Pay off student loans vs. 20% down payment

[OrthoInAL]

Hi everyone,

1st time poster here. I'm hoping to get some advice from everyone on a choice me and my partner have to make very soon. First, some background...

 

My partner is a pharmacist, making appx. $125k/yr, and I'm an orthodontist making appx. $200K/yr. We're in the process of building a home through a builder and will close on the home sometime in September or October most likely. The home is priced right at around $500K.

 

We paid off his student loans last year and I currently have about $120K remaining on my student loans (avg. interest rate around 6%). We started saving intensely for the home last fall and should have the full amount for a 20% down payment plus closing costs ($120K liquid, sitting in a bank account) by the end of the month. I've spoken with a local mortgage lender who does a lot of doctor loans, who told me today that the current rate for both a conventional 30-year mortgage and a 30-year doctor loan was 3.875% (it would be 4.125% for the doctor loan if not autodrafted out of their bank's account every month). The doctor loan also has no origination fee and obviously no PMI.

 

I've always hesitated regarding doctor loans because the rates always seem to be higher, I don't want to start out "underwater" on a house, and I figured I could just tough out another year and a half of living on one income vs two in order to get my loans paid off after paying 20% down on the house. But with the current rate situation, I'm curious about whether the liquid $120K would be better spent by paying off the student loans as soon as we close on the house, allowing us to start maxing out retirement accounts and "living our lives" per se....for the price of having a higher monthly mortgage payment and zero equity in the home. I ran the numbers on an online mortgage calculator and this is what I came up with (payments include principal, interest, HOA fees, taxes, and home insurance--but I overestimated on some of these to be safe):

 

30 year conventional: $2,457.09

30 year doctor loan: $2,927.62

 

I'd be very interested to hear everyone's thoughts on our situation.

[The White Coat Investor]

Ideally do both, but if I had to choose, I'd pay the student loans, use a doctor loan and refinance later if you're able to.

 

You're already underwater, whether it's on the house or your education.

[The White Coat Investor]

You could wait, rent someplace cheap, pay off the student loans, then save up the down payment, then buy the house. That is probably what I'd do, but as long as a high percentage of your income is going to building wealth now and you keep that up, it really doesn't matter that much.

[OrthoInAL]

I guess a big question I'm having is whether it's worth it to trade student loan debt for $100k more of home debt. In an ideal world we would have been totally out of student loan debt and built up a full 20% down payment before going through with our home contract.

 

And with regards to renting--renting cheaply is what we're currently doing and was the main reason we were able to pile up as much cash as we have over the past year.

 

Thanks for sharing your thoughts!

[CordMcNally]

Do you guys have an emergency fund?

 

I'd vote on paying towards the student loans. The home price is within the range of affordability so unless you guys are spending extravagantly in some other way, the housing costs should remain comfortable.

 

Do you guys currently have your own furniture? I'm assuming you're in Alabama by your name, although I guess it could be Alaska. $500k houses in Alabama are typically large and large houses take a lot of furniture to fill up. Furniture prices can get out of hand quickly if you let it.

[GXA]

I think this is a personal choice.

You can afford the house - though if you continue to rent cheaply you will be able to pay off the debts and start accumulating wealth.  If you have had enough of the rental, and are ready for a home, and are comfortable you will be in the area for a while buying would be reasonable.  Rates are still relatively low.

Though when you buy, you will be spending more on housing, and as lifestyles inflate, debt hangs around longer and it takes longer to accumulate wealth.

[OrthoInAL]

Good questions.

 

We have a decent sized emergency fund but would plan to fully fund it before paying off the loans (should only take 6 months or so).

 

With regards to furniture, we don't have much besides the same stuff we've had since dental/pharmacy school. Useable, but we don't plan to keep most of it forever. We've discussed only slowly furnishing the home over the course of 2-3 years. We do live in Alabama, but are building in one of the highest cost of living areas in the state mostly due to the highly rated school system and proximity to a large (by AL standards) downtown. The home is a 4br/3.5ba so not a mansion by any means.

[DMFA]

OrthoInAL wrote:

I guess a big question I’m having is whether it’s worth it to trade student loan debt for $100k more of home debt. In an ideal world we would have been totally out of student loan debt and built up a full 20% down payment before going through with our home contract.

 

And with regards to renting–renting cheaply is what we’re currently doing and was the main reason we were able to pile up as much cash as we have over the past year.

 

Thanks for sharing your thoughts!

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In a vacuum where those two are the only options, yes, mortgage debt is preferable to student debt. Lower interest (esp after factoring in tax deduction), hedge vs inflation, and share the exposure with the bank since the house is insured. If you can get a non-conforming loan with favorable terms, you may benefit from trading what you would have used for a down payment for your student debt instead.

However, if your debts are properly structured, i.e. refinanced to best possible rates and terms, your inflation-adjusted losses should ideally be near-zero anyway, and what to eliminate (or invest instead) is more a matter of personal choice than a lifesaving technique.

Also, some would argue that your debt is the emergency, and that you should eliminate it before building up a 6-month cash reserve. Again, that's a matter of opinion.

[DMFA]

Also why in the world is the interest rate on your student loans 6%? That should have been refinanced the second you could afford payments, unless you were in some sort of forgiveness program. Your rate should be literally less than half that.

[Hatton]

I am also in Alabama.  500k is a nice house.  I furnished mine by going to rural antique auctions over a 2-3 year period.  It will cost you a fraction of furniture store prices.

[adventure]

I'd first check your credit report (https://www.annualcreditreport.com) to make sure you don't have any issues on either report which would limit you from getting a mortgage.

Secondly, I'd shop around for mortgages. We called 15 lenders. There are some doctor loans lenders noted here.

We found great rates at other lenders too, often local banks, credit unions, etc.

Also, keep in mind there are several types of mortgages. Just to mention a few

– conforming (frannie/freddy) non-jumbo loans (<417k, or <625 in San Diego or other HCOLs)

– conforming jumbo loans (>417k, or >625 in San Diego or other HCOLs)

– non conforming (any size). Often these are when banks keep the loan (aka, they can’t/won’t sell to frannie/freddy). Doctor loans often fit in this group. The rules for these vary, as they aren’t as regulated as frannie/freddy loans.

You should determine which loan(s) are being described when you call. If you only quality for a conforming loan, the rates usually jump if you borrow over the "jumbo: 417k+" loan limit. So, if you only borrow 416, you may get a much better (1/2 pt in our case) overall rate than if you borrow 418.

I mention those differences, because we found several lenders will do non-conforming loans, maybe/maybe not call them "doctor loans", but they require 5-10% of a down payment. Not a bad compromise. You two can likely cashflow several % of the downpayment once you know when you'll close. Keep in mind, many (all?) mortgage closing bake in the cost of the first months mortage payment, so if you close on Jan 1st, you may not pay Jan or Feb, but your first months payment is in March. Budget accordingly.

I'd certainly trade the student loan debt for a mortgage. If I were you, I'd pay off 1/2 the student loan today, and consider putting the loans on whatever plan get your the lowest monthly payment. This might be moving to a "extended graduated repayment" with your loan, or this might mean refinancing with Sofi, etc. The goal of this is to ensure you have a good "debt to income" ratio to buy a house. Sometimes it's 35%, sometimes 43%, etc. Basically, divided all of your monthly bills by what you make pretax (125 + 200).

Note, if you have 5k/month credit card statement, even if you pay it in full each month, they'll often count the full 5k against you. However, if you pay off your credit card 1 day before the statement runs, then the credit report shows you owed "$0" at the end of each month, and you'll further improve you D:I.

Either way, I agree with WCI. Try and do both, but I'd rather pay mortgage interest (deductible if you can itemize.. which you two will be able to at that house mortgage level - unlike student loans. Trade for a lower rate, and for one that is deductible. win.win. Having no debt is an even better win!

And, I fully agree with this:

DMFA wrote:

Also why in the world is the interest rate on your student loans 6%? That should have been refinanced the second you could afford payments, unless you were in some sort of forgiveness program. Your rate should be literally less than half that.

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So, if you do go with the extended graduated plan or something, the day after you close, refinance the loans to the best possible rate! Don't let that interest rate linger at 6+% any further!

[hightower]

OrthoInAL wrote:

I guess a big question I’m having is whether it’s worth it to trade student loan debt for $100k more of home debt. In an ideal world we would have been totally out of student loan debt and built up a full 20% down payment before going through with our home contract.

 

And with regards to renting–renting cheaply is what we’re currently doing and was the main reason we were able to pile up as much cash as we have over the past year.

 

Thanks for sharing your thoughts!

Click to expand...

Yes it is worth it if you have to choose between the two.  Student loan debt is not tax deductible whereas mortgage debt is.  The mortgage interest tax deduction is a big government hand out to the wealthy.  Take advantage of it if you're going to have debt  For you two, you have a large enough income that you will benefit from the tax savings on that debt.  Pay off your student loans, get a bigger house loan (if you must buy a home).  Obviously the even better solution is to just keep renting and saving like you have and pay off your student loans now.  If I could go back in time, that's precisely what I would do.  You'd build wealth a lot faster in that scenario.  Look at how easily you saved up 120k cash.  Do that for 5-6 years or so while placing the money in a taxable account and you'll be a millionaire.

You didn't mention anything about your retirement savings.  Are you two contributing to tax-advantaged retirement accounts?  You should be maxing out your 401k's, doing backdoor roth's, and contributing to HSA's if available to you.  You need to factor this into your decision.  Again, all will be easier to do if you pay off your loans now and keep renting for awhile longer.  A giant house is a major drag on your ability to save (unfortunately, I know this from experience).  That mortgage payment is the MINIMUM per month you'll be paying towards that house.  There absolutely will be other costs you're not currently expecting...even in a new house.

[childay]

DMFA wrote:

Also why in the world is the interest rate on your student loans 6%? That should have been refinanced the second you could afford payments, unless you were in some sort of forgiveness program. Your rate should be literally less than half that.

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This!

[AnesPain]

hatton1 wrote:

I am also in Alabama.  500k is a nice house.  I furnished mine by going to rural antique auctions over a 2-3 year period.  It will cost you a fraction of furniture store prices.

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What auctions did you go to?  We are in Alabama also.  Currently building, and will need to furnish some at the end of this year/early next year and would love to save a few $$.

[Craigy]

My wife and I are currently in the same boat.  We'd like to pay down student debt ASAP but it will leave us with little funds for down payment.  Right now I am leaning toward just paying off the student loans first, which should make getting a good rate with a doctor loan even easier.