According to the credit watchdogs at Experian, $1.57 trillion in student loan debt was spread across an estimated 165.2 million accounts in 2020, so this a pretty significant concern. Explore whether it’s better to save for a down payment or pay off student loans first, or how you may be able to do both.
Saving for a Down Payment vs. Paying Off Student Loans
The right financial move for you depends on a few factors, but your debt-to-income ratio (DTI) may be the most important. Your DTI is the amount of your monthly income that goes toward paying your debts. They can include credit card debt, a car loan, and student loans. There are two types of debt-to-income ratio: front-end, and back-end. Front-end is calculated by your estimated housing costs (your mortgage payment and insurance) divided by your gross income. Back-end is the percentage of your gross income that goes toward housing costs plus other debts, like credit cards, car loans, and student loans. LendingTree indicates 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 did calculations based on $3,000 in monthly income, $300 a month in student loan payments, and other modest debt and housing expenses. It arrived at a debt-to-income ratio of 51.6%, above even the FHA-acceptable ratio.
Calculate Your Debt-to-Income Ratio
Calculate your debt-to-income ratio to see if obtaining a mortgage with your current student loan debt is doable. Focus on paying off your student loans first if your DTI isn’t up to par just yet. Then you can apply for a mortgage down the line. You’ll have to focus on paying off your student loan and other debts before applying for a mortgage if your DTI isn’t within an acceptable range. You can revisit the issue when your debt-to-income ratio is lower. You may want to start saving for a down payment first, while also paying off your student loans, if your DTI is acceptable to mortgage lenders. You may be able to do both.
How You Can Do Both
Perhaps your timeline to buy a 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 that much of an issue. Saving up for a down payment and paying off your student loans at the same time is doable. Start with a bare-bones budget. Cut any discretionary spending, from cable TV to happy hour with friends or shopping for unnecessary, noncritical items. Split the balance between your down payment fund and your student loan payments after you’ve covered all your non-discretionary spending, such as groceries, rent, and utilities. 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 payments 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.
The Next Steps
Many factors will play into your decision as to whether to pay off your student loans or save up for a down payment: your other debt, your credit score, and the interest rates on both your student loans and your mortgage. Consider these next steps if you’re still stumped.
Use a mortgage calculator to find out how much of a loan you’d prequalify for based on your current DTI, and what your monthly mortgage payments might be. Take advantage of grants and scholarships to help pay off your student loan debt if you decide to tackle your student loans first. Create a budget and start tracking your expenses. Both will help you reach your financial goals more quickly.
The old rule of thumb that you need to put 20% down in order to buy a house isn’t carved in stone. See if you qualify for a mortgage that requires less money down but still offers a decent interest rate. But stay away from adjustable-rate mortgages (ARMs). The interest rate on these loans adjusts after a certain period of time so your mortgage payment can increase dramatically over the life of the loan. Don’t get discouraged. You’re joined by millions of your college-graduate peers if you have student loan debt. You can pay off your loans and reach your other financial goals as well with a few actionable steps, a lot of hard work, and a manageable budget.
