Save for a Down Payment or Pay Off Student Loans?

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 a home, or try to do both at the same time?

Saving Up for a Down Payment First

Arguments for saving up for a down payment first include:

• Depending on where you live, what home you are buying, and the financials, owning a home could come out to be less expensive than renting.
• 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-driven repayment (IDR) plan that will lower your monthly payments.

Paying Student Loans Off First

Reasons to pay off your student loans first include:

• The longer you wait to pay off your student loan debt, the more interest you will pay. The higher the interest rate, the more you will save by paying the debt off as soon as possible.
• 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’s still a factor.
• Having any type of debt can have a negative psychological effect. Some people prefer to go into the home-buying process debt-free.
• Interest paid on student loans (up to $2,500 per year) is tax-deductible.

Doing Both

You may decide that you can handle paying down your student loan debt while also saving for a down payment on the home of your dreams. This can take some effort, but is entirely possible if you follow some simple guidelines:

Make a List of All Your Debts

This includes car loans, credit cards, student loans, and any other type of debt you have. Include the remaining principal (balance), interest rate, and minimum monthly payment for each one.

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. Once you have paid off the highest interest rate debt, roll that money into the next debt and continue the process until all is paid off. If you’re struggling to make payments, consider tabling the thought 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 from your checking account to avoid spending it. Open a savings account that pays the highest rate (online banks tend to be the 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.

Renegotiate/Consolidate

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 repayment 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; however, if you save money on your monthly payment, you can apply the difference to your down payment.

How Much You Need to Save for a Down Payment

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%, then mortgage insurance will add 0.3%–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 require mortgage insurance. If you qualify for a U.S. Department of Veterans Affairs (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 Strategies

The following savings strategies may help you save for a down payment faster:

Save Automatically

Use direct deposit or automatic transfer from your checking account to move a regular amount to savings. If you treat saving as an ongoing expense, you will be more likely to do it.

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.

Cut Expenses

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 off your student loan debt—you may not have to choose between the two. Keep in mind that circumstances change, and what’s impossible now may be possible in a year or two. Reevaluate your situation as needed, and be prepared to alter your plans as necessary. But keep saving—and don’t lose sight of these two very worthy goals!