Student Loans or Mortgage Downpayment? - From a Young Mustachian Grasshopper

[TigranMetz]

My wife and I are in the early stages of mustachianism and have had a lot of success in getting our financial house in order in the last year. I have one year left of graduate school and my wife is currently working full-time. We're giving any future school loans the middle finger and have been able to save enough for me to finish school without taking out any more student loans and then some (we're currently in about $75k in student loan debt already). Once I graduate and start working, we'll essentially be doubling our joint annual income. Here's where my question comes in. What is the most effective way to use the extra money: eliminating our student loan debt as quickly as possible or save aggressively for a 20% down-payment on a house/condo as quickly as possible? My reasoning for the latter would be that we're currently paying rent anyway and it would be much better if at least some of that money were going into property equity each month rather than being thrown down a hole. Thoughts?

[neo von retorch]

There are a lot of different factors that go into whether owning or renting is better financially. Mortgage rates are low right now, which does side in favor of owning, but here's my anecdotal cautionary tale.

This is *not* apples to apples, but I moved from a 600 sq ft 1BR apartment into a 3BR 2.5BA house. I have rented out my extra rooms for most of my 7 years of stay. If you ignore the money put into principal/equity, the interest, taxes, insurance, maintenance and repairs all add up so that, after all this time, even after bringing in a lot of rental income, I'm barely better off financially then I was with that apartment. In my case, that's because I've already had to replace the HVAC, a water heater and the roof. I haven't budgeted for repaving the driveway, but it needs it!

The point, though, is that it's possible owning will be less wise financially then renting. Even if it's not, think about this - I currently drive 15+ miles (30-40 minutes) one way to work. There are lovely apartments less than 5 minutes from the office. If I had not purchased, I'd certainly have moved to a much closer apartment by now. Homes can be expensive to maintain (and time-consuming), and they are the least liquid of assets. It's very difficult to sell them. Just compare them to any other investment. Plus, note that I've had to live with roommates all this time. If I had lived solo like I did in my apartment, it would have been much worse, financially.

I'm not saying it's wrong for you, but it's not an easy answer.

Now what's the rate on your student loan debt?

[lackofstache]

Use this: http://www.nytimes.com/interactive/2014/upshot/buy-rent-calculator.html?_r=0

Read this: http://jlcollinsnh.com/2012/02/23/rent-v-owning-your-home-opportunity-cost-and-running-some-numbers/

Then I'd look at your interest rate on your loans. If it's 4% or less, invest this money or save for a down payment if that makes more sense. If it's higher than 4-5% look at paying off debt quickly.

[Trudie]

I would suggest renting and eliminating your student loans.  The fact that you are currently in graduate school suggests that upon graduating your life may be in a bit of flux  -- that perhaps a new job or location might be in your future.  I think it is good to maintain some flexibility over housing arrangements in your early career.

Houses are difficult to get rid of and can be an albatross if you've decided you need to move or downshift.

I would punch out the school debt, let your life normalize, then make a housing decision.  Any money you save toward a healthy downpayment on a mortgage will not be wasted.  You can always reduce your interest cost buy buying it down up front and prepaying, and you will learn a lot from aggressively attacking your debt and modifying your habits now.

[BlueLesPaul]

+1 for paying off the student loan first.

I graduated with a similar amount of debt from law school in 2012 (about $60,000).  My wife had work through law school and had continued to work up until our child was born this month.  I took me about a year after graduating for me to find a full time job, but we have been DINKs for more than a year with an annual income of about $80,000 and will finish paying off the loan by July ( I am still underemployed, but that is another story).  After the loans are paid off, we then plan to throw our extra income and save for a 10% down over then next 10 months or so.  With you level of debt and a assume 6.55% interest rate (6.8% Fed Loans with a .25% reduction of direct debit) I guessing that if you keep the loan, you will pay about $4,500 in interest alone on an annual basis.  Pay off the loans, then save for a house.

[TigranMetz]

neogodless - Here's the approximate breakdown of the student loans:

$2,500 at 6.8%
$20,500 at 5.41%
$50,000 at 3.1% (variable)
$2,000 at 1.9% (variable)

My wife and I both have excellent credit scores and so I imagine we could get a good interest rate on a home loan (though I know that's not the only factor that goes into determining the rate). The other possibilities you brought up are very pertinent as well. Thanks for the feedback!

lackofstache - Thanks for the articles. That gives us a lot to chew on!

Trudie and BlueLesPaul - Thanks for your votes as well. We're currently throwing any extra cash we get at our loans at the moment (I'm in a paid internship and my wife does paid music gigs outside her day job every so often). We currently live in the DC area so costs of both renting and buying are pretty high.

Is there a way to figure out what our approximate mortgage interest rate would be if we did buy? (in a hypothetical situation)

[Trudie]

To figure out an interest rate just pick about 5 competitive banks in your area and go to their websites.  Nobody can predict the future, but it gives you an idea of where you're at today.  I'd also choose at least one credit union and if you have access to any loan programs (like through a Costco membership) check that also.

I would caution you to NOT think that renting is throwing money down a rathole.  There are many costs to home ownership that you should factor in, so it's not a simple equation.  I've known too many people who've had trouble selling homes, and when you're young and want to take advantage of opportunities being tied to a home can be a burden.  Read carefully and use the calculators.  Consider:  "Am I likely to have a great job opportunity in another town or another state in the next couple of years?"

[mozar]

You can go to the bank and get pre-approved. They'll give you a letter with the interest rate they would consider. But I doubt you will get a good rate with such high debt. I started with 135k in loans and I waited till I got it down to 20k before I bought. They also look at your debt to income ratio. So it depends on how much you pay out a month. They even included loans that were in deferment as part of my monthly total, even though I won't start paying on them until 2016.

[La Bibliotecaria Feroz]

Another vote for waiting. Because you are probably renting a student-type apartment, right? But I bet you would want to buy a real grown-up place with room for a nursery (should your thoughts be tending that way, which of course that might not). Which would mean that your monthly expenses would go way, way up.

I personally lost pretty much every penny I had ever had (except, thank God, my small retirement accounts) when my husband I bought a house and then decided a few years later that we didn't like the area after all. The market had tanked in the meantime (which we didn't really realize until we were committed to moving, and our experienced real estate agent seemed caught off-guard as well) and we wound up short-selling, trashing our credit. And we are far from the only people who know who've lost their asses on ill-advised home purchases. Don't buy a house until you are really, really, really sure and really, really, really ready.

[TigranMetz]

After deliberating with my wife at length and considering the many factors of our decision (some of which we hadn't thought of until you all pointed them out on this thread), my wife and I decided that we're going to focus completely on debt reduction for the time being. Thanks everyone for taking the time to offer your advice! You have really helped give us added knowledge and insight on making the decision.

I'm a first time poster in the MMM Forum and I will be coming back here for a long time to come. Thanks again!

[apfroggy0408]

Hi,

From a rather recent graduate to new kid in the work force I've been going through the same thing. Started my first salary job last February but hadn't found MMM til May of this year. I was working on saving 20% prior to finding MMM and got there pretty quick. Realized I had some high interest student loans I immediately took the high loans out.

I now only have 2 loans one at 4.8% and the other at 3.4%. I've also been trying to figure out what to do best with my money!

Pay off student loans/invest/save for downpayment on house.

Figuring out I have no idea where I'll be in the next upcoming months or even where I want to buy a house I'm eliminating the need of the downpayment and plan on paying off all my loans. I like that flexibility plus just being able to say I paid off all my loans in less than 2 years out of school!