Author Topic: Save for Down Payment or Pay Down Debt First?  (Read 5604 times)

Regisque

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Save for Down Payment or Pay Down Debt First?
« on: August 31, 2015, 10:00:14 AM »
Sorry for the novel. I need some help with financial planning, I can't decide between two options for paying down debt and saving for a home.

I'm in a situation where my wife and I are working off a large amount of student debt and would also like to save for a down payment on our first home.

We have about $100K in student loan debt at various interest rates.
$15K @ 6.49%
$45K @ 5.8%
$10K @ 5.75%
$17.6K @ 4.625%
$13.5K @ 4.25%

We have a combined income around $130K and are already making changes in spending habits. We have no CC debt and no car payments.

We would also like to save $44K over the next 4 years for a down payment on a home, likely in April of 2019.

We have looked at 2 different options:
  • Savings First - Pay into our Roth IRAs first each year for 2015, 16, 17, and 18 giving us $44K in contributions that we can pull with no
    tax implications in 2019 and any growth above and beyond we can leave as retirement funds.
    Once we max out our Roths each year we would pay off debt.With this option we should have enough in income to pay
    everything off in December of 2018 giving us 4 months for any further savings.

  • Debt first - With this we would attack debt first, paying it off by February of 2018.
    From there we would be able to direct the balance into a savings or investment account until we decide to make a home purchase early in 2019.
    This should be enough time for us to accumulate right around $45K.
    If we go with this method what vehicle should we use for the savings? Should I open an investment account or should we just
    use a savings account since it won't be sitting in there long?

Which choice is optimal or is there another option that we haven't though of?

fb132

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Re: Save for Down Payment or Pay Down Debt First?
« Reply #1 on: August 31, 2015, 10:21:33 AM »
Personally, I would get rid of your debt ASAP...like MMM would say concerning debt: "HERE IS A CLOUD OF KILLER BEES COVERING EVERY SQUARE INCH OF MY BODY AND STINGING ME CONSTANTLY!!!! I NEED TO STOP IT BEFORE I AM KILLED!!!".

Pay off that bloody 100K$ loan then think about saving a downpayment or else you will be juggling both of them and shitty things tend to happen during those times, so you might as well get rid of the debt first so you can concentrate on saving up a downpayments afterwards. A house is not a need, it's good to have, but it can also be a curse if you have debt and other things that start to creep up in between. Get rid of all the interest that is sucking you dry like those bee's that MMM was describing.

You should read this http://www.mrmoneymustache.com/2012/04/18/news-flash-your-debt-is-an-emergency/
« Last Edit: August 31, 2015, 10:24:35 AM by fb132 »

HappyHoya

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Re: Save for Down Payment or Pay Down Debt First?
« Reply #2 on: August 31, 2015, 10:21:53 AM »
My husband and I had a similar decision a few years ago, and we chose to pay off our debt first (while also maxing out retirement accounts). It hasn't been easy, and there were definitely times when I would be tempted by properties that were lovely homes and seemed like good investments and wish we had the cash, when it was very tempting to want to change course and take a more typical path to paying down our debt. I even got a job that had some loan forgiveness, meaning I ended up paying more towards the total loan payoff than I would have otherwise, if we hadn't been in such a rush to pay them off. All that said, I am really happy that we took this path. You never have perfect information about what the future holds, and getting rid of debt creates options and possibilities, whereas new obligations limit them. I was so relieved once our debt was under control. I didn't even realize how much it was stressing me out but getting out of debt was  a huge quality of life improvement. Also, I learned that there will always be new opportunities, and none of the opportunities we passed up were one-in-a-million. Not only do we have a better idea of what we want to buy now (and under what circumstances we would buy), but the delayed gratification + frugal practices we learned to pay off our debt are serving us well in every other decision since.

Good luck with whatever you decide!

JLee

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Re: Save for Down Payment or Pay Down Debt First?
« Reply #3 on: August 31, 2015, 10:24:44 AM »
I would knock out the debt first. You may want to post a case study to see if there are areas you can trim in your budget, too. :)

frugaliknowit

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Re: Save for Down Payment or Pay Down Debt First?
« Reply #4 on: August 31, 2015, 10:30:12 AM »
Debt first.

Even if you believed it to be "more optimal" to do something else, the psychology of reduced stress is worth it.  Having a mortgage with piles of SLs is stressful.

RWD

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Re: Save for Down Payment or Pay Down Debt First?
« Reply #5 on: August 31, 2015, 10:33:00 AM »
Another vote for tackling the debt first. You'll come out ahead in the long run, unless your current rent is ridiculous.

Regisque

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Re: Save for Down Payment or Pay Down Debt First?
« Reply #6 on: August 31, 2015, 10:38:15 AM »
Yea I'm a regular reader so we're reevaluating our budget regularly for anything we can work on. I'm working on reducing our grocery bill right now! My estimates here are based on worst case scenarios with our spending and income staying flat. Hopefully I'll be able to continue to reduce our spending and get there even faster. :)

The current rent is good as we live in a LCOL area and either way we would be clearing all debt before we take on a mortgage. But it seems like taking out the debt upfront and waiting to save until it is cleared has a lot of favor.

ShoulderThingThatGoesUp

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Re: Save for Down Payment or Pay Down Debt First?
« Reply #7 on: August 31, 2015, 10:40:27 AM »
Good news! You have a huge income and your expenses shouldn't be very high if it's the two of you in a one-bedroom and you have reasonable commutes. With your incomes, I don't think it's impossible to eliminate that debt and save $44k in the next five years. Best of all, you'll get a big boost from eliminating the $15k debt by pouring all extra money into it first, since it's got the highest interest rate.

I'm a red panda

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Re: Save for Down Payment or Pay Down Debt First?
« Reply #8 on: August 31, 2015, 10:45:26 AM »
$100k in debt? And you want to take on more (a mortgage)?

I would get chunk of that student loan gone before you think about a house.

Regisque

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Re: Save for Down Payment or Pay Down Debt First?
« Reply #9 on: August 31, 2015, 10:55:07 AM »
HA no I'm not taking out another dime of debt until I have it all paid off. I just need to decide how to pay it down. :)

TheOldestYoungMan

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Re: Save for Down Payment or Pay Down Debt First?
« Reply #10 on: August 31, 2015, 11:22:21 AM »
1.  Happy wife happy life.  Odds are the financial aspects of the decision are only about 1/2 to 1/3 of the relevant pieces.

2.  You have to live somewhere.  As long as you get a reasonably priced home without tying up too much of your capital, it's a really good way to manage a significant expense.

3.  I found having a mortgage was soul-crushing in a way that other debt never was.  I'm not sure why it felt different, but I'm reluctant to ever go back.  Certainly a mortgage plus other debt was the worst time of my life financially.  It's just a lot of money out the door every month, without much freedom to change the situation without changing your whole life.  You can sell a car if you get tired of the payment, but selling your house means moving.

4.  Chart it out.  If you do your debts in sequence, are you eventually debt free faster?  Consider if housing prices go up another 50% before you pay off your student loan debt.  What if you lose your job?

5.  Your largest expense isn't debt right now.  Even if you had a house payment.  Your largest expense is taxes.  Both schemes you suggest are leaving a huge amount of money on the table in the form of taxes that could be avoided altogether.  A couple can withdraw 20k from a traditional IRA (10k each) for a first time home, so you should probably do that, for at least the first 20k.  I think 401k plans will let you borrow from yourself for a first home too, which seems like it would be great.

http://www.madfientist.com/traditional-ira-vs-roth-ira/

What I did:

Max out any and all retirement vehicles.  Avoiding as much of that tax bill as I could.

Bought a modest house in a good neighborhood, with some extra bedrooms I could rent out.  Deductions on house plus additional deductions from renting a portion of your home further reduced tax bill.  Rent was high enough in my area that this resulted in a net positive cash flow for me of around $400/mo.

Reduce living expenses as much as I could stand, then a little bit more, and poured everything into the debt.

So it is entirely possible that buying the house is both the thing you want and the thing that will get you debt free fastest.

But there are so many factors to consider, and many of them rely on both you and your spouse's commitment to various things.

Mother Fussbudget

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Re: Save for Down Payment or Pay Down Debt First?
« Reply #11 on: August 31, 2015, 12:16:28 PM »
+1 for TheOldestYoungMan. 

Having taking a loan against my 401K to pay down debt, I recommend that strategy.  You can borrow up to 50% of the balance of your 401K, and all interest payments go to YOU.  In my case, it's a 4% interest loan to be paid back  to myself over X years.

Also, when you do the math for the 'rent vs buy' decision, don't forget to factor in the hidden costs of home ownership:
Taxes, Insurance, Electricity, Gas, water/sewer, garbage. 
I went from:
$1,721/month as a renter. ($1610 rent/heat/garbage) + $50 insurance + $20 electricity + $41 internet, to
$1,914/month as a homeowner.  [$1,646 (mortgage, taxes, ins) + $28 electric + $10(average) gas + $150 water/sewer + $39 garbage + $41 internet].

My reasons to buy were all intangibles.  The freedom to plant stuff, work on stuff in my garage, and have my son go to the best high school in the area (the biggest reason for the change) is worth the difference to me.  I also gained the tax advantage of deductible mortgage interest, but I think the standard deduction was just as good, if not better.  I will potentially go back to renting after my son graduates high school, and rent out the house as a source of income in FIRE.

charis

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Re: Save for Down Payment or Pay Down Debt First?
« Reply #12 on: August 31, 2015, 12:23:38 PM »
You obviously do not need to pay off the entire SL debt before you start saving.  It does have to (and shouldn't be) an either/or scenario.    You have a high income so you can max out your IRAs and pay down your student loans.   But if you have to buy a 200K+ house (which I hope you don't), definitely keep renting until that debt has been paid down a lot.

Kaikou

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Re: Save for Down Payment or Pay Down Debt First?
« Reply #13 on: August 31, 2015, 12:56:37 PM »
Pay off your debt

partgypsy

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Re: Save for Down Payment or Pay Down Debt First?
« Reply #14 on: August 31, 2015, 01:13:55 PM »
I don't have student loans so maybe I'm not the best to give advice, but I don't think you necessarily need to pay off all your student loans before buying a house (but yes the majority of the loan).

However I would make sure a) your total debt is reasonable (house plus student loans) which means probably a more modest house, and b) you have an accelerated plan for paying the loans off, whether it is a 5 or 8 or 10 years (obviously, knocking off the highest interest loans off first).
 
I don't think you can time the stock market, but I do think you can (somewhat) time the house market. Right now housing prices are high. I wouldn't be surprised if in next 3 years the markets soften in some locations (and the only reason I say this as these things do move in cycles). That's why I don't think you have to wait till every single dollar is paid off before saving and paying for a house, because it limits the flexibility to take advantage of flucuations in the housing market.

partgypsy

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Re: Save for Down Payment or Pay Down Debt First?
« Reply #15 on: August 31, 2015, 01:15:59 PM »
+1 for TheOldestYoungMan. 

Having taking a loan against my 401K to pay down debt, I recommend that strategy.  You can borrow up to 50% of the balance of your 401K, and all interest payments go to YOU.  In my case, it's a 4% interest loan to be paid back  to myself over X years.

Also, when you do the math for the 'rent vs buy' decision, don't forget to factor in the hidden costs of home ownership:
Taxes, Insurance, Electricity, Gas, water/sewer, garbage. 
I went from:
$1,721/month as a renter. ($1610 rent/heat/garbage) + $50 insurance + $20 electricity + $41 internet, to
$1,914/month as a homeowner.  [$1,646 (mortgage, taxes, ins) + $28 electric + $10(average) gas + $150 water/sewer + $39 garbage + $41 internet].

My reasons to buy were all intangibles.  The freedom to plant stuff, work on stuff in my garage, and have my son go to the best high school in the area (the biggest reason for the change) is worth the difference to me.  I also gained the tax advantage of deductible mortgage interest, but I think the standard deduction was just as good, if not better.  I will potentially go back to renting after my son graduates high school, and rent out the house as a source of income in FIRE.

I hate this idea. This means if you lose your job, not only do you have no income, you have to repay that 401K debt immediately. Which means you are at risk for losing your house. 

TheOldestYoungMan

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Re: Save for Down Payment or Pay Down Debt First?
« Reply #16 on: August 31, 2015, 02:13:10 PM »
The "401k debt" is not an actual debt.  Upon losing your job you'd be transferring your 401k balance to an outside IRA (probably) and any unpaid loan is subtracted from the balance, as in, counts as a distribution and would be subject to taxes and potentially a penalty if you couldn't figure out some other exemption you qualify for.  Since you just lost your job and your income would likely be lower that year as a result, this particular objection is more a "worried about stuff" then a reason not to.  I mean, you wouldn't pay back the 401k loan to avoid a penalty in lieu of making your house payment, that's nuts.

I think once you have regular contributions to something like this and see it grow (or tank), you are then reluctant to tap it at all, which is what happened to me.  I had planned on borrowing from my 401k, but by the time I got ready to buy a house, it had lost 40% of it's value, and I couldn't bear (!) to sell it, I just saved up extra cash without touching the 401k.

Cheapballer

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Re: Save for Down Payment or Pay Down Debt First?
« Reply #17 on: September 01, 2015, 09:41:39 AM »
However I would make sure a) your total debt is reasonable (house plus student loans) which means probably a more modest house, and b) you have an accelerated plan for paying the loans off, whether it is a 5 or 8 or 10 years (obviously, knocking off the highest interest loans off first).

I like this plan. 

I was in a similar situation couple years ago with $150k in student loans with payments north of $1500/month.  I paid $120k of principle off in about 3 years making my payments drop to $250/month.  I'm glad I did what I did because my wife and I had surprise and my daughter was born.  Daycare was an alarming $1800 a month.  If I didn't pay those student loans down, I would be in trouble and have no cash flow for anything. 

If you guys can live off of one income and totally use the other income for student loans, I would do that and just 'stache away the 401k up to the match.

Bikeguy

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Re: Save for Down Payment or Pay Down Debt First?
« Reply #18 on: September 03, 2015, 12:35:20 PM »
Is there any investment guaranteeing 5%?   The answer is no.   Except paying off your debt above 5% interest is a guaranteed return of 5%.

I'd pay off all the debt.

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I'm a red panda

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Re: Save for Down Payment or Pay Down Debt First?
« Reply #19 on: September 03, 2015, 01:19:15 PM »
The "401k debt" is not an actual debt.  Upon losing your job you'd be transferring your 401k balance to an outside IRA (probably) and any unpaid loan is subtracted from the balance,

Assuming the remaining balance in the 401k is greater than the loan.  Otherwise the loan must be paid off upon termination/change in job.

TheOldestYoungMan

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Re: Save for Down Payment or Pay Down Debt First?
« Reply #20 on: September 04, 2015, 12:49:34 PM »
The "401k debt" is not an actual debt.  Upon losing your job you'd be transferring your 401k balance to an outside IRA (probably) and any unpaid loan is subtracted from the balance,

Assuming the remaining balance in the 401k is greater than the loan.  Otherwise the loan must be paid off upon termination/change in job.

OK.

Let's say you have a 401k balance of 20k.  You are allowed to "borrow" 10k.

Now the balance is 10k.  With an outstanding loan of 10k.

The next day the market tanks 50%.  And you lose your job.

You now have a balance of 5k.  And an outstanding loan of 10k.  You have a few choices at this point.  You can:
1.  Repay the 10k right away, because for some reason you had the cash laying around and decided to do that.
2.  Count the 10k as a distribution and pay taxes/penalties.
3.  Use the remaining 5k to wipe out half of the 10k, and just count 5k as a distribution and pay taxes/penalties
4.  Take advantage of any number of strategies to re-arrange your total savings to pay back the 5k (or 10k) and avoid the taxes or at least the penalties.
5.  Lose your house (your original objection) because you ignore other available options and otherwise have no other savings, so you stop making payments on the house so you can pay back this loan?

This, to me, is the embodiment of worrying about things that are both unlikely to pass and far easier to deal with than you think if they ever actually do pass.

Particularly because, when you think about it, had you not taken the loan out, instead of 10k someplace else (like a house) and 5k in the market (15k total) you'd be at 10k in the market.  Even if the transactional costs of figuring out the loan as a distribution or recharacterization or whatever end up being 50% (which is way higher than likely) you still came out way ahead in terms of actual net wealth.

So in a very bad situation in which the remaining 401k balance can't cover the loan amount, and the difference is huge...the difference represents killer market-timing on your part.  You got half of your 401k out just prior to a huge crash! yay!

dess1313

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Re: Save for Down Payment or Pay Down Debt First?
« Reply #21 on: September 04, 2015, 08:45:38 PM »
PAY DOWN DEBT!!!
I would get rid of the three highest interest loans for sure before ever considering a house.  Otherwise it is like having two mortgages tied like big rocks to your ankles and you are trying to swim.

After 3-4 loans are paid off you could consider stocking up an emergency fund/down payment as well as a bit of an emergency fund.  At that time i would consider starting the housing search.  But once you have your down payment, put the rest back to focus on the very last debt.  You might find a house right away, but it could take 6 months to find a good one.  if it takes 6 months, you'd be able to pay down the rest of your loans.  If you find the right place right away, you have your down payment and you have almost no debt left.  You also want a few $ set aside for closing costs, fees, and maybe a few essentials or small renos




mozar

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Re: Save for Down Payment or Pay Down Debt First?
« Reply #22 on: September 06, 2015, 09:58:56 AM »
I would pay off all the debt over 5% then start saving for a down payment.

Merrie

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Re: Save for Down Payment or Pay Down Debt First?
« Reply #23 on: September 06, 2015, 10:38:10 AM »
Having a lot of SL debt and a mortgage suuuuucks. If I could go back in time I would get the SLs gone first and also save for retirement, while I was living somewhere less expensive where someone else did the maintenance. I would not tap the Roth balance like you are talking about. I would save money in the Roths and get the SLs gone. Once you have gotten rid of the SLs it shouldn't take too long to save up for the down payment. If you are already planning to wait 4 years to buy a house, what's another year or two? It's another year or two to get yourself a really solid financial footing. 

Lanthiriel

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Re: Save for Down Payment or Pay Down Debt First?
« Reply #24 on: September 06, 2015, 04:27:14 PM »
Just an anecdote, but my husband and I decided to buy a house early this year when we still had $25k in student loan debt. We were on track to finish paying it off by October. We had been keeping an eye on the market for a long time and a house came up like nothing else we'd seen so we decided to jump on it.

Big mistake. The house is structurally completely fine and pretty updated, but once we moved in, we realized there was a lot that needed work. We painted the entire interior, did a ton of yard work/landscaping, and recently had to replace the hot water heater and rewire the boiler. We're probably $7-8k into improvements after 6 months of ownership, which is a pretty significant amount of money that didn't go toward the debt.

Today we still have $20k in student loans, which makes me CRAZY. There is a moratorium on major house projects, vacations, and eating out--any unnecessary at all, really--until it's gone.

I really wish we had waited to buy until the loans were gone. It would be much less stressful if our only debt was the mortgage. My strong recommendation is to pay off your debt before taking on the liability of a house.