Help a Reader: Debts Versus House

Here's a question I recently received from a reader:

I'm 27 and I'm struggling with the decision to either pay off the remainder of my debts, or start saving for a house.  Now, to give you some background, the only debts I have is around $11,000 of student loans and $17,000 car payments (both interests are under 6%).  That's it.  I'm in a successful field and I already have an emergency fund, I'm contributing to my 401k and maxing out my IRA but I'm left torn between either becoming completely debt free or start looking for a house.  The housing market gets better for buyers in my area every day, but the idea of completely being debt free may not happen again in my lifetime if I purchase a house. Is there any advice for someone in my situation?

What would you suggest she do?

Comments

[Chris]

Forget about the student loan and keep writing off the interest if you can, keep paying off the car, and save for a house. Or better yet, sell the nice car and use that money to pay for the house!

[Matt]

Payoff the debt. It is so much easier juggling the things that happen when your a homeowner without debts payments looming over your head.

[Graham]

I'm in the same situation now ($6000 of student loans to pay off is all the debt I have though), and my wife and I are going to move into a cheap apartment and try to save as much as possible toward and house and finish our debt off.

We were considering a house at the beginning of the year, but it fell through and we couldn't be happier. Ideally, although it may not be mathematically the best investment, I'd like to save up and pay cash for a house. Not having a mortgage payment in the future will free up a lot of monthly income and will just be better on us emotionally.

I recommend becoming debt free first. :)

[Chris]

I might add about student loan debt, that I have very favorable financing on my consolidated loan to the point that if I pay it off now vs 20-30 years, I would loose money! Why? Inflation eats at it, and I get to write off a percentage of the interest on my taxes. I makes more sense to invest the money in stocks or a house rather than pay off such an easy loan early. It is well worth the juggle.

Also, should my income suddenly drop I can go into "economic hardship" mode and miss payments with no penalty.

[Ryan]

Pay off the debt. The emotional/stress relief alone will be worth it.

[Nicholas Paldino]

I think it is important here to address the mentality regarding debt. Debt in itself is not a bad thing, and when managed properly, can work for you.

However, many people look at debt as something to avoid at all costs (which isn't a bad sentiment entirely). Look at it as a tool, one which should be applied to the right situation at the right time, and questions like these should be easier to answer.

[Jeremy]

Why not do a little of both, i.e., knock out the car payment, then look at saving for or buying a house? Personally, I despise carrying debt for a depreciating asset (like a car), and I smile a little on the inside when my coworkers talk about making their next car payments, knowing that the only costs for my cars are the normal operating costs and insurance.

I tend to agree that financially, it may be advantageous to keep the student loan. I'm in the same boat with the wife's ~$40K student loan at ~3%, but I'm strongly considering knocking that thing out to have the peace of mind of no debt.

[Tonya Hughes]

Pay off the debt as fast as you can. I recommend paying off the higher interest items first. If you have to reduce your 401k and IRA a little bit to become debt free first and then pour on the savings for the house and retirement. Do not get rid of 401k altogether. At least keep the free matches!

[rwh]

I echo the earlier comments about paying off the car loan first as it is an asset that depreciates and the loan isn't tax deductable. In addition, ask yourself if the car is really that important to you. You didn't say what kind of car, how much it cost, what kind of gas mileage it gets etc. But if you can sell it for more than 17k you might want to look at buying an econobox for under 15k, which will save you operating expenses plus immediately lowering your debt.

[andy]

go debt free first! go check out dave ramsey.

[Kevin]

Not enough info here -

1) how much is your rent vs. what a house payment would be? If the mortgage won't be much more, I would say go for it. Loan rates are historically low now and you might be able to find a good price on a home.

2) you said car payments with an "S" - are you married? If not, why do you have 2 cars? Sell one and use that money to pay off the debts.

[Angie]

Main factor is monthly rent vs. mortgage, property taxes, and insurance. I have done this myself, creating a spreadsheet which in turn tells me how much house I could afford in order to keep the same payment. If you could get a home in your area for that price range and don't plan on moving for 3-4+ years then it is probably in your best interest.

A main part of this is to be sure you have accurate input values for your area. Most online calculators standard values can be WAY off. Especially for property taxes. They can end up adding a few hundred each month depending upon how you estimate it.

I am trying to make the same decision as you at this point in time. Except my debt load and interest rates are considerably higher at around 100k.

[Randy]

I agree not enough info. How much disposable per month?

I would double the payments on both the car payment and the student loans and save the rest towards a home purchase.

[tom]

1) Refinance the car loans - you can find rates as low as 4.5%

2) Start looking for a house and a mortgage lender. As Kevin said, rates are low, and it's a buyers market. Do this only if you plan on staying put for at least 2+ years.

As long as you can handle all of the monthly payments, I don't see why you cannot start saving for a house if that's something you really want to do.

[Financial Goal]

How much down payment will be needed on the house that you are looking to purchase? I would pay off the car payment but also give you the opportunity to save for the down payment on the side as well. It all depends on how much you make and how much you need for the down payment.

[JK]

I agree with some of the comments above... If you have 2 cars (and payments) you might look into selling one of them, or possibly both and getting a more versatile vehicle. I like crew cab trucks for this reason. I need a truck 2-3 times a week, and need room for passengers very often as well, so this is a good compromise.

I have my student loans on the extended payment plan... Doing this frees up about $150/mo in cash that I can use for savings/investments/fun!

Now here's my advice if you don't want to get rid of your car(s):

Pay them off exactly as scheduled. Any money you give back to the bank is gone FOREVER. (The Bank loves it when you pay early!)
If you have ANY extra money to save, do so, and I would save it where you have quick access to it (3 days max).

For example, say you win $10,000 on a lottery ticket today. You have 2 options: 1) Pay down your car loan. 2) Save it.

Either of these could be good options. If you paid down some debt, you may be able to have them recast the loan, so you have a smaller payment for the rest of the term and free up some cash. However, if anything changes with employment, etc. You would still have $7000 in debt and no way to make those payments.

If you save it, even in a conservative account at 3%, you will have probably 3-6 months worth of liquid cash in case anything unexpected does happen.

I know many people talk about the "feeling" of being debt-free, and that is fine if that is what makes them feel good, but rarely is it in your best interest to be debt-free.

For me, this is how I see my financial position going:

Stage 1: Lots of debt, a little cash

Stage 2: Lots more debt, a little more cash

Stage 3: Lots of debt, Lots of cash

Stage 4: A little debt, TONS of cash

If you are afraid of debt, you must seek to understand it, or it will own you. If you understand it, and use it wisely, you will have power over debt.

JK

[jc]

I don't think most of the advice posted to date addresses a key question. What is the probability you will want to own that same house five or six years from now? How stable is your job and it's location? Are you in a realtionship or do you contemplate one that might cause you to change your mind about where you want to live or the your accommodations. Unless you are pretty certain your present circumstances are not going to change in the next five years, continue to rent. At your age, the probability your circumstances will change is greater than the probability that buying a house will be a good short term investmetn. Good luck. jc

[rob]

@JK:

You realize though, that if a person does decide to pay early rather than have that liquid cash reserve, the early payment usually tends to push out the next due date. For instance, in my scenario, I can go a long time without making a single payment toward my mortgage because I have paid extra on it for a while. While I may not have that mortgage money sitting in a crappy 3% account, that doesn't matter because if Murphy visits, my monthly obligations won't be so intense until my mortgage due date catches up with me. In my case, less emergency money can go a lot further than it normally would. (Obviously I am sure no one would like to think of not paying on their mortgage...but I'm just making a point.)

[JK]

rob-

That has not been my experience with my mortgage company (Bank of America). However, my hometown bank does do loans like that to make sure that they get the full amount of interest that was built into the loan.

However, if you have cash you have much more flexibility than having your car loan or mortgage paid up for 3,6, or however many months. You can use it for your mortgage or car payment, but you can also save it, you can invest, buy real estate, etc. But if you give it to the bank, they aren't giving it back. Period.

I'd rather have a "crappy" 3%...

JK

[ballen]

work on becoming debt free, then save up enough money to get a 15-year affordable home loan no more than 25% of your take home pay.. Or if your a real saver you can wait and save up to buy the house without borrowing money... either way being debt free again or remaining debt free will seem within reach.
Hope that helps

[Monetary Karma]

This is a no-brainer. Buy a house and do it as soon as possible. Who cares about being debt-free? What's the first thing you're going to want to do when you're debt-free? From the sound of it, you'll buy a house (and you'll be back in debt).

The subprime meltdown has created a perfect buying opportunity for first-time buyers. First you have your pick of houses on which prices will continue to fall over the next 6-18 months (depending who you ask) - thus giving you some time to save for a down payment. Second, mortgage rates are at historic lows.

Provided you don't buy more house than you can afford, this is really a simple decision. Don't let the sirens song of being debt-free distract you from the fact that housing prices are close to bottoming and interest rates are at historic lows (but on their way up).

Buy a house within your means and do it as soon as you can.

[Lashawn]

I would suggest dividing any extra income between making the car payments and saving for the house. Having on an existing loan and making regular on time payments might prove to be valuable when you go for a mortgage.

[Ada]

rob -- If they're pushing off your next payment the bank is probably not applying your prepayment (solely) to principal.