There’s little that causes more financial stress than student loans and your mortgage – so which do you pay off first?
You’re making good money, paying your bills each month and even saving, and now you even have your own home. Chances are good you took on some student loan debt to get here but hey, that’s good debt, right?
If you’re like millions of other Americans in your position, you’re considering throwing some extra cash at one or the other to pay them off more quickly. This isn’t a bad idea at all, but which one commands the most attention?
Assuming your mortgage and student loans look similar in amounts, this can be a tricky question. The urge to fully “own” your home – that is, not be beholden to a mortgage – is a powerful motivator and an fantastic indicator that you’ve finally “made it”. That said, student loans can have insane interest rates and without paying extra, you might be paying them well into your years where you’ve forgotten what you learned in college.
We’re going to look at some cold, hard facts surrounding both of these types of debt and how to address them correctly for your situation.
Student Loans vs Mortgage: Which To Pay Off First
Make sure your other finances are set first
You definitely don’t want to worry about paying off huge debts like student loans or a mortgage if you have consumer debts still lingering. Run through this brief checklist to ensure that you’re in a place to consider attacking your mortgage or student loans:
If you still have credit card debt, pay that off first. Consumer debts like car loans, credit cards and personal loans are the worst type of debt. While a house or even student loans represent an investment, consumer debt is almost always bad and should be paid off asap. This is because it isn’t secured but also consumer debt tends to have extremely high interest rates. Get it gone as quickly as possible.
Are you matching your retirement contributions? If the answer is no, get there first. Many companies offer matching benefits, and if you’re not maxing that out, you’re losing out on money. If you do the math, the amount you’d save paying more on your mortgage will almost certainly not outpace what you’re earning by maxing your retirement.
Do you have an emergency savings fund? This is critical and one of the first things most money management services will recommend. Setting aside even a small amount each paycheck to fluff a fund for the unexpected is critical. Since you’re likely past the “set aside $1,000” mark, you’ll want to make sure you have 6 months salary saved up for emergencies.
Assuming all these boxes are checked, we can go ahead to part two.
Why and why not paying off makes sense
Student loans pros and cons
Paying off these huge debts allows you to exert more financial freedom. When you see your monthly paycheck go up $1,000 per month because an enormous drain like student loans are gone, that can have a profoundly positive psychological effect. Moreover, student loans can carry dramatically high interest rates; there are plenty of stories of people paying the minimum for years only to end up somehow in more debt than when they started. In this case, paying them off aggressively might be your only chance to see them resolved.
To expand on the idea of never paying them off, student loans are one of the only types of debt that cannot be absolved in bankruptcy, which aside from being absurd, is also problematic should things take a downturn. This is a good reason to focus on paying them off quickly and aggressively, so that it doesn’t loom over you.
If your loans are lower interest rate, however, paying them off might not be the best plan. You can probably find a source of investment that pays a higher interest rate than your loans charge. If that’s the case, your money will serve you better being invested. This is where hiring a financial advisor is critical, because juggling those numbers is pretty difficult to do on your own.
Mortgage pros and cons
Since mortgages tend to be very low interest rates but on very high debts, it’s easy to pay a tiny bit more each month to dramatically reduce your overall total payments. One extra payment per year can shave literal years off your mortgage repayment. For this reason, aggressively paying your mortgage down produces a ceiling effect. At a certain point, you would get better return on your money paying a certain amount more each year and leaving it at that.
Opposite the stance on bankruptcy in student loans, a mortgage for your primary residence cannot be attacked in most bankruptcy cases. This make it a safe bet to not aggressively pay down in the event of a personal economic downturn.
With all of that said, no matter what you’re paying down, you’re investing your money in a source that will not return it. While you need to pay down your debt, that money might be more useful invested somewhere else or even just on-hand in an emergency.
Which should I pay off first
Compare your interest rates
Naturally one will likely be several percentage points higher, so you can use that to gauge what your long-term payments will look like. If the interest is very similar, then look at which you owe more on. If you owe say $10,000 in student loans and your interest rate is negligibly different from your mortgage’s, then pay the student loan off first and concentrate on the mortgage afterwards. As we said before, there’s a lot to be said regarding the feeling of completely paying off a debt.
Additionally, determine if there’s a risk that your interest rates will change. Generally you’ll know if your rates are variable, and if they’re not, it’s a non-issue. If they can vary, though, the one in danger of the widest margin of variability should be paid off first.
Determine the likelihood of needing forbearance
Again, we’re taking all of this into consideration only on the assumption that your other financials are in order. While this should include emergency funds, it’s understandable that sometimes stuff happens. If you get sick, lose your job or some other unpleasantness, student loans have options to forebear your payments or defer them until things are going more smoothly. Mortgages don’t have this option, so consider this when weighing the two.
Consider the likelihood that you will move soon
If you might be reselling your house, it doesn’t make sense to pay off your mortgage. Likewise if you’re considering moving and you get an offer on your house that is too good to pass up, aggressively paying on your mortgage doesn’t make sense, either.
Consider your options and make the choice that fits you best
At the end of the day, there is no one-size-fits-all answer here. Both student loans and mortgages function similarly, have similar balances and interest rates and are both considered good debts. If there are incentives to paying one down faster than the other, they will be individualized to each person. Evaluate your options within the framework above and determine for yourself which – if any – you should be aggressively paying on.
Remember that any investment you can make that pays a higher interest rate than your loans will be a better investment of your money. Along those lines, understand that sinking money into these loans creates an investment that isn’t liquid; once it’s in, you can’t get it out. Only pay off these long-standing debts if your other financials are in order and you’re comfortable and confident in your financial future.
Are you considering paying off your mortgage or student loans more aggressively? What are your main concerns, assuming we didn’t address them above? I’d love to hear about them in the comments and maybe I can help!