Is it better to pay off student loans quickly or to save up for a down payment for a house?

Jun 13
Posted by Lisa

A Nerd Wallet reader asked:  Is it better to pay off student loans quickly or to save up for a down payment for a house?

Background:  I have a 10-month emergency fund saved up and will be graduating from graduate school in May. I will be working full-time and wonder if I should put my monthly savings toward paying off more of my $60,000 in student loans than my monthly payments or toward saving up to buying a first home/condo. I live in D.C. I annually max out my retirement funds contribution limits. I'm not sure if it's better to pay down the student loan debt early or to save up for a down payment on a property since my rent money is just going to a big black hole never to be seen again and I can write off the student loan interest. I will earn about $65,000+ annually once I graduate. If it's better to pay off the student loans first, is there a threshold point where I can then transfer my energy to saving up for a house? Like at $20,000 paid off? I'm 30 and would like to have a place that I own.

The only way I'm in favor of you buying a house is if it's a multifamily unit and you generate some rental income.  Otherwise, a single family home is just an expense and an anvil for a 30-year-old. Khan Academy has a good video on the topic of renting vs. buying here.

If you are going to go ahead and buy the single family home anyway, here's what I suggest to minimize the risk to your financial security:

  1. Emergency Fund - you said you have 10 months set aside.  I suggest six, and you can do an Amish version if you believe you could cut your monthly spending on food, entertainment, etc.  And go ahead and back out what your would receive from unemployment compensation.
  2. Use the excess money in your emergency savings to pay down your student loan debt.
  3. Calculate the maximum payment you can make toward paying off your student loan that would allow you to continue to contribute 15% of your gross income to retirement savings.  I am unmoved by the student loan interest tax deduction. Get the monkey off your back.
  4. After the student loan is gone (that's my threshold), accumulate enough money to put 20% down on your new house (I abhor PMI payments), plus closing costs, plus obvious repairs that will need to be made within the first year.  Limit your loan to an amount that puts your monthly payment (including escrow) at no more than 28% of your gross monthly income.

There is nothing sexy about my answer unless you think being sensible is sexy.  Buying a home is often  a much bigger financial black hole than making rent payments.

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