Pay off Student Loans or Buy a House: What Should You Do First?
5 min read
Posted on April 19, 2022
After earning a degree, many graduates want to prioritize financial stability. They may begin paying off student loans, saving up for homeownership or even investing for their future retirement. These are three significant costs, though. As such, you may wonder what’s the better decision: to buy a home after graduation or pay off a large chunk of student loan debt. The answer may rely on financial stability (or lack thereof).
The decision to pay off student loans or buy a house will vary depending on factors such as your unique financial situation, monthly income and current credit score.
Should You Pay Off Student Loan Debt or Buy a House First?
Before picking one side or another in the “paying off student loans before buying a house” debate, there are a few factors that go into this major financial decision. Because everyone has a different financial situation, there may be times when it makes more sense to focus on paying off your student loans. Likewise, there may be times when it can be better to purchase a home.
For these reasons, there is no wrong answer to this question. You should fully evaluate your finances before making the final decision to become a homeowner or focus on your student loans. Let’s discuss the specific situations in which borrowers may benefit from paying off their student loans or buying a home first.
When To Focus on Paying Off Your Student Loans
There are a handful of specific situations where it could make more sense to focus on paying off your student loans. These situations can include:
- You have a high debt-to-income ratio. If you have a high debt-to-income (DTI) ratio, you may not be in a great place to purchase a house after graduation. While this tends to vary from lender to lender, a DTI above 43% is typically considered too high to qualify for a mortgage. However, if you wait until your credit report improves, you pay off your credit card debt or you have a lower student loan balance, you may be able to get more favorable interest rates from mortgage lenders.
- You don’t have an emergency fund. Even if you have enough money to pay your monthly mortgage payment and make a reasonable down payment on your home, it still might not be the right time to buy because of your lack of preparation for the unexpected. Homeownership comes with responsibilities and hidden costs, and it can benefit you to be ready for them — even if you’re lucky enough never to have to deal with them. You may want to have an emergency fund in a separate savings account before you buy a home. If you don’t, you might not want to buy until you do. This isn’t a requirement, but merely a good rule of thumb.
- You don’t know where you want to live permanently. Buying a house is a major task that can require a lot of time, effort, and financial stake. For this reason, it might stop you from moving around as frequently as you can as a renter. Like the point above, this isn’t a necessity, but merely a good suggestion to keep in mind. If you are considering a move to a new city, a new job or a lifestyle change, it may not be the best decision to purchase a home right after graduation. Renters can have more flexibility to move around while they settle into their careers. At the same time, homeowners can enjoy the luxury of secure housing while working a job that keeps them in one place.
- You don’t have enough for a down payment. For example, with a FHA loan — or a Federal Housing Administration loan — first-time homebuyers get the chance to put a down payment on a home for as low as 3.5%. However, these first-time homebuyers are also required to get private mortgage insurance if they don’t put down at least 20%. This insurance policy is an extra financial expense that can add more to your monthly home loan payment if you don’t hit that benchmark of 20%.
Ultimately, your decision should be informed by your finances. You should never feel pressured to rush into paying off student loans or buying a house before you’re ready. As such, make sure your bank account and your monthly student loan payments are in order first.
When To Focus on Making a Home Purchase
On the other hand, there are also situations where it may make sense to focus on making a home purchase alongside paying off your student loan debt. These situations can include:
- Your loans have low interest rates. Whether you have federal student loans with low rates or got a low rate by refinancing your student loans, you could consider buying a home instead of paying down the balance on your student loans first. Of course, you should carefully consider all your expenses and state of finances to make sure that you can afford to take on a house payment.
- You have a good debt-to-income ratio. Having a solid debt-to-income ratio of under 36% may be a sign that you are financially ready to purchase a house. Not only can a good DTI ratio potentially help you secure a lower interest rate, but it could also secure you a higher loan amount in total. (Some lenders may allow you to borrow with a DTI as high as 43%, but this is typically the cutoff.)
You should always ensure that you’ll be financially prepared for all costs that come along with homeownership. Things like home repairs, closing fees, interest, property taxes, insurance and other additional costs will add up quickly, and realtors might not always be clear about this. The bottom line is that you need to be in the right financial situation to make your monthly debt payments on time and continue to save before you consider making a home purchase.
How Can Student Loans Affect Buying a Home in the Future?
One final factor to consider before deciding to pay off student loans or buy a house is how student loans can affect your ability to buy a home in the future. If you are like most college grads, you probably have around $30,000 in both federal and private loans. These loans can affect your debt-to-income ratio, especially right after college.
In turn, your debt-to-income ratio can impact how you qualify for loans, such as personal loans and mortgages. Because of this, you may only qualify for a comparatively high interest rate on loans you try to take out in the future. You might even find yourself getting denied for a home loan or a car loan.
If you would like to qualify for a mortgage in the future, focus on lowering your debt-to-income ratio under 43% before anything else. This action can help if you decide to apply for student loan refinancing, as well. While having a student loan balance will not necessarily stop you from buying a home, it is important to understand your repayment plan and make timely payments as needed. If your loans go into default, it can make it that much harder for you to secure a mortgage in the future.
Learn More About Student Loan Repayment Plans
So, should you pay off student loans before buying a house? Or are your loans and finances in a good enough place for you to buy a house even with a student loan balance remaining? The simple answer is that it depends on what your finances look like, and what your financial goals are. You need to consider your personal finances before deciding to buy a home or pay off your student loans.
If you’re interested in seeing if you qualify to lower your student loan rates — or even if you’ve recently bought a home and need to refinance your student loans — we’re here to help you learn more about your options.
The information provided in this blog post is not intended to provide legal, financial or tax advice. We recommend consulting with a financial adviser before making a major financial decision.