If you’ve landed a steady job and have a good handle on your day-to-day expenses, you might be considering taking the leap into homeownership. But if you’re still paying off your student loans, does it make sense to buy a house before you’ve paid off your debt?
“Getting into a home can be a good way to build savings and to pay yourself rather than paying someone else for the cost of your housing,” says Matt Ribe, senior director of legislative affairs and corporate secretary for the National Foundation for Credit Counseling. “[But] given the interest rates that are typically associated with student loans, it’s not unreasonable to want to prioritize paying those when you’re just starting out.”
The bottom line? Limit your debt to what you can afford to pay. Here are some questions to ask yourself before making this important decision:
What’s the Interest Rate on Your Student Loans?
“Typically, subsidized government loans are in the 6.5 – 7% range,” says Ribe. “Private loans can be even higher. Even with refinanced loans, you’d be extremely lucky to get less than 5%.” The higher your interest rate, the greater your incentive to pay off your loans before you buy a home.
Are You Making Progress on Paying Down Your Loans?
“It’s possible with some of the income-driven student loan repayment plans to achieve a very low monthly payment,” Ribe says. “But if that payment is not covering the amount of interest that’s accruing every month, then you’re not making progress on repaying your student loan, which means you may have longer-term affordability issues. Don’t conflate your [lower] monthly student loan payment with room in your budget without doing a more thorough analysis.”
What’s Your Debt-to-Income Ratio?
To qualify for a mortgage, your debt-to-income ratio (DTI) should be less than 43%, but many experts recommend it be no higher than 36%. The lower your DTI, the lower the stress of monthly payments.
If your DTI exceeds 43%, focus on paying down your student loans and other debt before pursuing homeownership. “Credit card balances typically have the highest interest rates,” Ribe says, “so we certainly advocate paying those down first.”
Do you have a rainy-day fund?
Experts recommend you have at least three to six months’ worth of expenses put aside in the event of an emergency. As a homeowner, you’ll also want savings to cover inevitable repairs.
“The total cost of a home is much greater than your monthly payment,” says Ribe. “There are some maintenance and homeownership costs, mortgage insurance, property taxes, etc. … so make sure you have some money set aside after you cover your down payment to take care of those types of contingencies.”
If your monthly student loan payments are standing in the way of your ability to build a hefty rainy-day fund, consider holding off on a home purchase until your cash reserves can adequately cover repairs and other emergencies.
Are You Contributing to Your Retirement?
Purchasing a house may be a personal goal and may even be a good investment, but don’t let it completely replace your retirement savings. If your employer is matching your contribution, at a minimum you should be contributing at least as much as your employer match annually to ensure you aren’t leaving free money on the table.
Remember that contributions to your retirement account in your 20s provide far higher returns than those made in your 40s. That said, once you’ve covered your employer match, it may make sense for you to buy a home or pay off high-interest student loans instead of investing more in your retirement account. That will depend on your income, tax bracket, investment returns and other personal factors.
How’s Your Credit Score?
The best mortgage rates go to buyers with excellent credit scores (above 740). But if your score is below 680, you may be better off waiting to buy a home until you have a chance to improve it.
Paying your student loans on time each month and never missing payments helps you earn a better credit score. Student loans also add to your credit mix of installment and revolving loans, which can have a small beneficial impact on your credit score, according to FICO.
When you pay off your student loans in full, it helps lower your DTI, but your credit score may dip slightly if you don’t have another installment loan in good standing on the books. In this scenario, to keep a good mix of credit after your loans are paid off, you might consider applying for credit in the form of a mortgage – if your financial circumstances allow. If not, focus on paying down your other debt and getting your credit utilization below 30% on each account.
Can You Get a Good Mortgage Rate?
Usually, getting the most favorable mortgage terms requires 20% down, but not always. “There are a number of first-time homebuyer mortgage products that are attractive in terms of being able to purchase a home with a low down payment at a good rate,” says Ribe. Just make sure you plan to stay in the home long enough to build some equity.
If you can’t get a good mortgage rate, your focus should be on paying down your student loans and shrinking your DTI. This could increase your chances of getting a better rate when you finally apply for a home loan.
Do You Plan to Live in the Home for the Foreseeable Future?
The longer you plan to own a home, the greater your chances of building equity. If you aren’t quite sure where you want to settle down or envision a job transfer out of the area, for example, it may be best to wait.
“Anything less than five years, you’re going to want to rethink your options,” Ribe says. So, if there’s a pretty good chance you’ll move soon, focus on paying off your student loans.
In the end, choosing whether to pay off your student loans before buying a house is both a financial and personal decision. “There’s no one-size solution that fits everyone, so I encourage people thinking about this to speak with an expert counselor,” advises Ribe. You can find a counselor through the National Foundation for Credit Counseling website.
Mary Purcell is a freelance consumer finance and health writer based in the San Francisco Bay Area. Her articles have appeared on Narrative, SafeBee and other outlets. She covers home buying and mortgages, business lending and insurance for MoneyGeek.com.
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