What is more important to you: paying off your student loans or saving up to buy a house?
Knowing which is more important does not answer whether to put more money towards student loans or a down payment for a house. But without knowing the answer to this question, it’s impossible to make the right choice.
The goal of life is not to accumulate as much money as possible. Instead, our life goals are more complex and personal. We earn money as a tool to calm our fears and pursue our desires.
For graduating lawyers with mounds of student loan debt (commonly exceeding $150,000), student loans impose financial and mental restrictions on us. Lawyers may feel confined to a job they dislike so they can pay their student loans, or maybe they feel pressured to work extra hours to ensure their job security.
For lawyers who consider themselves potential homebuyers, homeownership is an important goal. Buying a home represents security, success, and owning a small part of the American dream.
No lawyer wants to make student loan payments, and most lawyers want to own a home. For lawyers who desire to have their student loans paid off as soon as possible and who want to buy a home in the next ten years or sooner, they may ask: Where should I put my money?
Money should go where it gets the best return
Lawyers are smart. Smart enough to know that people earn money in ways besides exchanging billable hours for a paycheck. Lawyers can also make money by generating a return on their investment. Whether it is the interest paid on cash in a savings account or a monthly check from a rental property, as long as your money is not under a mattress, it has the opportunity to earn you more money.
So it makes sense to put our money wherever we can get the highest expected return on our investment.
The expected return is easy to calculate for debt with a fixed interest rate. It is just the interest rate. Let us compare two loans, a $1,000 loan with a 2% interest rate and a $200 loan with a 6% interest rate. After calculating the interest payment, the $1,000 loan accrues more interest than the $200 loan ($20 vs. $12). Does it make sense to pay off the $1,000 loan first since its interest payment is larger than the $200 loan?
Example: A lawyer can only pay $100 per month towards loans, they are considering paying off the $1,000 loan first, the $200 loan first, or splitting the payments $50/$50 between both loans until one is paid off and then putting $100 towards the remaining loan. Which strategy pays the least towards loans?
Paying off the $200 loan first!
- $1000 first strategy: $1578 total paid, 15.8 periods until paid off
- $200 first strategy: $1402 total paid, 14 periods until paid off
- 50/50 split strategy: $1416 total paid, 14.2 periods until paid off
While the $200 first strategy was the most financially optimal, the 50/50 split paid only slightly more and paid off the amount owed in nearly the same time.
For debt like student loans, the interest rate is known. For investments, the future is unknown. Some investments may increase by 10%, while others may decrease by 10%. The uncertainty makes it more challenging when deciding between paying extra on student loans or saving/investing money.
The financially optimal way puts cash in the highest returning investments. But the financially best way may not be the best personal way to allocate money. That is because life is so much more than financial outcomes.
When decisions are made solely on financial considerations, we may trade off some personal benefits.
Saving to buy a house today using a savings account will produce a negligible return on investment (0.01%-0.5%). Comparing this 0.01% interest rate against the higher interest rate of a student loan would suggest it is better to spend money on student loans.
But this comparison is too simplistic. Saving for and buying a home has many hard-to-calculate benefits. They include:
- Increased sense of stability
- More control over your home style and design
- Greater sense of community
- Greater sense of privacy
- Forced savings by building equity in the home
Along with the potential future appreciation of a home’s value, these benefits can outweigh the return on investment from paying off a higher interest student loan sooner.
So I propose a new way for lawyers to evaluate this decision.
Put money where it has the best return on goals, not return on investment.
When making this decision, look at your life goals and not solely at your investment returns and interest rates. Where do you find value in life? Is lifestyle flexibility more valuable to you than owning a home?
The interest rates from student loans and expected returns from buying a home are factors in the decision, but for a lawyer who wants to own a home, does it make sense to delay saving up for a house until student loans are all paid? Nope!
In the example above, the 50/50 strategy between both loans was not optimal, but the outcome was not terrible either.
Investing based on goals instead of return rates will lead to a more valuable life.
But investing based on goals comes with a need for a disciplined perspective. Maybe that new house is a top priority, but it is not the only priority. For student loan borrowers, student loan payments are due monthly. Allocating money based on return on goals does not neglect these payments. It just permits us to put more of our money in places that spreadsheets would not recommend.
Considerations when making your decision
For lawyers who want to own a home, here are a few questions to consider before deciding:
- What are the prevailing interest rates?
- When would you like to own a home?
- Do you initially want a starter home, or are you okay with delaying buying until you can afford a dream home?
- Do you see yourself living in your current area for at least five years after buying a home?
- Are you comfortable with making multiple loan payments at a time?
- How high of a priority is owning a home?
What are the interest rates available to you?
If a lawyer refinanced their student loans, they have a substantially lower interest rate. As shown in the example above, the interest rate of a student loan can have a significant financial impact on this decision. A 2.5% interest rate has lower monthly payments, and there are more attractive investment options than a student loan with a 7% interest rate has. The savings of the lower monthly student loan payments can now go towards other goals.
Likewise, what are the mortgage rates provided to a lawyer? Currently, mortgage rates are at historic lows. People can speculate on whether rates will continue to drop or if increases are on the horizon. It is impossible to know what will happen in the future, so rather than guessing, we should use what we know: current rates.
For lawyers who have a few years of saving before having enough for a down payment, the expected movement in mortgage rates is irrelevant. Lawyers should focus on what they can control. Doing something like obtaining a lower student loan interest rate will go a long way towards affording a down payment in the future.
For lawyers with enough (but not as much as they might want) for a down payment and a low student loan interest rate, current rates are a more significant factor in this decision. It may make more sense to buy a home now at a lower mortgage rate than to wait to save up more for a larger down payment, with a potentially higher future mortgage rate. Remember that the financial numbers matter, but they should not be the only factor in deciding.
How comfortable are you with multiple loan payments?
Lawyers who have student loans and enough saved for a down payment should be aware that buying a home would leave them with two potentially sizable monthly loan payments. Feeling secure both financially and professionally can affect if this is the right decision.
Financially, lawyers need to be aware that student loan payments and a mortgage will limit their financial flexibility for the foreseeable future. The obligation to make these monthly payments can become a financial burden, and the consequences for not making payments on time can be financially detrimental.
These two loans can also affect your professional flexibility. For Biglaw lawyers suffering from burnout or who want to pursue another career path, these payments can force lawyers to feel trapped at their job. It can also add stress to an already stressful career because losing their job will not change the obligation of these payments. Lawyers may feel compelled to give up more of their work-life balance in exchange for a feeling of greater job security.
Timeline for buying a home
Is buying a home a short-term goal (0-2 years), medium-term goal (3-10 years), or a long-term goal (10+ years)? This timeline is important because it affects how much savings need to go towards a down payment.
Lawyers with a home as a short-term goal should save as much as they can towards the down payment. Having more money for a down payment provides great buying options, more negotiating power, better mortgage terms, and lower mortgage payments.
Lawyers with a medium-term outlook have more flexibility. A good strategy is to figure out the minimum down payment needed to buy a desirable home. Once this number is determined, the focus should be on saving up to that amount. After reaching this number, then lawyers should do three things:
- Monitor the market for a good home buying opportunity.
- Put some money towards student loans if better investments are not available.
- Continue to save into the down payment fund.
When the time to buy a home is 3-10 years, lawyers can be selective in the houses they want to purchase. There is no need to rush into a home purchase. Remain patient, add to your down payment fund, and buy when the time is right.
For lawyers with a long-term goal of buying a home, the home is likely not a top financial priority. Since most student loans are on a 10-year repayment term, likely, a lawyer will not buy their home until there are no more student loan payments. Lawyers should consider refinancing their student loans and invest the savings plus other money into appropriate investments, including pre-paying student loan payments. Over a 10+ year time horizon, these investments will hopefully appreciate. The lawyer can sell these appreciated assets for a future down payment.
For lawyers planning to buy a home in the next five years, each extra payment towards student loans reduces savings for a down payment. If buying a home in the future is a goal, but a lawyer doesn’t have a set timeline, then purchasing a home isn’t a primary goal. Money towards goals like paying off student loans may be a better approach.
Type of home to purchase
What type of home will be purchased? Is it a small starter home for 1-2 people until there is a need to upgrade to a larger home later? Or is it a larger home to raise a family and live in for a long time? Or is the goal to build a custom-made dream home?
When buying a home, the type of home can affect the decision too. A larger home or dream home will take more years to save for than a starter home. For lawyers who are eager to become homeowners and you want to begin with a starter home, saving for a down payment over paying down student loans is probably the better decision.
For lawyers who want to skip the starter home and are okay renting until they can afford a larger home or build their dream home, this will require more years of saving money. It may even take more time to save for than the repayment period of student loans. When considering that larger homes require a larger down payment and have higher annual expenses, it may make more financial sense to delay buying a home.
Do you plan to stay for years?
How long does someone plan to live in an area? Is their plan to stay in their current location for a while?
Let us say a lawyer accepted an offer to work at a Biglaw firm in New York City. The city offers an exciting opportunity for a young law professional, but this lawyer does not plan to live in New York forever. It may not make sense to buy a home when it is unlikely for them to stay there long-term.
A general rule of thumb is that a home buyer should buy a home if they expect to live in it for at least five years. That is because, in a time frame of fewer than five years, volatility in home prices may leave lawyers in a worse or similar price level. Plus, purchasing a home involves closing and moving costs. After accounting for these costs, homeowners will need some price appreciation to break even. Historical data suggests that the longer someone owns their home, the higher the chance of it appreciating. Buying a home for a short time puts the investment at a higher risk of losing money.
Is buying a home a high priority?
If you value financial flexibility over everything and buying a house is not an important goal for you, or maybe it’s not even a goal at all, then putting more money towards student loans is probably the better choice. Debt is one of the significant roadblocks to financial freedom, so it makes sense to get rid of it as soon as possible while saving and investing for the future.
If buying a home is a high priority, a lawyer would increase their savings for a down payment by only making the required student loan payments and nothing more.
The decision to pay off student loans or save for a down payment is not an all-or-nothing decision. Instead, the answer is likely somewhere in between. Since student loans have required monthly payments, lawyers will have to make these regardless of the importance of buying a home.
After making the required student loan payment, a Biglaw lawyer will have additional money to spend, save, and invest accordingly. Some lawyers view student loans as a nuisance rather than a problem. They are more likely to be okay with having these payments while saving towards additional goals. Other lawyers will be uncomfortable knowing that these student loans exist. Paying off these loans can bring peace of mind that saving for other financial goals cannot.
Ultimately the decision comes down to each lawyer’s goals and objectives. The answer to paying off student loans vs. saving up for a down payment is a personal one to make. The financial consequences matter, but that is not the only factor when measuring return on goals.
A financial planner who works with young lawyers, L.J. Jones noticed when his fiancée graduated law school that she and her classmates were graduating with a large amount of student debt and little if any, personal finance education. Driven to help young lawyers repay their student loans, invest effectively, and save/spend intentionally, he opened Developing Financial to educate and guide young lawyers through their career’s unique financial challenges regardless of their net worth or income.