MoneyDummy at One Money dummy getting smarter says she’s convinced. One should pay off his/her student loan debt before buying a house or concentrating on paying off a mortgage.
I couldn’t disagree more. Certainly, there is something to be said about having no other debt except for your mortgage. However, I think that this is more of a situational decision. Take my situation for instance. I pay 3.75% on my student loans. I pay 6.75% on my mortgage. By paying on my mortage first and foremost, I effectively earn 3% on my money. That doesn’t even include the potential increase in value of my home. If my home increases by 5% each year, that’s an extra 5% I make by paying(or having) a mortgage over just paying off my student loans. It may not sound like much but when you start thinking about the total dollar amoun of a mortgage or the average total student loans, it can add up in a hurry.
I was told once that student loan money is the cheapest money you’ll ever borrow. MoneyDummy refers to Dave Ramsey in her post. Dave is the same person who pushes the “snowball” payoff method. In that method, Dave almost always suggests putting the debt with the highest interest rate first for payoff. I can’t see any logical reason why student loans would be an exception.
As further evidence for my arguement, I ask you, would you ever get a home equity loan or refinance your home to pay off a debt that had a lower interest rate? Even if it were a credit card? Student loans are also unsecured debt. They cannot repossess your education if you default. They can repossess your home.
It still comes down to a personal decision, but my opinion is that paying on the mortgage and other debt with higher interest rates makes better money sense. Student loans truly are the cheapest money you can borrow. Leave them for last on your payoff schedule. You’ll be making money on the deal.
I should point out that I am not a financial professional and any thing that I write here should not be taken for financial gospel and the only advice I am legally qualified to dispense is this: Consult a financial professional.
[tags]mortgage, student loans, dave ramsey, dave, financial, interest rates[/tags]
{ 12 comments… read them below or add one }
I actually think it would depend on the tax benefit you would receive from either the student loan interest deduction, or the mortgage interest rate deduction. It used to be that the student loan one expired after 5 years, so then the benefit wasn’t as great. (Though at the time, it was still a very cheap interest rate for borrowing, so it did work out for me to pay it last.)
One thing though is that the student loan is not collateralized. They can’t take back your degree if you don’t pay it, unlike a house. Now will that tip people over into paying the mortgage first? Dunno, but yet another thing to consider if you’re going into dire straits. A diploma can’t be repossessed.
LOL. I knew that post would draw a little fire. *Grin*
Mathematically speaking, you’re totally spot-on that it would be cheaper (though not as much for us as for you, it looks like) to pay off the student loans first.
While I was listening to Dave Ramsey this morning, I realized that perhaps for myself and certainly for Mr. MoneyDummy, he was right: Financial wellness is only 10% about math and 90% about people. Since the math benefits for us are relatively small, and the psychological feeling of having only the “best” kind of debt is huge, we feel good about killing the student debts first.
I really admire people like you, for whom the sheer math is enough of a psychological motivation to burn that debt up. Nice work!!!
BTW: I’m wondering if I misunderstood, misheard, or misread Ramsey. I didn’t hear him say to pay off the lowest debt first; I heard him say that although it makes mathematical sense to pay off the highest-rate debt first, it makes human sense to pay off the SMALLEST debt first.
I wonder if he’s said different things at different times. Leave it to the pfblog community to pick up on that!
I think the “Smallest debt” bit you heard is something he refers to often. The idea there is that if you start with the largest debt, it can sometimes seem unsurmountable and that by paying a smaller debt first, it makes human sense in that it gives us a sense of accomplishment.
Mapgirl is correct also in adding that the tax benefit is something to take into effect.
Again, each of us makes that decision on whether it makes sense(financial or human) to pay off the debt that we pay off in the order that we pay it off. As long as it gets paid off, does it really matter? Very little, I think.
Dave’s debt roll-over consists of paying down the smallest debt first, even if that debt has a lower interest rate. My husband and I used Excel to calculate whether it would be quicker to pay off the debt by doing it Dave’s way or by starting with the debt with the highest interest. It turned out we would finish in the same month, although we’d end up playing slightly more total (with interest) with the debt rollover. The thing about the debt roll-over is the emotional aspect of debt pay-off. If you are knocking your debts off using the roll-over, you (‘you’ being most people) will get more satisfaction than feeling like you’re paying continually on enormous debts that never go away.
What if you have some private student loans at a variable interest rate? Wouldn’t it makes sense to pay that off first if the interest were more than the mortgage?
Not only should you get a mortgage before paying it off, if you have public student loans at a low interest rate you should drag the payments out as long as you can.
Why?
Because investing that money will give greater returns in the long run. It is a penny wise and a pound foolish to pay the student loans off early if that means you can’t invest anything. The tax deduction on the student loan interest is just gravy on top.
HOWEVER, if you lack discipline, and if dragging out your student loan means you spend that extra money shopping, then yes, by all means, pay off the loans.
This strategy is more fully articulated at Get Compounding.
All fine, but by applying cash to the down payment instead of the loan could dramatically change the interest rate offered. That has the potential to make the difference of thousands of dollars in the long term.
Use the Zilch software program – it’s free to try and I used it to pay off all of my debts. It has several calculation methods – including the ability to add an “extra” sum every month toward your debt (on top of the minimums) to show you what would happen if you would just not get that starbucks everyday, etc. A really easy to use awesome program.
I would advocate paying the student loans off first unless you are either certain of your future (who can be these days?) and have disability insurance or have rich family that can help you out if need be. Student loan debt cannot be discharged in a bankruptcy. No one wants to think that could happen to them, but if you lose your job and can’t pay your mortgage, the worst that can happen is you declare bankruptcy and (possibly) lose your house. They never stop coming after you for student loans; and during the time you’re not paying, the penalties and interest keep building.
For me, the peace of mind of knowing I’ll never be in the situation where I can’t get out of my debt if worse comes to worst is worth the possible loss in net worth from not investing the money (at an interest rate that is not guaranteed), or paying more money overall due to the higher interest rate on the mortgage.
I ran the numbers in a mortgage calculator on paying off the house 1st vs paying off the student loans 1st. My mortgage is $130,000 @4.75% (15yr, $1010/month) and my SL’s are $70,000 @2.7% (25 yr, $340/month).
Applying my extra money monthly to the house 1st gets me debt free 26 months sooner than if I applied all extra to the SL’s 1st. Getting rid of the mortgage frees up so much more money monthly so that if times got tougher then just paying the minimums toward SL’s would be much easier than paying the minimums toward the mortgage. Plus the difference in interest rates says to pay the mortgage first.
I’m a huge Dave Ramsey fan, but I just can’t come up with any scenario where paying off the SL’s first is in my personal best interests. I guess there’s some merit to the fact that I could always sell the house and get out from under that debt and I can’t do that to the SL’s. But if I die then my SL’s go away. The mortgage would still be owed. Those are somewhat offsetting reasons for either.
Mike: While I believe you are correct about not being able to discharge student loans through a bankruptcy, there are other benefits which can help with financial hardship. For example, if you lose your job or have a low income, you can apply for a hardship deferal which could suspend you SL payments for a year or more. If you become legally disabled, the loans are forgiven. Besides, you could pay the $20/month for long-term disability insurance with the money you save by paying your mortgage off before your student loan!
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