Liz Weston, one of the best personal finance experts out there, recently received this question from a reader:
Next year we will be shopping for a house in the $150,000-to-$200,000 range and hope to have $20,000 to $30,000 saved for a down payment. We have about $75,000 in student loans we are paying down. Would it be better to eliminate, say, one $3,000 student loan early or keep the $3,000 for a bigger down payment?
The reader is asking the wrong question. Whether to put $3,000 in savings or toward the loan is a deck chairs on the Titanic conversation. The real question is “should we try to buy a house or should we pay off our student loans?”
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The answer depends on a few things. The conservative position on this topic is to say, “Pay off your student loans before you try to buy a house.” That’s basically my position but it can be a little extreme. Here are the situations where it might be OK to buy a house even when you have a pile of student loans:
- Someone is willing to give you the money for the down payment as a gift. My first choice in this situation would be to say, “Hey, thanks for the offer. Wanna pay off my student loans instead and then I’ll start saving for a down payment on my own?!”
- You have only federal loans and a very secure government job that qualifies you for the 10-year loan forgiveness program. Be careful with this one. I don’t like this plan if you have a job at a small non-profit because you could lose the job and lose your eligibility for loan forgiveness.
- The home you’re buying is extremely cheap and in a market where owning is much, much cheaper than renting, e.g. a $5,000 foreclosure in Flint, Michigan. But if you’re looking at a $200,000 house, you could probably find a cheap rental for less and use the extra money toward the student loans.
In most situations, adding a mortgage to a $75,000 student loan pile will simply add too much risk, stress, and uncertainty to your life — especially when you experience a job loss, illness, or other unexpected minor financial crisis that happens to almost all people at some point in their lives.
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With any luck, the couple writing to Ms. Weston will have a hard time finding a lender willing to write a mortgage with that high of a debt-to-income ratio. If not, we may have the seeds of the next financial crisis.
