Save for a Down Payment or Pay Off Student Loans?

Smart ways to juggle these competing demands on your resources

Fact checked by David RubinReviewed by Katie MillerFact checked by David RubinReviewed by Katie Miller

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?

Key Takeaways

• 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 savings strategies.

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.

Important

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.

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.

Important

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.

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 include 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.

Important

Saving automatically, such as through direct deposit or automatic transfers from your checking account, can make saving for a down payment easier.

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 more quickly. You could also try asking for a raise at your current job or volunteering to work overtime.

How Do I Start Saving for My House?

To start saving toward a house, you have to commit to the process. If you need help, consider setting up an automatic transfer to regularly move money from your checking account to a dedicated savings account.

Is It Better To Buy a House or Pay Off My Student Loan?

There are a variety of factors to consider when choosing between buying a house or paying off a student loan, and the correct decision will vary from person to person. To determine which might be right for you, consider your priorities, time frame, and financial situation.

Should I Actually Pay Off My Student Loans?

You absolutely should pay off your student loans. In fact, you will likely save money in the long run by taking care of your student loan debt as quickly as possible. Consider refinancing or consolidating your student loans to secure a lower monthly payment and/or interest rate.

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!

Read the original article on Investopedia.