It doesn’t seem fair to have to either pay off student loans or buy a home. Can’t you do both? After all, you went to college to get a good education and a good job. In order to do that, though, you needed student loans. Now you want to own a home. But, making those payments can get tricky.
The thought of adding a mortgage payment to it can just seem overwhelming. The good news is, you can do both. But, you have to time it right. We help you discover more below.
Start With Your Student Loan Interest Rates
The most expensive part of student loans is the interest. At a minimum, you must cover the monthly interest costs. Even if you do this, though, you’ll still pay a lot of interest in the end. The longer it takes you to pay the principal off or at least down, the longer the interest accumulates.
If you don’t cover the interest, it continually gets capitalized. This means added back onto your principal balance. What happens in the end? You pay interest on your interest. That doesn’t sound good, does it?
The good news is that the lower your interest rate is, the easier it is to buy a home. That might not make sense, but we’ll explain.
If you have a high interest rate, let’s say 10% just for example purposes. You pay a lot to borrow that money. You want to pay it off as fast as possible. You won’t find any investments, including real estate (in the short-term), in most cases, that will provide you with greater than a 10% ROI.
However, if you have a lower interest rate, let’s say 4%, you may be able to use some of your monthly funds for a mortgage. Just how much should you use? It depends on your situation. Generally, you have to keep your debt ratio at or below 43% of your gross monthly income. This includes your new mortgage payment, student loans, and any other monthly obligations you have.
This may help you decide how much of your income you can put towards a mortgage. It’s a delicate balance between paying student loans and your mortgage payment.
What’s the Balance on Your Student Loans?
Another large factor is the balance on your student loans. Have you only paid interest since you’ve been out of deferment? You are only shooting yourself in the foot if that’s the case. You have to pay down the principal in order to make headway on the loan. If you can’t afford more than the minimum payment, you probably shouldn’t buy a home yet. Don’t worry, there are ways around this.
Your student loan payments come with options. The standard or default option is a payment amortized over 10 years. Many new graduates can’t afford this payment. They end up just covering the interest and hoping for the best. Instead, try an income-based repayment plan.
These plans offer a variety of options. Each option tailors your monthly payment to your current level of income. Most programs require you to reapply every year. Many of the programs also include loan forgiveness, though. After you make payments for 10 years, the Department of Education may forgive the remaining balance. This leaves even more money available to you to buy a home.
What’s Your Credit Score?
Your credit score plays a role in this decision as well. Of course, it affects whether you can buy a home or not. But, there are many programs out there, even for borrowers with lower credit scores. FHA loans are just one example. You only need a 580 credit score to qualify for a 3.5% down payment loan.
If you pay off student loans, though, it could hurt your credit score. This sounds crazy, but it’s true. Many factors make up your credit score. The age of accounts and the type of credit are two of those. If you pay off your student loans you get rid of your installment debt. You also make your average account age younger. If you have another good-standing installment debt to replace it with, your score may not be affected.
In this case, buying a home could help you. You put your money somewhere where you will see a return on your investment. You also keep your credit score up. Once you secure the mortgage, if you pay the student loans off and your score dips, you won’t be affected for long.
How Long are you Staying Put?
Your plans for the future affect the decision too. Investing in real estate often makes sense when you plan to stay in the area for at least 7 years. If your plans are more short-term, you could take a loss. That could have been money you used to pay off student loans. While you can’t predict the future, try carefully evaluating your plans to see if may stay put for at least that long.
If you will move in the near future, you may be better off paying off those student loans. This way when you do move, you have more capital to use. Paying the loans off now and investing in a home when you find your “forever” home may be a better choice in this situation.
The Bottom Line
Should you direct all of your money to paying off student loans? In most cases, you probably shouldn’t. There are ways to get help. At the very least, you want to apply for loan forgiveness. This requires you to sign up for an income-driven repayment plan. This way you’ll only pay what you can afford. But, you’ll also have less debt in a minimum of 10 years.
Using your money to pay off your student loans could leave you without your own home for a long time. Instead, focus the minimum amount on your loans and save for a home. As long as you stay consistent with your student loan payments and take advantage of loan forgiveness, you should come out ahead in the deal.