Yahoo Finance Pay Off Student Loans or Save for a Home Downpayment? Here’s What Experts Say You Should Choose
The resumption of student loan debt has put a dent in millions of Americans’ savings. To put this in context, there are 44 million Americans with student loan debt, the average monthly student loan payment is $503, and the average borrower takes 20 years to repay their student loan debt, according to the Education Data Initiative.
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In turn, it’s no surprise that two-thirds — 67% — of recent college graduates with student loan debt say their student loan debt is preventing them from participating in major life milestones such as saving for retirement, getting married or buying a home, according to Fidelity.
Against that backdrop, it may be difficult for those who want to buy a home to choose between paying off student loans or saving for a home down payment.
“When it comes to prioritizing paying off student loans or saving for a home down payment, there is no ‘one-size-fits-all’ answer to this conundrum — it comes down to each person’s unique financial situation and their broader financial goals,” said Steve Sexton, CEO of Sexton Advisory Group.
Here is what experts have to say about this.
It Depends on How Much Overall Debt You Have
As Sexton explained, the majority of interest rates on student debt tend to range on the lower end — between 2.5% and 5.5% — so if you’re in this range and you don’t have any other major outstanding debts at higher interest rates, one could argue that there is less harm in paying the minimums on your student debt while allocating more money toward your home down payment savings.
“While there are several factors that come into play, the general rule of thumb is the higher the interest rate, the more repayment on that debt should be prioritized to avoid paying more in interest over time,” he said.
Yet, Sexton also noted that this decision should be made in the context of your broader financial goals — for example, do you have high-interest credit card debt? Do you already have an emergency fund? How much have you contributed to your retirement accounts, and do you stand to benefit from employer matching programs?
“Another factor that could influence your decision-making is your debt-to-income ratio,” he said, adding that if your student loans are considerable in relation to your salary, this could potentially hurt your chances of qualifying for a mortgage, even if you already have the down payment for your home saved.
“Depending on where you stand, you may consider prioritizing these milestones ahead of saving for a home down payment,” he said.
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Not an Either-Or Decision
Some experts also argued that unless your student loans have exorbitant interest rates or monthly payments, you may not necessarily need to choose between them in a completely binary way.
“One of the important parts of managing personal finances well, is a constant reevaluation of your ‘hierarchy of savings,'” said Stephen Kates, CFP, principal financial analyst for Annuity.org.
In other words, he said, this means that the best use of your excess money may change over time, as your needs and preferences change, so determining when you want to be able to buy a house, and how much you’ll need is a major factor in your decision.
“As you graduate college, paying down your highest interest rate student loans may be at the top of your list with only the vague idea of buying a house in the future,” he said. And as you progress through your payments and get older, you may find that you desire a house more than you desire an accelerated payoff schedule for your loans, he added.
In addition, he noted that if your remaining loans have lower interest rates than when you began, through refinancing, payoffs or consolidation, then your savings toward a house may offer a better rate of return than paying down your loans.
“Despite some advice to the contrary, holding low-interest debt instead of paying it off as fast as possible is not a bad idea. If you can put your money to work at a higher expected rate of return than your debt interest rate, you should do so,” Kates said.
Do You Really Want a House?
Other experts, such as Jay Zigmont, PhD, MBA, CFP, founder and CEO of Childfree Wealth, argued that the first thing to debate is if you really want to buy a house or not.
“You don’t need to buy a house to get ahead, it is just one option,” he said. “If you are more nomadic, as many of my Childfree clients are, renting may be a better choice.”
Zigmont added that when it comes to student loans, you need to decide if you are going to pay them off or work toward forgiveness.
For instance, he said, with the new SAVE (Saving on a Valuable Education) plan, your payments can be lowered, and any additional interest is not added to the loan.
“Your loans can be forgiven in 20 years (undergrad) or 25 years (graduate),” Zigmont said. ” If you are on a SAVE plan and planning on forgiveness, then it may not make sense to pay off your student loans. If you’ve got a six-figure loan, chances are this will be your best bet.”
He added, however, that if on the other hand, you are planning on paying off your student loan, then it should come first before saving for a downpayment.
“Ideally you should be completely out of debt, have a fully funded emergency fund and have saved 20% for a downpayment before buying a house,” he said. “If you have no debt you are likely to be able to afford a house versus barely making ends meet.”
Other experts — such as Stoy Hall CFP, CEO and founder of Black Mammoth — echoed this sentiment, saying that paying the minimums on student loans and signing up for the SAVE program allows you to then save and live life how you want without the burden of paying all your extra income to student loans.
“On the flip side, currently in our society, it is better to rent than buy in most cases,” he said. “You have time — at least two to three years before we start to see that trend change.”
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