Understanding the home buying process before you start shopping for a home can make it easier.
Many people dream of buying homes, but attaining that milestone becomes far more challenging when you graduate college saddled with student debt. The more of your income you’re forced to give up each month in the form of student loan payments, the harder it will be for you to save up money for a home down payment. Furthermore, if too much of your income is monopolized by student loans, you might struggle to keep up with the costs of owning property once you actually buy.
On the other hand, the longer you continue paying rent, the longer you’ll be paying someone else’s mortgage instead of your own. As such, you may not want to let your student loans prevent you from buying sooner rather than later.
So should you pay off your student debt before saving for a home, or do the opposite? Most of the time, tackling your student loans first makes the most sense. By carrying that debt, you’ll continue to rack up costly interest charges that eat away at your earnings and make saving for other important goals, like homeownership, very difficult.
Saving money on interest is perhaps the most compelling reason for prioritizing student loan repayments above all else. The sooner you pay off your student loans, the less interest you’ll pay. And if you borrowed privately for college, that’s certainly something you’ll want to keep in mind, since the interest charged by private lenders can be high enough to mimic that of a credit card.
Imagine you owe $30,000 in student loans at 6% interest, and you’re supposed to repay that sum over 10 years. If you stick to that original schedule, you’ll end up spending just under $10,000 on interest alone.
Now let’s say you work a side job your first year out of college that puts $5,000 in your pocket. You can use that money for either a home down payment, or to pay into your student loans. If you go with the latter, you’ll save yourself a good $3,000 in interest.
Keep in mind that many private lenders charge far more than 6% interest, so if you’re able to pay those loans off ahead of schedule, you stand to save even more. Another thing to remember is that private loans often come with variable interest rates. If you pay them off early, you lower your risk of seeing your monthly payments jump once your rate climbs, so that’s another reason to focus your extra money on getting out of student debt, and then start putting cash aside for a home down payment.
Another point to consider is that having a monthly student loan payment could make it difficult to afford your home once you buy it. Remember, when you own property, it’s not just your mortgage payment, property taxes, and insurance you’ll need to worry about; you’ll also have to cover the cost of maintenance and repairs, and those could be substantial. (In fact, regular maintenance can equal up to 4% of your property’s value. This means that if you buy a $300,000 home, you could be looking at $1,000 a month, or $12,000 a year.) Therefore, if you’re currently paying, say, $350 a month in student loans, buying a house after knocking out that debt will give you that much extra money for upkeep on an ongoing basis.
Additionally, you may have an easier time qualifying for a mortgage if you pay off your student loans first. That’s because a large amount of student debt can drive up your debt-to-income ratio (a measure of your debt relative to what you earn), thereby making lenders more hesitant to give you a loan. Or, to put it another way, a lender might be more willing to lend you $200,000 to buy a house when you’re not already coming in $30,000 in the hole.
Incidentally, spending some time paying off your student debt before attempting to buy a home could help your credit score by boosting your payment history. Your payment history speaks to your tendency to pay your bills on time, and it’s the single most important factor in determining a credit score. If you do a good job of keeping up with your student loan payments, your credit score will climb, and if you then apply for a mortgage after the fact, you’re more likely to not only get approved, but snag a more favorable rate in the process.
There’s also the stress factor to consider. Having a nagging monthly student debt payment is stressful enough in its own right, but adding a mortgage payment to the mix could be enough to send you over the edge. Being on the hook for several debt payments also leaves you with fewer options in the event a financial emergency strikes. Therefore, it really helps to go into homeownership without a pile of student loans in your name, which is why it often pays to knock out your debt and then start accumulating your down payment.
It’s generally a better idea to pay off your student loans before buying a home. However, there are some scenarios where prioritizing homeownership can make sense.
If you’re located in a major city where renting is growing increasingly unaffordable, buying a home might actually help lower your housing costs on an ongoing basis once that down payment is out of the way. And that, in turn, makes the idea of buying less risky when you still have student debt hanging over your head.
Additionally, when you own a home, you have the ability to use it as an income source, either by building equity or renting it out. People buy homes and take on tenants all the time, and if that’s your plan, then you could, conceivably, focus on coming up with your down payment, buy a home, and then use the proceeds from your tenants to pay off your student loans.
Owning a home also buys you stability — something renting does not. If you have children, moving to another neighborhood could mean having to switch school districts, and when you rent, you can’t discount the possibility that you’ll be forced to leave your home. When you own a home, no one can kick you out unless you stop making mortgage payments, at which point the bank can reclaim your property.
Another thing to keep in mind is that student loan debt, like mortgage debt, is considered a healthy kind to have (whereas credit card debt is certainly not). As such, hanging onto that debt for longer to save up for a house isn’t the worst financial move you can make, because as long as you manage to keep up with your loan payments, you’ll continuously be building your credit.
There are also some lucrative tax breaks available to homeowners, like the option to deduct your mortgage interest and property taxes. The longer you wait to buy, the longer you’ll wait to reap those perks. Still, the savings you reap from these tax breaks will probably amount to less than the savings you’ll enjoy by paying off your student loans early — especially if your loans have a high interest rate attached to them.
Many folks (younger adults in particular) feel forced to choose between paying off their student loans and saving for a house. In reality, however, there’s always the option to pay off your loans and save for a home simultaneously. If you have extra money to work with at the end of each month, you might consider splitting it by applying some to your outstanding loan balance, and putting the rest into whatever account is housing the funds for your home down payment.
Furthermore, it’s certainly not unheard of to continue paying student debt while taking on the financial responsibility of homeownership. Many people buy homes while having auto or credit card debt hanging over their heads, so there’s no reason to assume you can’t buy a house and just keep making your student loan payments as you’ve been doing.
That said, if you’re going to buy a home before getting out of debt (student or otherwise), make sure to keep your housing costs affordable. This means making sure that your mortgage, property taxes, and insurance don’t exceed 30% of your income (and, ideally in this situation, keeping them well below that threshold). Until your student debt is paid off, you may not have much financial wiggle room on a monthly basis, and the last thing you want is to risk falling behind on your mortgage because too much of your income is tied up in student debt.
Owing money for your education doesn’t have to be an impediment to buying a home if you earn enough to make your monthly loan payments, accumulate enough cash for a down payment, and then tackle a student loan and mortgage simultaneously. Before you go that route, however, think about the peace of mind that comes with knowing that you’re only on the hook for one type of debt each month, as opposed to two different types. You might find that even if you can swing your student loans and a mortgage, you’re better off getting rid of the former before pursuing the latter.
Remember, if you don’t finish paying off your student loans before you buy a house, and your costs associated with homeownership wind up being higher than expected, you can’t just make the decision to stop paying for either. A mortgage is a long-term commitment, and if you knock out your student debt before taking one on, you’ll have one less payment to worry about falling behind on.