Coming into some inheritance, how to smartly put it to the best use to pay off my debt and/or pay for a home downpayment?

Question

I'm in the United States.

A family member just passed and it looks like I'll be coming into a little inheritance ($30,000 USD). I've got quite a bit of debt and am also looking at potentially buying a house in the next couple of years. I'm wondering, financially is it smarter to pay off all remaining debts and work from the ground up to build up a downpayment - or is it better for me to pay off part of my debt and get into a home faster? I see benefits to no longer paying rent to someone else, but instead into my own home. But disadvantages in that I would be retaining some residual debt.

Here's the breakdown of my debt:

Debt/Loans: Unsubsidized Student Loans ($8,200)
US $2800 @ 6.55%
US $2000 @ 6.55%
US $1900 @ 6.55%
US $1500 @ 6.55%

Subsidized Student Loans ($11,200)
US $2700 @ 4.25%
US $4200 @ 3.15%
US $4300 @ 3.15%

Auto Loan US $21,000 @ 5.99% ($355/mo)

My Income information:
Gross: US $4909/mo
Net Income after retirement, insurances etc.: US $2,996/month
Rent & Utilities: $700/mo

Partners income: Gross $36K/year
Partners Rent & Utilities: $700/mo
Partners Debt: $160/mo (total $10,000)

Homes in the town I work in average price are $463K, but the towns 10-20 minutes away are $317K - $299K. So we'll (my partner and I) probably be looking at a home right around $300K in the next few years.

And for those of you who say sell my car - I know it's expensive, but it keeps me safe and will for the next two decades AND I love it. It's one of the things that makes life worth living and I won't give it up.

So knowing all this, what is the most financially-sound decision to do with the 30K? Pay all debt off upfront and build a down payment or pay off the Auto loan & some of my Un-subsidized loans and get into a home faster? Thoughts and advice are appreciated!

Additional info: Neither of us has ever owned a home & my partner and I don't currently share funds. We split the cost of living but his money pays for his debt and mine pays for my education and my car. We've talked and are planning that once we find a home we love and any future purchases we make together, we'll combine finances to tackle them - but my student loans and my car is my responsibility and his 10K debt is his.

Also how much will I need to pay toward taxes on a $30K inheritance? anybody know?

Edit: I'm currently saving ~$500/month to build an emergency fund. I'm putting away $500/month into a separate account and each year I put that money toward my debt. So at the end of this year I'll have $6,000 to put on my Auto loan + the regular payments will bring the auto loan to ~$13K by the time I get the inheritance.

Answer 1

The math on questions like this is pretty easy, really. Excess funds goes toward the loans earning the highest interest rates, first.

Where the difficulty comes from is psychologically, in my opinion. That is, say you use the windfall to knock off all those 6.55% loans. You need to use the money that was going monthly to pay those to then follow the same first rule -- you apply that same excess money to the next highest interest rate loan. Psychologically, you must act like you still have to pay that loan, and not spend the newly excess funds on things not in your plan. It can be hard to have that discipline.

Similarly, once the loans are zeroed out, then you pay into a house fund in the same way. You take all the money that was going monthly to loans, and put that into the savings vehicle for your goal of having a house.

One exception worth nothing: if you a living someplace where the housing market is truly exploding -- home values are going up very, very rapidly. In such a case, driving toward home down payment first may make the most sense, because the time you lose paying the debt may cost you more in increased home value later on. However, it is rare for such a market to exist and be sustainable. And especially today (June 2020) with the virus and economies all very large unknowns, I don't think anyone can truly say what most any market is going to do.

My opinion would be to take the safe 'return' of knocking those debts down. Paying off debts will help when it comes time for a house anyway, because your credit report will be better: demonstrations of loans being paid off & lower debt to income ratios -- both help your score and ease of getting a mortgage.

Answer 2

Note: My main goal isn't to pay off the loans 100% before saving for a house, it's to get your loan amounts lower with the same payment amount so that you are paying less in interest in the long run. At no point would I refinance any of the loans. I also know that my math takes into account a future value of the car loan but a present value of student loans. So your numbers will be different when you get your inheritance to pay everything off, but the logic should still be the same.

I am going to walk through the math step by step of what I would do. We are working with $30,000 dollars of free cash flow from your relative. You have $40,400 in debt, but in your edit you said you can bring the car loan down to $13,000 so in the future you will have about $32,400 in future debt. You would need $60,000 down payment on a house plus to avoid pmi, and lets say $8,000 in closing costs, for a total of $68,000 saved for the house.

• $30,000 Inheritance
• $32,400 Debt ($8,200 + $11,200 + $13,000)
• $0 / $68,000 Saved for a house ($60,000 down + $8,000 closing)

Once you get your inheritance, I would pay off all your Unsubsidized Student Loans first because 6.55% is way too high to have running around. I would also pay off highest Subsidized Student Loan Interest of 4.25%. That would be a total of $10,900 towards student loans.

• $19,100 Inheritance ($30,000 - $10,900)
• $21,500 Debt ($32,400 - 10,900)
• $0 Saved for house

Your car loan will at $13,000 when you get your inheritance, so second pay off most of your car loan, I would personally bring it down to $5,000, so that would be $8000 towards the car and keeping $355/month payments.

• $11,100 Inheritance ($19,000 - $8,000)
• $13,500 Debt ($21,500 - $8,000)
• $0 Saved for a house

Now place the rest of your inheritance towards your home down payment

• $0 Inheritance
• $13,500 Debt
• $11,100 / $68,000 Saved for a house

You are saving $500 to put to debt and $500 for an emergency fund. Once your emergency fund is 3 - 6 months worth of expenses, start putting $1000 away for a home down payment. You also have one less student loan to pay off so let's say that (along with some penny pinching) frees up another $200/month which means you can save $1,200 towards your house. You have $68,000 - $11,100 = $56,900 left to reach your goal. taking $56,900 / ($1,200 * 12) = 4 years of saving before reaching your goal. you can also expedite the saving process by investing your saved money into a high interest saving account, cd, or bond that mature in the next couple of years.

EDIT: Your car should be paid off about 1.25 years after you get your inheritance. So the extra $355 can go towards your other loans or your house, and get those paid off in less than 2 years. I am going to assume that your house is your main objective, so I will do that math for that. After 1.25 years of saving $1,200 you should have $1,200 * 15 months = $18,000 saved.

The goal now is $56,900 - $18,000 = $38,900 which can be reached in $38,900 / (($1,200 + $355) * 12) = 2.25 years, which means you will have reduced your debut to $4,000 - $7,000 (depending on your loan agreement) and have money for a house in 1.25 + 2.25 = 3.5 years.

Answer 3

Paying off your auto loan and unsubsidized loans would be a significant impact to both your overall interest cost, as well as your monthly cashflow. You didn't mention the term length on these loans, but if you wait 3-5 years to buy a house, you will have paid off much of the loans by then anyway, so you might as well pay them off earlier and reduce your interest. This also has the benefit of increasing your flexibility by not 'committing yourself today', to buying a house. You don't want 30k burning a hole in your pocket so you make the 'soon' decision instead of the 'right' decision.

If on the other hand you were already about to buy a house, and the increased down payment would give you better interest terms, reduced mortgage insurance, greater buying options - then the increased down payment could be quite worth it. Just don't let those benefits push you into making a decision you might not be ready for yet.

Let this be an opportunity to improve your financial restraint, and start you on a path to better financial dceision making - and that includes not financing a car costing that much relative to your income, at such poor interest rates.