Repay Student Loans or Make 20% Down Payment?

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Contributor

We are preparing to sell our home and purchase a new one. The equity in our current home will pay off the majority of our student loan balance (loans are at 5.25%), but we will only be able to make a 5% down payment on our new home if we pay off the loans so we would have PMI with this option. The new home loan will be around 4.25%. The other option is to use the old home's equity as a 20% down payment in the new home and not have PMI; but we will have higher debt obligations if we do this between our new home loan and our student loan payments. I am thinking it makes sense to pay off the student loan balance and make the smaller down payment. We can save more money this way, both to pay down to 20% equity more quickly and to boost other savings accounts. Is this a good idea? I appreciate any thoughts/feedback.

3 REPLIES

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IMHO pay off the student loan debt or at least half of it. The immediate effect on your debt to income will be better as you'll now have a lower rate to pay off. Not sure why you're paying PMI instead of using a VA loan, but if you pay half of the SL, you'll have the remaining half to contribute to your down payment. I'd talk to a financial advisor before making any decisions.
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Great question, investquest22!

 

I am not a financial expert, but we do have a team here at USAA that will be able to answer any unanswered question for you.

 

The Financial Improvement Team (FIT) helps members with Debt Management, budgeting and building and maintaining good credit. If you would like to speak to this team, please call (800) 245-9360 between the hours of 8am-6pm central time. Thank you, best of luck!

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I agree that it probably makes a lot more sense to pay the student loan off first. Here's an equation you could use because I'm a nerd like that:

 

Yearly PMI = x

 

New home cost = y

 

Student loan amount = z 

 

Yearly added cost (if you choose to pay down your student loans first):  .15*y*.0425 + x (The cost of owing interest on an additional 15% on your home plus PMI)

 

Yearly added cost (if you choose to put all the money towards a down payment): z*.0525 (The cost of your student loan interest)

 

Pick whichever option is less.