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This question already has an answer here:

I'm entering into the latter half of my twenties, and I'm now faced with a question I've seen a few times before on this site: should I pay off my student loans or use the money as a down payment for a house?

The reason I'm asking instead of using the answers to those questions is that none of those questions have directly looked into the "opportunity cost" (caused by mortgage rate changes) of not purchasing a home. My student loans are on the order of 20K @ 5.5%. I already overpay them each month. I'm looking into purchasing a house around 200K - 300K. Paying my loans off early would save me a few thousand dollars over the loan's lifetime (8-10 years). However, even a minor fluctuation in interest rates would cause the "cost" of a home to go up tens of thousand of dollars or more over its lifetime. Assume I have enough cash currently to either make a 20% down payment on a home or pay off my student loans.

To me this seems like a simple decision (buy the house while interest rates are low, saving more money in the long run), but it seems to fly in the face of the nearly-ubiquitous advice of "get rid of debt first", so I'm wondering if I'm missing anything.

I've heard it said many times that you shouldn't view your home as a money-generating asset, but for the purposes of this question I am looking at purely the financial considerations.

Financial assumptions I have that may be wrong:

  1. Freeing up the "cash flow" of not having a student loan payment each month would make owning a home easier (there are a lot of "hidden costs")
  2. When interest rates rise, so will the interest rate of other investments (thus decreasing the "opportunity cost" of not buying a house with low rates)
  3. Purchasing a home with less than a 20% down payment (incurring PMI) is such a bad financial decision it is not even on the table
  4. I understand that interest rates aren't guaranteed to go up or down, but given the historical lows they are currently experiencing, I personally expect them to rise over the next few years.

marked as duplicate by DumbCoder, JoeTaxpayer Dec 16 '15 at 20:17

This question has been asked before and already has an answer. If those answers do not fully address your question, please ask a new question.

  • 3 Doesn't a bigger down payment get you a better deal ? get rid of debt first Not true always. There are conditions when you can ignore it. – DumbCoder Dec 16 '15 at 16:12
  • The possible duplicate question doesn't discuss interest rate fluctuations at all, which is a core consideration of this question. – WannabeCoder Dec 16 '15 at 16:17
  • interest rate fluctuations They aren't a daily occurrence. I am not sure about US markets, but in UK you lock in for a specific term where your mortgage rate is constant. So interest rate fluctuations don't affect you as you are locked in for the term. – DumbCoder Dec 16 '15 at 16:26
  • I'm not referring to my personal mortgage rate, I'm referring to the benchmark rate set by the Federal Reserve. The banking industry revolves around this number (all other rates are effectively derivatives of this) - including mortgage rates. If the Fed raises interest rates by .25% or .5%, then this will cause mortgage rates to raise as well, making my potential home purchase cost that much more. If I already had a mortgage, then yes, this would not affect me. But Fed rate changes will affect what interest rates are offered for a potential mortgage. – WannabeCoder Dec 16 '15 at 16:32
  • I understand how rates are used, so no need to explain. Secondly do you realize that mortgage rates are just a premium over the Fed rates ? So how does Fed rate hike/reduction affect you if you are locked in for a certain period in a fixed rate for your mortgage, assuming you can change mortgages. And Fed rates are dependent on the whole economy, not only US, so predicting when Fed will change rates will be difficult, if not impossible. Even the best brains in Wall Street cannot do that for sure. – DumbCoder Dec 16 '15 at 16:42
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Choosing the right home is a much bigger decision than saving a couple thousand dollars in interest over the life of a student loan.

If you are truly in a situation where it is appropriate to shop for a home, you should keep the cash available for making a down-payment on a home you will be happy with. This will allow you to get a mortgage that you are comfortable with. It might even help you get a better price on the home -- either by buying when the timing is right, or by being a more credible buyer.

How can you know if it is "appropriate to shop for a home"?

  • All of the people who will need to be happy with the home can participate in the purchasing decision, without being rushed. You are already in the area where you wish to purchase. If you are married, your spouse is available to help shop. If you hope to get married, you are engaged, and your spouse-to-be can help shop.
  • You know how much home it would be useful to have. You have an idea of how large a family you hope to have. You know your cooking, entertaining, and relaxing habits.
  • You know what area(s) you would be comfortable living in. You know what outdoor activities you like, what schools are suitable, what sorts of people you would like to have as neighbors, what traffic conditions are acceptable. A good real estate agent can help you find neighborhoods that match your criteria.
  • You can afford the home you ultimately purchase. (Based on your question, it seems that you can.)

When you find the home that is right for you (and your family, if relevant) then you should be in a position to purchase it. Some houses are better (for some people) than others. I recommend working with a good home inspector. If you are looking for a new home, the home inspector can let you know which builders build solid, durable homes. If you are not looking for a new home, I recommend working with a good real estate agent, whose priorities are your long-term happiness and getting you a fair price. A good agent can show you multiple possibilities you might be happy with, so that you can negotiate for a home from a position of strength.

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The fact that you have a 200K-300K range means you haven't picked out the house yet. That means that if you believe the feds decision today will cause mortgage rates to rise, you have already missed the window.

You would have to apply for the mortgage today, and lock it in; then find a house; negotiate a price; and then go to settlement before the lock in period expires.

You need to decide "can you afford the house you want/need under two options?":

  • use 20K to pay off the student loan
  • use 20K to increase your down payment.

Keep in mind that if mortgage rates drop in a few years you can refinance then, of course you might move before the 30 years mortgage ends.

You will need to apply for a mortgage and let the lender run the numbers for you to determine what rate and fees you will have under the two options.

  • I'm considering the interest rate change today (as you point out, that is pointless). I'm looking at the 2-5 year window, in which I expect interest rates to (continue to) rise. – WannabeCoder Dec 16 '15 at 16:51
  • You can get pre-approved for a monthly payment / down-payment combination without choosing a house. I am not aware of any American banks that will lock in a mortgage loan rate without an application that identifies a specific home to be purchased. – Jasper Dec 16 '15 at 19:26

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