Pay off Student loans before Mortgage?
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.
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MoneyDummy said,
Wrote on August 7, 2006 @ 2:48 pm
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!!!
MoneyDummy said,
Wrote on August 7, 2006 @ 2:51 pm
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!
mapgirl said,
Wrote on August 7, 2006 @ 3:03 pm
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.
thatedeguy said,
Wrote on August 7, 2006 @ 3:34 pm
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.
Through a Glass Darkly said,
Wrote on August 8, 2006 @ 9:08 am
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.
Jennifer said,
Wrote on September 13, 2006 @ 7:08 pm
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?
longtermer said,
Wrote on September 19, 2006 @ 7:36 pm
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.