Should You Pay Off Your Student Loans or Save for a Down Payment?
Don't let student loan debt keep you from the American Dream
If you have student loan debt, you are not alone. According to the credit watchdogs at Experian, there is now $1.44 trillion in student loan debt across an estimated 44 million borrowers.
But like many new college graduates, you may also want to buy your first home. This financial goal is a rite of passage for many Americans, but those with student loan debt may be left wondering how their debt will affect their ability to buy a home. We explore if it’s better to save for a down payment or pay off student loans first—or how you may be able to do both.
Should I Save for a Down Payment or Pay Off My Student Loans?
The right financial move for you depends on a few factors, but most importantly, your debt-to-income ratio. Your debt-to-income ratio is the amount of your monthly income that does toward paying your debt. This can include credit card debt, a car loan, and student loan debt.
Keep in mind that there are two types of debt-to-income ratio: front-end, and back-end. Front-end is calculated by estimated housing costs (i.e., your mortgage payment and insurance) divided by gross income. Back-end is the percentage of your gross income that goes housing costs, plus other debts, like credit cards, car loans, and student loans. Mortgage lenders generally look for a back-end debt-to-income ratio of 36% or less, though the Federal Housing Administration will accept a DTI as high as 50%.
Calculate Your Debt to Income Ratio
If your debt-to-income ratio isn’t up to par just yet, focus on paying off your student loans to lower your debt-to-income ratio, and then apply for another mortgage down the line. You could also save up money for a larger down payment, which will decrease your necessary mortgage amount, in which case, your debt-to-income ratio may not be a sticking point.
One study found that the average college graduate with student loan debt would be unlikely to qualify for a mortgage due to their debt-to-income ratio. It also found that half of those with student loan debt had a debt-to-income ratio of 49%, well above the suggested ratio.
Before deciding which path you’d rather take, calculate your debt-to-income ratio, and see if obtaining a mortgage with your current student loan debt is doable.
If your debt-to-income ratio is not within the acceptable range for a mortgage, then you’ll need to focus on paying off your student (and other) debt before getting a mortgage. Once your debt-to-income ratio is lower, you can revisit.
If your debt-to-income ratio is acceptable to mortgage lenders, then you may want to start saving for a down payment first, while also paying on your student loans. Read on to learn how you can do both.
How You Can Do Both
Perhaps your timeline to buy a new home isn’t as flexible and you can’t wait to pay off your student loans first. Or maybe you’d prefer to work toward both financial goals simultaneously, and your debt-to-income ratio isn’t an issue. Saving up for a down payment and paying off your student loans at the same time is definitely doable.
Start off with a bare-bones budget. Cut any discretionary spending, from cable TV to happy hours with friends, even shopping for clothing. After you’ve made all your non-discretionary spending, like groceries, rent, and utilities, split the rest between your down payment fund and your student loan payments.
You may want to allocate a bit more to one debt. For example, if you have a credit card with a high-interest rate, focus on paying that off first. Then, put the money saved on interest toward your down payment and your other debt, including student loan debt.
Other tips to work toward both goals at the same time—put the funds for your down payment in a separate or hard-to-access bank account, so you won’t be tempted to spend it. Have both your monthly savings goal and your student loan payment automatically deducted from your checking account each month. Or work on refinancing and consolidating your student loans to get a better interest rate or payment plan.
When deciding whether to pay off your student loans or save up for a down payment, many factors—such as other debt, your credit score, and the interest rates on both your student loans and your mortgage—will play into your decision. Consider these next steps if you’re still stumped.
- Calculate your debt-to-income ratio to see if it’s the acceptable range to qualify for a mortgage. Then use a mortgage calculator to find out how much you’d prequalify for, and what your monthly mortgage payments might be. An online mortgage calculator can help you determine this number.
- If you decide to tackle your student loans first, take advantage of grants and scholarships to help pay off your student loan debt.
- Create a budget and start tracking expenses. Both will help you reach your financial goals (i.e., paying off your student loan debt or buying a home) more quickly.
- The old rule of thumb that you need to put 20% down in order to buy a house isn’t always the case. See if you qualify for a mortgage that requires less down but still offers a good interest rate. Stay away from adjustable-rate mortgages (ARM) though, since the interest rate adjusts after a certain period of time. This means your mortgage payment can increase dramatically.
- Most importantly, don’t get discouraged. After all, if you have student loan debt, you’re joined by 44 million of your college-graduate peers. And with a few actionable steps, a lot of hard work, and a manageable budget, you can pay off your student loans and reach your other financial goals, as well.
Consumer Financial Protection Bureau. "Record Student Debt Spurring Employers to Offer Student Loan Repayment Benefits," Accessed Oct. 14, 2019.
Experian. "Student Loan Debt Climbs to $1.4 Trillion in 2019," Accessed Oct. 14, 2019.
Fannie Mae. "B3-6-02: Debt-to-Income Ratios (08/07/2019)," Accessed Oct. 14, 2019.
Young Invincibles. "Denied? The Impact of Student Debt on the Ability to Buy a House," Page 3. Accessed Oct. 14, 2019.
Young Invincibles. "Denied? The Impact of Student Debt on the Ability to Buy a House," Page 6. Accessed Oct. 14, 2019.