Setting aside money for a down payment on a house might seem like a waste if you are dealing with student loan debt.
However, focusing on student loans could mean putting off homeownership for years or even decades.
Finding an optimal strategy for balancing a desire for home ownership with your need to eliminate student debt isn’t easy. There isn’t a simple answer, and there isn’t an equation that will spit out the right decision.
The good news is that student loans don’t necessarily mean you can’t buy a home, and saving for a home doesn’t mean you have to be irresponsible with your student loans.
If you ask the right questions, you can find a realistic strategy that best fits your needs.
Interest Rate Considerations
Interest rates are vital when deciding whether to save for a down payment or eliminate debt.
If your savings account offers a 1.20% interest rate and your student loan charges a 9.60% interest rate, it might seem like paying down student debt is the obvious decision.
However, our analysis doesn’t end with a simple rate comparison.
For example, you could move your money to a different bank that offers a better interest rate. Some banks are now paying over 5% on savings accounts and CDs.
Likewise, there are options for student loans. If you have federal loans, paying the minimum and working towards forgiveness might be the best approach. If you have private loans, refinancing the debt with a new lender could lower the interest rate considerably.
In other words, even if you currently have a brutally high student loan interest rate and an atrociously low savings account interest rate, there are fixes available.
Your Goals Matter
The math on whether or not home ownership is a good idea is notoriously tricky.
The simple version is that the longer you stay in your house, the more it makes sense to buy.
Some factors go beyond building assets. You might want to live closer to family or work. Owning a home might be a major life goal.
If buying a home is important to you, it should be a consideration. Your happiness matters.
I’m not saying you should ignore your student loans and buy whatever makes you happy. Instead, I’m saying that your non-financial priorities also matter.
Sherpa Thought: A lot of personal finance advice makes judgments about right and wrong.
While some moves are objectively bad ideas or inherently risky, in many other cases, it comes down to personal preferences. The right decision for you may not be right for someone else.
When Student Loans Should Ge Paid Off First
There are situations where addressing your student debt is an obvious choice.
You might have so much student debt that you cannot qualify for a mortgage. If student loan payments eat up 40% of your income, there probably isn’t room for a home loan, and a mortgage company won’t lend you any money.
This doesn’t necessarily mean that you have to pay off all of your student loans, but it does mean that eliminating some of those loans may be required.
If you are in this situation, talking to a mortgage lender might be a good idea. Discuss which loans are the biggest issue on your credit report. It won’t necessarily be the loan with the highest interest rate. Sometimes it makes sense to attack a loan with a small balance but a large monthly payment.
Figure out the loan that is the biggest issue and attack it.
You can revisit the home mortgage question once your student debt situation becomes more manageable.
Student Loans Could be an Afterthought
In some cases, your student loan balance doesn’t matter.
Suppose you have over $100,000 of student loan debt. If that debt is federal and you work towards forgiveness, student loans shouldn’t change your plans.
Your monthly student loan payment will impact your Debt-to-Income ratio and potentially reduce home buying power. However, this situation may not change for over a decade.
Student debt will probably make buying a home more of a challenge, but paying them off first, or paying extra, doesn’t make sense.
Sherpa Tip: Sometimes, changing repayment plans is the only step needed to get student loans ready for a mortgage application. In many cases, picking the right repayment plan makes qualifying for a mortgage significantly easier.
Strategy for Borrowers Caught in the Middle
If you don’t fall into one of the aforementioned categories, figuring out the best approach can be complicated.
In this instance, I’d suggest building up a large emergency fund. For starters, having an emergency fund isn’t just a luxury — it is a necessity.
This exercise can provide valuable insight into the down payment question. You might look back after a few months and see that saving isn’t going well, and it is better to focus on your debt. You might also discover that you are doing well saving, and a down payment is a reasonable goal.
If your emergency fund grows beyond what is necessary, you can either use the money for the down payment on your mortgage or knock out a huge chunk of student debt.
There isn’t a substitute for personal experience, and spending several months saving can provide valuable insight. Plus, that emergency fund could come in handy.
Tips and Other Items to Consider
- You don’t need a 20% down payment. The conventional wisdom used to be that you needed a 20% down payment because it avoided PMI. For a student loan borrower, this is an especially difficult goal. Setting aside 3-5% may be sufficient for your needs.
- Don’t forget other debts. If you have credit card debt charging 20%, that is item number one on your to-do list.
- Make sure home ownership is right for you. Some people prefer to rent. Others have to move often for work. Buying a house and selling it a year later is usually a costly mistake.
- Use this time to learn. While you are getting your finances in order, take the opportunity to learn. Talk to mortgage lenders. Find a buyer’s agent and start looking at homes.
Most importantly, take a detailed look at your student loans and figure out how to optimize them for the mortgage application process.
