Should You Save for a Down Payment or Pay off Student Loans?

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If you're like most Americans, buying a home is on your bucket list. A National Association of Realtors survey found that the majority (75%) of non-homeowners considered owning a home to be part of their American Dream. Be that as it may, affording a down payment can be one of the biggest hurdles to getting there.

To put things in perspective, the median down payment for first-time buyers in 2019 was 6% of the home's purchase price, although some home loans make it possible to get approved with as little as 3.5%. Still, that translates to almost $9,000 for a $250,000 home.

For consumers with hefty student loan debt, a down payment that size may feel unreachable. The Federal Reserve reports that student debt borrowers on average owe upwards of $20,000 and have an average monthly payment that ranges from $200 to $299.

Deciding whether to save for a down payment or pay off student loan debt depends on a number of factors. There isn't a one-size-fits-all answer. There are, however, certain situations where it's smart to prioritize one over the other. Read on to learn more.

When Does It Make Sense to Save for a Down Payment First?

In some circumstances, directing more of your income toward saving for a down payment could pay off in the long run. Consider doing so if:

  • Mortgage rates are especially low. Mortgage rates are currently at a historic low, which can mean big interest savings compared with what you'd otherwise pay. Striking while the iron's hot and locking in a fixed lower rate now can stretch your dollar further and get you in the home of your dreams. Lower rates also help shave down your monthly mortgage payment to a point that it makes homeownership affordable.
  • Home prices are looking good. Prices can vary greatly depending on local markets, but the national median home price as of June 2020 was $295,300. That's up over $17,000 from last year, which means that home prices are currently on the rise. It's impossible to predict future home prices, but waiting around as they continue to climb could mean missing out on great homebuying opportunities. That being said, many local markets are also seeing a sharp increase in pandemic-related short sales and foreclosures.

What Are the Benefits of Starting to Pay off Student Loans First?

Drilling down on your student loans might make more sense than saving for a down payment in a few scenarios. Here are a couple potential benefits.

Student Loan Interest Savings

This could be the case if your loans have variable interest rates. Unlike fixed rates, which stay the same over the life of the loan, variable rates fluctuate. Paying off your variable rate loan or loans faster could shield you from a potential rate hike in the future.

One other workaround is to refinance your student loans to lock in a lower fixed rate. Just keep in mind that refinancing requires a credit check and may involve multiple loan applications. You'll also be closing an account on your credit report. These factors all may contribute to temporarily lower credit scores, which could hurt you when mortgage shopping. For best results, wait for your scores to rebound before submitting loan applications.

Reduced Debt-to-Income Ratio

When reviewing your mortgage application, lenders will take a look at your debt-to-income ratio (DTI). This metric considers your existing debt obligations and helps lenders to determine whether you can afford your mortgage payment.

To calculate your DTI, simply add up your monthly debt payments, then divide the sum by your gross monthly income. If the total is 43% or higher, you'll likely have trouble qualifying for a mortgage. Paying down your student loans can reduce your DTI—and make you a more attractive borrower to mortgage lenders.

How to Start Paying Off Student Loans While Saving for a Down Payment

If you're still torn between saving for a down payment and paying off your student loans, take heart in knowing that it doesn't have to be an either-or situation. With the right planning and budgeting, it's possible to do both at the same time.

Creating a budget and sticking with it can help you rein in overspending so that you can chip away at your student debt and build your down payment fund simultaneously. An added bonus is that you'll also be reducing your DTI month after month, which will help when you eventually begin shopping for a mortgage.

While you're saving, resist the urge to dip into your down payment fund, even if it's an emergency. Consider keeping separate accounts for your emergency fund, day-to-day expenses and your home savings. A high-yield savings account you deposit money into every month (possibly automatically) can put down payment savings out of sight and out of mind. You'll also be earning money on interest while it grows.

One other trick is to leverage cash windfalls like tax refunds, inheritances, work bonuses and raises. Whenever you come into some money, consider dividing it equally between debt repayment and saving for a home.

Can Student Loans Affect Getting a Mortgage?

When it comes to getting approved for a mortgage, your student loan debt comes into play in how it affects your payment history and debt-to-income ratio.

To qualify for a conventional mortgage, borrowers typically need to have a credit score of about 620. Payment history is the most important factor in determining your FICO® Score (the scoring model used in many mortgage lending decisions), so having a history of late or missed student loan payments will drag down your score and make it harder to get approved for a loan with great rates, or at all. On the other side of the coin, consistent, timely payments will reflect positively. Generally speaking, the best mortgage rates and terms go to borrowers who have higher credit scores.

Your debt-to-income ratio, as explained above, will also factor into whether you can qualify for a mortgage loan, and what rates you'll receive if you approved. High student loan payments can compromise your ability to get a mortgage loan.

The Bottom Line

Making progress while working toward two different financial goals can be a balancing act. If buying a home is important to you, know that it doesn't have to mean putting your student loans on the back burner. Whether you choose to tackle them both at the same time or prioritize one over the other, maintaining a strong credit score is an important part of the homebuying journey. Stay on top of it by checking your credit report and credit score for free with Experian.