc - and pay that $450/month student loan.
posted by acoutu at 6:31 PM on December 31, 2010

The housing market hasn't bottomed yet, according to a LOT of experts. I would pay off the student loans.
posted by Slinga at 6:50 PM on December 31, 2010

First thing-congrats on saving that money, and further congrats on doing your best to make a good rational decision on your financial future. With these kind of habits you are likely to do just fine (but anyone can make mistakes, so don't get cocky) with any decision.

Being debt free is always preferable to having debt, however we all live in the real world and with the setup we have it just isn't possible for most of us to be debt free, and sometimes it is better to be in debt now to enjoy a life style you want. I totally agree with mhoye's advice above.

I would very carefully evaluate the housing market where you live (BIG hint: if the median price is equal to or less than three times the median household income in your area (Lookup MSA statistics for your area on the bureau of labor statistics page) than the housing market is not overpriced in your area, but there are few more things to consider) It really is true that there isn't one housing market for the US. Kinda what happened (and not the only thing but one of them) is that there WAS one lending market for the US and so loans got made to people that shouldn't have been made and now there are lots of foreclosures, driving down prices. For some places that meant big drops that aren't over yet, for others it meant little drops that now represent a great buying opportunity IF you have the money to make a 20% down conventional loan.

I have friends that bought a nice house in phoenix a year ago for about twice there yearly income and are doing great, they bought at the bottom for their house and now have a fairly easy time paying all there bills, an easier time than they did renting and get a huge house to live in. They did give up some mobility for equity but they aren't in a hurry to move and have a stable employment.

So my biggest advice is to carefully evaluate how much house you can afford and then decide if living in that house is the lifestyle you want, or is being out of your student loans (no small thing either) is the lifestyle you want. And remember in the long run we are all dead so for gods sake make the decision that will make you happiest and sleep best at night and run with it.
posted by bartonlong at 7:41 PM on December 31, 2010

To clarify: I don't think there are enough facts for anyone in AskMe to make a determination - perhaps the OP should speak with a financial advisor who can be completely acquainted with the particulars. In general, paying down any debt is a good idea; however, in specific circumstances that may apply to the OP it is not a good idea to overpay low-interest differ-able debt like some student loans. It all depends on particulars... which are not really given.
posted by muddgirl at 9:03 PM on December 31, 2010

What stood out to me is that your girlfriend is against it. Does she live with you? Is living together in your long term plans? If marriage is in the cards (long term) understand that your debt will become her debt, so she's right to worry. I ask because if you buy a house now, and stay with your girlfriend long term, she will probably end up moving into whatever house you chose now, which might not be the house that would be best for her. Especially since her opinion already doesn't matter.
posted by fermezporte at 9:18 AM on January 1, 2011

You never know what the future will hold. I think that the most valuable thing many people have learned as a result of the recession is that you can't really rely on your life situation to remain the same. You could lose your job, or have some kind of medical emergency, or experience a fire. I sincerely hope that none of those things actually do happen to you, but you never know. Paying off your loans now would mean that you have one less thing over your head that you would have to worry about should something happen. Pay them off. Just think of how freeing it will feel! Then you can start with a clean slate while you save up for a down payment.
posted by delicate_dahlias at 10:23 AM on January 1, 2011

It may not be the best purely financial advice, given low interest rates, but I'd pay off the student loan as quickly as possible. Owing money sucks. Pay it off, and know that every penny you earn after that isn't going to pay off a debt. It's one less thing you can worry about - and it's something you can erase from your life now.

There are all kinds of arguments that could be made about property values and the time-value of money and whatnot - but from my personal experience, NOT having debt hanging over you is a fantastic feeling.

Stop thinking of a house as an investment. A mortgage costs you money. House maintenance costs money. House insurance costs money. Owning a house isn't a free ride by any means. Renting gives you the opportunity to move, and, especially right now, there is nothing wrong with cash in the bank.


real-estate can be an investment - but buying for investment purposes and buying because you want to live there are two different things - don't mix them up. The properties you buy for one are completely different than the properties you would buy for the other in all likelihood.
posted by TravellingDen at 12:51 PM on January 1, 2011

@muddgirl: "If your student loan interest is lower than what you can earn by investing, then paying off a student loan is a losing proposition."

Mathematically true - but mortgaging a home is an uncertain investment with a load of risks and expenses attached to it... and at the moment he's sitting on cash and paying interest on a student loan. No-brainer - pay the loan.
posted by TravellingDen at 12:55 PM on January 1, 2011

I never indicated that I thought buying a house was a good idea. Again, there are not enough details here.
posted by muddgirl at 9:27 AM on January 2, 2011

It depends on the relative interest rates, but personally, I'd go for the house, if you find a good one in a stable neighbourhood and you want to live in the same place for at least the next 5 years and are up for the maintenance costs and time. Housing can be an investment (and rent is just going to a landlord), but it's only a good one if you're in it for long term. For me, my regular housing costs went down by approximately $200/month, even in the boom times, but the flip side of that is that I'm spending more time shovelling snow and mowing the lawn. I just like the idea that my mortgage payments are paying down debt rather than enriching a landlord, like my (higher) rent was doing.

Also, student loan interest is a tax decuction (at least, it is where I am, not sure about where you are anonymous), so it's usually the last thing that people pay off.
posted by Kurichina at 10:18 AM on January 4, 2011