How much of my income should I put towards paying off student loans vs saving for a house?

Question

New grad here. I finally got all the wonderful mail from the student loan companies informing me I need to start making loan payments. I never realized how much the interest on these things could come out to; 5% seems like such a small number. I also want to save up to buy a condo eventually, but I don't want to lose money on the interest of the student loans. I have a 3 year goal to save up for the down payment of a $500k condo. I have $26k in loans at about 5%. I have an income of $95k not including health care and retirement savings and I'm estimating about $800 in monthly payments.

My question is, how quickly should I be trying to pay off these loans? Should I just forget about saving for a condo until they are paid off?

Answer 1

In my opinion, you should pay off the student loans as soon as possible, before you start saving for the house downpayment.

$26k is a big number, but you have a great salary. (Nice!) Up until now, you have been a poor college student, accustomed to a relatively low standard of living. Your $800 per month plan would have you pay off the loan in 3 years, but I would challenge you to pay off this entire student loan in 1 year or less. A monthly loan payment of $2226 will pay off your loan in 12 months.

After that is done, if you take the same amount you had been paying toward your student loans and save it for your condo, in less than two years you'll have a 10% down payment saved ($50k). The whole thing will take less than three years.

There are three reasons why I recommend paying off the loan first before saving for the condo: one is practical and two are philosophical.

1. Practical: You will save money on interest. Paying off the loan in 1 year vs. 3 years will save you $1343. You won't find a short-term safe investment that will beat 5% in interest.

2. Philosophical: The loan is something current and concrete that you can focus on. Your condo is a dream at this point, and there is lots of time to change your mind. If the $2k+ per month amount is at all a sacrifice for you, then in a few months, you might be tempted to say to yourself, "This month I really want a vacation, so I'll just skip this month of saving." For the loan, however, if you establish a concrete goal of 12 months to pay off the loan, it will hopefully help motivate you to allocate this money and stick to your plan.

3. Philosophical: Getting used to borrowing money, making payments to a bank, and paying interest is not a great way to live. It is better, in my opinion, to eliminate your debt as fast as possible and start getting accustomed to saving cash for what you want. Clean up your debt, and resolve not to borrow any more money except for a reasonably-sized mortgage on your home.

Answer 2

3 years ago I wrote Student Loans and Your First Mortgage in response to this exact question by a fellow blogger in my state.

What I focused on was the way banks qualify you for a loan, a percentage for the housing cost, and a higher number that also comprises all other debt. If the goal is speed-to-purchase, you make minimum payments on the student loan, and save for the $100K downpayment as fast as you can.

The question back to you is whether the purchase is your priority, and how debt averse you are.

I'd caution, if you work for a company with a matched 401(k), I'd still deposit to the match, but no more.

Personal finance is just that, personal. We don't know your entire situation, your current rental expenses vs your total condo cost when you buy. If you are in a location where renting costs far more than your cost of ownership, Ben might change his mind a bit. If the reverse is true, you're living a college student's lifestyle with a room costing $400/mo sharing a house with friends, I'll back off and say to pay the loan and save until you can't tolerate the situation. You'll find there are few situations that have a perfect answer without having all the details.

Answer 3

I would add this as comment if I could.

Basically a lot of people say you can't beat the interest rate when you invest vs paying off a loan which is typically correct, however you really need to learn how to save money. It's quite easy getting into debt and paying it off but what tends to happen with a lot of people is they continue that cycle when they see how easy it is and never have a decent amount of savings.

I would make the minimum payments or slightly more and then save as much as possible, learn to sacrifice on luxuries which are extremely tempting when you are just starting out to earn good money. I'm not sure about your cost of living but set up a direct debit to take 10% of your salary after tax every month a couple days after you get paid. Having a large lump sum will do wonders for your credit and will enforce good habits

Answer 4

At an income of $95K you are on the edge of qualify for $500,000 mortgage (once you have a down payment).

Yes the fastest way to qualify for a $500,000 condo is to save for a down payment. I am suggesting that might not be the best long term financial plan. You are only going to qualify for a 30 year term. You still have a student loan where interest is not tax deductible. You have put you yourself in a long term debt position and if you lose your job a potential cash flow problem with a risk of losing the condo.

Since you are living at home I would go after that student debt. Looks like you could pay it off in like a year. I don't know prices in you area but maybe go in at less than $500,000 for your first home.