Pay off 81,000 in loans at 3.5% or save for 20% home down payment?

[ucastr03]

Dear Retirement Community,

I am trying to decide what to do about my student loan debt. It's a burden of $81 thousand dollars at 3.5 %. Payments are $600/ month. I have saved $80 thousand dollars and have that cash available to either pay off my student loans or put a down payment on a home. What should I do?

Thank you in advance for your reply.

 

[arebelspy]

Insufficient data.

The answer will depend on a number of things such as risk tolerance, personal preference, etc.

I'd say the biggest factor is when do you plan on purchasing said home?

I'd bet most would say don't pay off the low interest student loans.

Regardless, your mortgage will likely be more than that 3.5%, so putting the extra money into paying off the mortgage (i.e. having a larger down payment) instead of the student loans makes sense.

Of course then you'll hit the question of pay off mortgage or invest, but do a search on that one and you'll find plenty of reading material.

 

[Animorph]

3.5% is not a bad interest rate, and a little better than the best you could get for a home loan, if it is a fixed rate and long term. In that case I'd keep it and get a comparably smaller home loan or even use it for the down payment. Keep in mind 100% financing has its risks still.

If it's a variable interest rate then I might pay it off, though investment, housing, and later loan payoff prospects would influence that decision. Considering interest rates are likely to stay low for a few years, could you increase your payments to retire the loan early before its rate increased too much? Even if you bought the home?

 

[BigMoneyJim]

The numbers need to be considered, but this is probably one of those lifestyle/comfort choices more than a math decision.

Worst case: Mortgages and student loans are treated differently under new bankruptcy laws than other debt. The student loan balance won't go away if you run into unforeseen financial trouble.

Best case: Letting 3.5% ride while making smart savings, investment and house-buying choices could look really smart *if* the math and luck goes well.

I didn't have student debt, but at 30 years of age I had $20k credit card debt, $10k auto loan debt and $60k in a 401(k). The debt was becoming a burden, and I wanted out of it, but due to early withdrawal penalties and taxes, using the 401(k) funds to pay off my debts would have wiped out the 401(k), and then I wouldn't be sure if I had the discipline to avoid running up consumer debt again.

So instead I set out to pay off the debt and was able to speed it up by selling the car to cover the loan, buy a cheaper car under better terms, consolidate my CC debt on a relative's lower-interest card and then pay off the debt over 5 years. During the paydown I still contributed to my 401(k) and had about $1k in cash cushion, but had no "emergency fund" outside of available credit or retirement savings.

At that point I still had my retirement savings intact, was debt-free and knew I could maintain a budget to avoid running up more debt. After being tax-free I was able to build after-tax savings and buy my first house. Somewhere in there I bought and paid off another car. My next car will still have a loan, but I think the one after that may be bought in cash.

So from that angle my leaning is to prioritize paying off the student loan, but I can certainly see the appeal of letting the 3.5% ride while making other smart financial moves.

 

[panacea]

At that rate, the best financial decision is probably to let it ride and make minimum payments. Having said that, having that kind of debt hanging over me would admittedly bother me. I think if I were you, my highest priority would be to get into a house ASAP while home prices are still depressed and rates are at all time lows. However, I'd buy a house that is very affordable (less than what the bank will say you can afford) so that you have lots of excess cash flows to do the other things you want to do... perhaps rebuild your cash cushion, put lots away for retirement and go after that student debt. Good luck!

 

[tightasadrum]

I agree with keeping the 3.5% loan. If it really bugs you to see so much of your life in the future paying on that loan, pay a little extra each month. But hold onto the cash for other things.

 

[BigMoneyJim]

my highest priority would be to get into a house ASAP while home prices are still depressed and rates are at all time lows.

Yeah, there is that. A big motivator for me buying my first house was the low prices plus low rates. But I went FHA and 3.5% down since I didn't have enough for 20% down or even 10% down plus closing costs, at least not comfortably and/or without using my retirement savings. But I'm stuck with [-]P[/-]MI for at least a few years.

However, I'd buy a house that is very affordable (less than what the bank will say you can afford) so that you have lots of excess cash flows to do the other things you want to do... perhaps rebuild your cash cushion, put lots away for retirement and go after that student debt.

Definitely. I chose my house viewing it as a commodity and picked largely on how easy I thought it may be to resell in the future. I also projected that, assuming apartment rents increase, my house will be cheaper in monthly expenses than my former 1-BR apartment in not too many years. 5? 10? 15?

 

[Midpack]

I assume you're paying rent in some form. If so, you can either continue to make rent payments that do nothing for your net worth, or make a mortgage payment of about the same amount, and build equity/net worth. Still need to put a pencil to paper, but unless you're living somewhere for free...another factor.

 

[aaronc879]

I wouldn't do anything right now. Just make your regular payment and continue to add to your savings. Decide how much you want to pay for a house then when you have enough to put 20% down AND pay off the student loan debt and still have a 6 month cushion, then do so. The last thing I would do is add the debt of a house when I already have significant debt.

 

[pb4uski]

Is your motivation to buy a home that you want to own your own home or just that you aren't sure what to do with the 80k?

Another option is to prudently invest the 80k, continue to rent or whatever you do for housing now and continue to make payments on the student loan.

The answer would seem to me to depend on whether you really yearn to own your own home or not. If you do, your best move would probably be to find the home you want, buy it putting down 20% or so and if any of the 80K is leftover then have it be your emergency fund. I would not be in any hurry to retire 3.5% debt where the interest is tax deductible.

If you don't care to own a home, then retire the debt to a level where all the interest is all tax deductible and invest the remainder.

 

[sirion]

I agree with aaronc879--keep doing what you are doing until you buy the house, then set aside a decent emergency fund to cover household repairs (1-3% of house value), figure out how to max out your tax-deferred accounts, and put any extra to the debt.

 

[ronocnikral]

I had a difficult time sleeping when I had student loans. Guess what I would recommend you do?

Since we don't know if you sleep in your parent's basement or if you have any other goals, I'll stick with my inferred suggestion above.

 

[newb]

I would argue that you cant afford to buy a home until those debts are paid in full. $600 a month in thrown away cash is a lot. continue renting or doing whatever youre doing until those debts are gone, then save for the house.

 

[kfindley79]

I have a growing dislike of debt. I have had it for far too long and I am fed up with not having a total say of where I spend my money...plus I really like saving money for fun things.

If I were you, I would pay off the debt and do something beneficial with the student loan payment.