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My fiance and I currently have the opportunity to buy our first house for 200k due to a large 19k bonus that will be coming to me from my employer.

We're considering two uses for the additional money (when added to our existing savings). One is putting 25k down (12.5%) and paying off our student loans. The other is putting 40k down to avoid the PMI entirely.

These are my estimates (We have not identified a specific property yet so exact #s aren't possible):

Mortgage Rate - 3.899% 30 year fixed
Insurance - $800/year
Taxes - $3,500/year
PMI - $1,812/year
Our Student Loan Balances (All are Fed loans) - $24,668
Our Potential Student Loan Interest Remaining (if we do the minimum payment) - $4,365

To calculate the mortgage, I've been using the excellent calculator here: http://usmortgagecalculator.org/

With the above numbers, it breaks down like this:
Monthly Payment (12.5% down): $1,334
Monthly Payment (20% down): $1,112 + our current $400 student loan payment = $1,512
Difference in Monthly Payment:$178

Total Cost After 30 years (12.5% down): $459,268 + $24,668 = $483,936
Total Cost After 30 years (20% down): $440,647.89 + ($24,668 + $4,365) = $469,680
Cost Difference After 30 years: $14,255

Assuming my calculations are correct, paying off our student loans now will cost us around $14k over the life of the loan!

So what seems to be a GOOD decision short-term (paying off loans early) actually seems to be a BAD decision long-term on paper.

Given that is our first home, I don't expect to see the mortgage through all 30 years, so I'm not sure if we're really going to lose all of this $14,255. It could just be an illusion that will never come to pass?

Then again, I think of emergency situations like job loss - we can defer our student loans, but falling behind on the mortgage isn't a good option. So then it makes more to "slow pay" the student loans and enjoy the lower mortgage.

What do you all think? Should we go into deeper debt to save money over time or feel good about eliminating debt now to risk losing money long-term?

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    You don't mention the student loan interest rate. That would help us answer, or at least answer with exact numbers. – JoeTaxpayer Aug 9 '16 at 17:16
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    Not financial advice: Wait until you're actually married to buy a home together. – David G Aug 9 '16 at 19:53
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    Unrelated financial advice: since you're thinking about spending a large amount on a house and/or loan payoff, you do already have at least 3 months regular expenses saved up in a very liquid account, right? If you don't, well, do yourself a favor and do that. A downsizing can happen just as easy as a bonus can, and some fresh-out-of-college new guy is prime on the chopping block if cut backs are necessary. – corsiKa Aug 9 '16 at 21:34
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    I have a problem with the math here. In one case you have 25k down plus 25k (roughly) to pay off the student loan making 50k. In the other case you have 40k to put down. Where is the other 10k? Unrelated but I agree with David G, it is best to wait till you are married to buy the house together. – homer150mw Aug 9 '16 at 22:19
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    Last time a got a large bonus like that more than half went straight to the tax man in Income Tax. Is that an issue to consider? – sMaN Aug 10 '16 at 4:00
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There are times that the simplest explanation (or analysis) is best.

You show that, for a time, the PMI is $1812/yr. And it's the cost you will incur by sending $15,000 to the student loan instead of using it as a downpayment. 1812/15000 is 12%. The loan is already costing you 4% (I know, 3.899, a rounding error), so in effect, that $15,000 is costing 16%. I doubt the student loan is even double digits.

Use the $15,000 toward the downpayment. Take the $1812 plus the $859 per year saved on the mortgage payment, and throw the $2671 towards the student loan. This is the simple solution. (Note: $15000 at 4% for 30 years is a payment of $71.61 or $859/yr.)

Part of the PMI issue is that PMI gets removed when you hit 80% due to natural amortization. i.e. the timeframe due to normal payments. If you make extra payments, and hit 80% a year after you close, that's nice, but the bank will drag its feet, and the appraisal (at your cost) may come back low. Then what?

Last, without the S/L interest rate and term, I can't calculate the numbers the way your example showed, but don't mix up term and cash flow with actual cost. Say I owed my mom $50000, at zero interest, and $500/mo payment. Sending $50K would "free up" that $500/mo, but there are better uses for that money, such as high interest debt. You propose to create 16% debt in your scenario.

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    Hey Joe, thanks for your answer. I'm mostly following you, but how did you calculate the $859 savings per year on the mortgage payment? I'm not sure how you reached that number. – SPGuru Aug 9 '16 at 19:24
  • I edited the answer to explain – JoeTaxpayer Aug 9 '16 at 19:27
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    I've thought about this answer some more - It seems to provide the most lucid explanation of the problem while providing a clear solution. Thanks Joe for all your help! – SPGuru Aug 13 '16 at 22:16
  • @SPGuru - You are most welcome. I appreciate the feedback. – JoeTaxpayer Aug 13 '16 at 23:48
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Congratulations on your bonus may many more come your way.

I am having a bit of trouble following your numbers but it seems you are considering PMI for the life of your loan. Once you get below 20% loan to value, you can petition the mortgage company to remove the PMI (with conventional loans; VA and FHA have lifetime PMI).

If it was me, I'd do one of two things. Both involve paying off the student loan now. The savings from the student loan payment will assist you in helping you meet one of the two goals below. Also both involve getting a 15 year fixed.

The first would be to buy the house now, and work like crazy to get rid of the PMI. My goal would be to get rid of this within 18 months.

The second would be to save up enough cash for the 20% down and then buy the house. You'd miss out on the house you are looking at, which is kind of heartbreaking. Who is to say that a better home does not come along at the same price? My goal would be to have the downpayment in 9 months, and really try to have it in 6 months.

Being an old guy that has experience how much of a virtue patience is, I'd recommend the second option.

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    Since it's the same amount of money in option 1, wouldn't skipping the (higher rate) PMI and then "working like crazy to get rid off the student loan" be better? – TTT Aug 9 '16 at 18:19
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    @TTT - that's sort of my answer, but, I won't say to kill the S/L before knowing its rate. I hope even (very conservative) Pete would agree, don't forgo matched 401(k) to pay off that debt sooner. The question is very specific, and doesn't discuss the full picture. – JoeTaxpayer Aug 9 '16 at 18:24
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    VA does not have PMI, VA has a one time funding fee in place of PMI. The fee is part of closing and is a percentage of the loan amount. – homer150mw Aug 9 '16 at 22:25
  • Who is to say that a better home does not come along at the same price? is advice that depends very much on your local market. In hotter areas you could expect it to go up by anything up to 5% in that time. – pjc50 Aug 10 '16 at 8:31
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Don't forget to take into account the tax deductability of the interest and PMI into the equation. Of course, this would based on your current pay rate, and your rates after marriage. Your mentioning the flexibility in future changes is also a key aspect to take into consideration.

  • +1 as a welcome to Money.SE, and that I agree that if one were doing a precise analysis, it's post tax for both expenses and returns. Here, the cost for PMI decision is so egregious, that the tax concern is not a tipping point. With sub 4% loans it rarely is, lately. But we shouldn't be complacent, rates won't always be this low. – JoeTaxpayer Aug 9 '16 at 22:03
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The calculations you suggest have some issues, but I think they are not necessary to answer the question:

It sounds like you are buying the house either way. So the question really is simply whether to pay toward your house first or your loan first. In that case, the answer is simple: pay whichever has the highest interest rate first. Make the minimum payment on the other until the first is paid off. Remember this and make it your mantra for the rest of your life. If you have any debts (such as credit cards) that charge a rate higher than the two options you have presented, do them first.

Now, be careful as you compute the interest rates. Most likely you can deduct interest on your mortgage, so its effective interest rate is lower [it is (1-T)*R instead of R, where T is your marginal tax rate]. For a while, the cost of mortgage insurance will make your effective mortgage rate artificially high, but it sounds like you intend to get to that 20% hurdle pretty fast, so my guess is that this is not a big factor.

Congratulations on your bonus and good luck with your new home.

  • Thanks for your answer. What issues do you see with my calculations? The numbers I am giving (aside from student loan interest) are direct from the calculator I hyperlinked in the original question. – SPGuru Aug 13 '16 at 22:12
  • No offense to you intended, of course. The calculations ignore the time value of money. Looking at the total dollars you pay is not the right way to evaluate its effect on your wealth nor (equivalently) to choose which one will make you best off. One could pose a problem such that your approach suggests that option A is best while in reality option B is unambiguously better. – farnsy Aug 13 '16 at 22:18
  • No offense taken. I think by "time value of money" you mean that I could potentially re-invest any money saved and make up more than the $14000 deficit I'm seeing now, correct? – SPGuru Aug 13 '16 at 22:35
  • Additionally, wouldn't it make more sense (generally) to not focus solely on the interest rate, but the highest actual interest? For example, say I have two loans, one 50k @ 4% and another 20k @ 5%, both over X number of years. 50k(.04) = $2000 and 20k(.05) = $1000. Based on that math, I would think that the 50k loan has more interest associated with it, even though it's a lower rate because the principal is much higher? – SPGuru Aug 13 '16 at 22:43
  • If both cases involve the same consumption (as in your question), interest amounts are an intermediate step that will often serve to throw one off. The fact that some debts are short term while others are long and debts have different sizes confounds many analyses, but properly computed interest rates transcend these issues and lead to the correct (wealth maximizing) answer. That is, if one properly discounts all the payments made, one should arrive at the same answer as the rate method. – farnsy Aug 14 '16 at 0:10

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