If you're looking to buy your first home and are saddled with student loan debt, you may have a decision to make. Should you use your resources to pay off your student loans more quickly, save up for a down payment on the home, or try to do both at the same time?
- The sooner you pay off your student loans, the less interest you'll pay overall.
- However, student loans tend to have relatively low interest rates and home prices can rise every year.
- Ideally it's possible to work toward both goals, if you can follow some simple saving strategies.
Saving Up for a Down Payment First
Arguments for saving up for a down payment first include:
- Owning a home can be less expensive than renting and can provide emotional comfort in having your own place to fix up and remodel as you see fit.
- Housing prices, interest rates, and the cost of renting could continue to rise if you put off buying a home in favor of paying off debt.
- Having student loan debt is not as bad as other types of debt. That's because student loans have longer repayment terms and typically feature lower interest rates.
- Since your down payment will lower the overall cost of your mortgage, it may be more advantageous to save up money for a home than to pay off a low-interest student loan.
- You may qualify for student loan forgiveness or an income-based repayment plan that will lower your monthly payments.
- Interest paid on student loans (up to $2,500 per year) is tax-deductible.
Paying Loans Off First
Reasons to pay off your student loans first include:
- The longer you wait to pay off debt, the more interest you will pay. The higher the interest rate, the more you will save by paying the debt off.
- If your student loan interest rate is variable, it will likely go up over time, costing you even more.
- Paying off student loans means the debt is entirely erased from your credit report. While student loan debt isn't a huge factor in your credit rating, it is a factor.
- Having debt can have a psychological effect. Some people prefer to go into the home-buying process debt-free.
You may decide you can handle paying down your student loan debt while saving for a down payment on the home of your dreams. This can take some effort, but it is entirely possible if you follow some simple guidelines:
Make a List of All Your Debts
Pay Off High-Interest Debt First
Pay as much as possible on the loan with the highest interest rate. Pay at least the minimum due on all others. If you're struggling to make payments, you should table the thoughts of owning a home for a little while (since even with down payment funds, lenders need to ensure you can repay your mortgage and other bills as well) and consider seeking debt relief.
Put Savings in a Separate Account
Keep your down payment savings separate to avoid spending it. Open a savings account that pays the highest rate (online banks tend to be most competitive) or set up an investment account to increase your potential yield over time. Be aware, however, that investing is risky, and you could lose a good chunk of your money in a down market.
Don't Neglect Other Savings
You should have an emergency fund of three to six months' income and retirement savings to round out your financial picture. Each of these is a separate account. If your job offers a 401(k) or similar retirement plan, make sure you put enough in it to take advantage of any employer matching.
Consider refinancing or consolidating your student loans to lower payments or the interest rate. Find out if you are eligible to convert to an income-based payment plan. Mortgage lenders will use your standard repayment plan to calculate your debt-to-income (DTI) ratio, so lowering your payment may not help you qualify for a home loan.
Keep Paying Student Loans
Deferment or forbearance of your student loans is generally a bad idea if you can avoid it. It may not hurt your credit rating, but interest will continue to accrue. Making regular payments keeps you on track to pay off your loans on time.
How Much You Need to Save
To obtain a conventional loan without the extra expense of private mortgage insurance (PMI), you will need a down payment equal to 20% of the selling price. If your down payment is less than 20%, mortgage insurance will add between 0.3% and 1.5% to the cost of the total loan.
Federal Housing Administration (FHA) loans require only a 3.5% down payment but come at a higher interest rate and also require mortgage insurance. If you qualify for a VA loan, these loans come with zero down payment requirements and other benefits for former military service members. Additionally, there are a number of low down payment programs available if you qualify. A Conventional 97 loan is another option. The 97 refers to the loan-to-value (LTV) ratio, where you are able to borrow up to 97% of your home's value.
Saving automatically, such as through direct deposit or automatic transfers from your checking account, can make it easier.
These savings strategies may help you reach your savings goal sooner:
Put Extra Money in Savings
Work bonuses, holiday gift checks, rebates, and tax refunds can all go into savings. Avoid the temptation to spend that money, and you will realize your savings goal sooner.
Look for places to cut spending and divert that money into savings. Places to cut include entertainment, eating out, subscriptions, expensive vacations, and clothing. If you rent, consider moving back in with your parents (with their permission, of course). Offer to pay something for room and board.
Get a Second Job
Income from a part-time job that can be dedicated to savings will help you reach your goal quicker. You could also try asking for a raise at your current job or volunteering to work overtime.
The Bottom Line
It's often possible to save for a down payment on your first home while paying down student loan debt. You may not have to choose between the two. Keep in mind that circumstances change, and what is impossible now may be possible in a year or two. Re-evaluate your situation as needed and be prepared to alter your plans as necessary. But keep saving—and don't lose sight of those two very worthy goals!