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Retirement vs. Student Loans vs. Mortgage: Which Comes First?

Eliminating student debt, saving for retirement, and buying a house are all important financial goals that can be hard to balance.

Written By: Michael P. Lux, Esq.

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For many Americans, the three biggest financial challenges of their lives will be paying off student loans, buying a house, and saving for retirement.

Each one of these goals is a huge challenge. Meeting all three goals is even more difficult.

Hitting these milestones is complicated by the fact that starting early is important for each goal.

  • The sooner student loans are paid off, the less money that is spent on interest.
  • Early retirement contributions are important for growth and a comfortable retirement.
  • Buying the right home at the right time can save a small fortune in rent and be the realization of a dream.

Factors like taxes, law changes, and different personal goals can greatly influence the strategy. There is no simple order of priorities.

The good news is that it is possible to balance these three goals. Today we will look at strategies to maximize retirement, accelerate student loan repayment, and buy a home.

Before Getting Started: Make Ends Meet

Put simply, if monthly spending exceeds monthly income, all three major goals are a long shot.

Going one step further, the more cash that can be freed up each month, the better.

Careful budgeting can shed a light on opportunities for saving. Many claim that they are only spending money on the essentials, but by taking a look at monthly spending, they may realize that there are some costs that can be cut or reduced.

Once the monthly budget is under control, student loan borrowers can shift their focus towards long-term goals.

Student Debt Elimination Strategy

There isn’t a simple rule of thumb for paying off student loans, because there are so many differences between the loans.

For some borrowers, chasing after student loan forgiveness will be the best opportunity to get rid of the debt.

Others may have loans with high interest rates, sometimes over 10%. Repayment of these loans is a much more urgent issue. Borrowers with high-interest student debt should either be aggressively paying off the loans or finding ways to get a lower interest rate.

The low-interest student loans are much less of a priority. Some borrowers have loans with interest rates at 3% or below. The fortunate borrowers in this category will usually benefit from paying the minimum. This allows additional funds to be used for goals like saving for a house or retirement.

Many borrowers will have interest rates that don’t fall into an obvious category. These borrowers will have to compare their student loan options with other opportunities.

Retirement Planning with Student Debt

Saving for retirement can seem overwhelming and complicated.

This site has already taken a detailed look at retirement plans and strategies for student loan borrowers.

A couple of important takeaways for planning purposes are the following:

  • Employer matches are an excellent opportunity. Employees will almost always want to maximize this benefit. Employer matching provides instant balance growth, and there is no way to go back in time to catch up on lost matching contributions.
  • Student loans with interest rates greater than 10% next need to be eliminated. Most investors can’t reasonably expect a return on their investments of more than 10%. Paying down high-interest student loans is like a guaranteed return on that investment.

Deciding between paying extra towards a student loan or saving for retirement can often come down to interest rates. If the investment is expected to earn 6% per year and the student loan charges 4% interest per year, the borrower is coming out ahead by 2% by investing. When the numbers are flipped, borrowers are better off paying down their debt.

Special Tip for Federal Loan Forgiveness Borrowers: Those working towards federal student loan forgiveness can get a double benefit by putting money in certain tax-advantaged retirement accounts like a 401(k) or IRA. These contributions not only build retirement savings, but the money set aside will lower the borrower’s AGI, which means lower payments on income-driven repayment plans like IBR, PAYE, and REPAYE.

Projecting the expected return on retirement contributions is far from an exact science. In some years the stock market does really well and can grow by more than 20%. In other years it can lose significantly. For planning purposes, savers can usually expect to earn 5-8% on average, but that will depend upon the investments selected.

Student loan borrowers looking to save for retirement will have to balance a number of factors that go beyond the math.

  • What is your appetite for risk? Investing in the stock market can be risky, but it also provides opportunities for growth.
  • Are you debt averse? Some people hate having any debt to their name, even if it means missing out on retirement opportunities, they want the debt eliminated first.

Generally speaking, high-interest student debt planning is easy because it just needs to be paid off right away. The low-interest debt is likewise easy because the money can be put to more productive use elsewhere. The interest rates in the middle range are where things get tricky, and judgment calls need to be made.

The important thing is the mindset. The goal isn’t to simply pay off all student debt as soon as possible. The goal isn’t to hit a retirement balance as soon as possible. The goal is to build wealth. Building wealth while eliminating student debt isn’t easy, but it can be done.

Buying a Home/Paying off a Mortgage

Purchasing a home is the largest purchase that most people make and is often a 30-year commitment. In addition to all of the work that goes into deciding when to buy and finding the right home, financial planning can be quite daunting.

There are two important home purchase phases for student loan borrowers trying to balance student loans, retirement and buying a house.

Phase 1: Getting the Mortgage
Phase 2: Paying off the Mortgage

Qualifying for a Mortgage with Student Loans

Student loan debt makes qualifying for a mortgage more difficult. It also makes saving for a down payment a challenge.

We’ve previously taken a close look at ways to manipulate student debt to help qualify for a mortgage, so today, we will get into the strategy behind saving for a down payment.

Traditionally, homebuyers needed to set aside 20% for a down payment. However, many lenders will now accept 5% down, or in some cases, even less. The downside for buyers with a smaller down payment is that they will have to borrow more, which means higher monthly payments. They will also likely have to deal with PMI (Private Mortgage Insurance).

Setting aside any down payment can be a challenge with larger student debt balances. The problem with saving for a down payment is that the highest interest savings accounts normally max out at around 2%. This means that money will probably go a little further when applied to a student loan balance or set aside for retirement due to the higher interest rates involved.

As a result, prospective homebuyers need to balance their need for a down payment against opportunities to eliminate debt or save for retirement. One possible workaround is borrowing money from a 401(k) or taking a first-time homebuyer IRA withdrawal. Dipping into retirement accounts early is always a risk, but it is one that some are willing to make.

Here again, there is no single right or wrong answer. The key is to look at a few different scenarios. Weighing the pros and cons of each option may shed light on the most desirable approach.

Paying Down the Mortgage or Student Loans

For student loan borrowers with a mortgage, it may be tempting to try to get the house paid off early.

Most financial experts will argue that with mortgage rates currently very low, it makes more sense to set the money aside for retirement rather than paying the house off early. However, there is a certain peace of mind that comes with a house being paid off, so many borrowers make it a priority.

With student loan interest rates normally much higher than mortgage rates, it typically makes more sense to pay off the student loans first. One notable exception would be for borrowers who are working towards student loan forgiveness.

Taxes can also shift the numbers. Mortgage interest is deductible, but it is only for people that itemize, and many couples will not benefit due to the recently raised standard deduction. Student loan interest is a much smaller deduction. However, because it is “above-the-line” it won’t matter whether the borrower itemizes or not. Be sure to understand the tax strategy for student loan borrowers and consult a tax expert when weighing paying down student debt against paying down a mortgage.

Final Thoughts

Eliminating student loans, buying a house, and saving for retirement are all important financial goals. Starting early is a critical component for each goal.

Student loan borrowers may have to make some tough decisions, but by understanding how these different goals interact, borrowers can put together an ideal plan that fits their individual needs.

About the Author

Student loan expert Michael Lux is a licensed attorney and the founder of The Student Loan Sherpa. He has helped borrowers navigate life with student debt since 2013.

Insight from Michael has been featured in US News & World Report, Forbes, The Wall Street Journal, and numerous other online and print publications.

Michael is available for speaking engagements and to respond to press inquiries.

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