Should You Pay Off Your Student Loan Before You Buy a Home?

Should You Pay Off Your Student Loan Before You Buy a Home?

Posted May 27, 2015 by Mike Cagney & filed under Featured Posts, Mortgage, Student Loans.

It’s been incredible to hear the overwhelmingly positive feedback we’ve received since we started offering mortgage loans, particularly since rolling out the mobile mortgage experience, which gives you real rates in under two minutes right from your phone.

Our mortgage is unique in that it was built with the needs of early stage professionals in mind: low down payment (as little as 10%), high maximum balance (up to $5 million), flexible debt-to-income limits and a simple, online application process, most of which can be done on your phone. Judging by the demand we’re seeing, a lot of people have been waiting for something like this to come along.

Because our members tend to be Millennials and Gen X’ers who are often dealing with student loans, one question we’ve heard repeatedly is whether it’s best to completely pay off education debt before taking on a mortgage loan. While the answer depends on several factors, in general if you have enough for the down payment and you want to buy a home, in my view you are better off buying now rather than waiting.

For example, let’s assume the following:
• You’ve saved up $100,000, and anticipate saving another $50,000 next year.
• You have $50,000 in student debt at a 5.75% interest rate.
• You have your eyes on a $1,000,000 home, and you qualify for and select a 10% down, 3.9% 7/1 ARM mortgage from SoFi.

You have two options. You can buy the home today, and pay off the student loan in a year. Or pay off the student loan now, and buy the home in a year. There are two quantitative factors that contribute to your decision: your marginal tax rate and your expectation of real estate appreciation.

For example, to calculate the mortgage loan difference in the scenario above, if you bought today and realized a 3.5% annual nominal real estate appreciation with a 35% marginal tax rate, you would end up about $25,000 ahead after five years, versus about $9,000 ahead if you waited a year – a $16,000 difference.

The difference in savings from buying a house now come from three key sources:

1. Home Price Appreciation. According to Investopedia, price appreciation is the largest measurable financial benefit to home ownership. The sooner you buy your home, the sooner you begin to benefit. In this example, you are putting down 10%. If the home appreciates 3%, you make 3% on $1,000,000, or $30,000, against a down payment of $100,000. Essentially, you’re getting a levered 30% return.
2. Mortgage Interest Deduction. The sooner you buy your home, the sooner you get your mortgage interest deduction. In this example, it starts off as a $12,000 annual benefit.
3. Accumulated Loan Interest. Offsetting these gains is the interest you pay on your student loan, and the extra year of mortgage interest paid.

There is also an important qualitative consideration here, including things like when do you want to move into your home? What’s the cost of renting for another year versus buying the home you want to live in for the next five?

We made some simplifying assumptions here – such as you make your payments annually, you keep your money in the bank where it earns zero interest, and rent and mortgage payments are the same. We also chose a 7/1 ARM, though the analysis holds if you choose an interest-only or 30-year fixed rate loan.

As always, your own situation will vary – you can use a mortgage calculator to do the math yourself, or learn more on the SoFi website.

Finally, since we’re talking about mortgages, we have to show lots of legalese. You can read it all here.