What to do with my money -- pay off student loan or buy house?

[willdude]

Ah yes, the age-old question for people who are not particularly old of age. I'm facing this conundrum, and figured this would be a good place to seek advise.

My situation is this: I have $29k in a private student loan, with a variable interest rate based on LIBOR, which is currently 5.28%. There's about 8.5 years left on it, with a current monthly payment of $355. That projects to about $7200 in interest at the current rate over the remainder, which will no longer be tax deductible based on my income, and of course would change with the interest. If I just paid off my loan now, it'd take most of my savings, but I save at a pretty high rate and would be able to save this money back in about 2 years.

However, with house prices and mortgage rates as low as they are, it would seem advantageous to buy a house instead, especially since I'd qualify for the $8k tax credit as a first-time home buyer. I've been trying to wrap my head around this decision from several different angles, but it really seems to come down to a gamble as to whether the economy, and housing market in particular, will rebound significantly over the next two years. Any other advise or things I should be considering?

[gt0163c]

One thing to think about is, if you do decide to buy a house, you'll be in debt for both the mortgage as well as your student loan. So, how you feel about debt in general is something to think about. Buying a house would probably wipe out a good portion of your savings as well.

Personally, and I have nothing other than a bit of experience, an analytical mind and the information that anyone can read about in general news sources, I would think that in most places, the housing market will start to come back...at some point, but it's going to be slow. How far it comes back and how fast will be very dependent upon where you live and the economic conditions in the area. Detroit, it's all going to depend on what happens in the auto industry in the next few months. DFW is going to be partly dependent on the government defense reviews and what's in the federal budget for the upcoming year.

Personally, if it was me, I would hold off on buying a house for the moment. But, it wouldn't be a bad idea to talk to a realtor or buyer's agent and take a look at what's available in the market. (Provided you're able to "just look".) That way, you can assess what the market is like, get an idea of what's available in your price range, figure out what you want in a house, etc. For my first house, it took me about 9 months of looking to first figure out what I was looking for and then to find that house. I thought I knew what I wanted originally, but it turned out that was more of what I was used to in the area where I grew up and would have been too big and not in the right area for what I really need and, ultimately want, now.

Meanwhile, after making sure I had a good emergency fund set aside (at least 3-6 months living expenses, but that will be dependent upon you particular situation and industry), I'd start splitting any savings between paying down the student loan and saving for the down payment on a house.

Once you decide to buy, you'll already have a good reputation with a realtor/buyer's agent and be familiar with the area and what you want. That should make your final purchasing decision easier.

Best of luck.

[Philip Brewer]

It's the sort of thing where you can't know the right answer without knowing the future--what will happen to home values, what will happen to interest rates, etc.

With that in mind, I'd suggest hedging your bets. Start paying off your student loan at an accelerated pace, but not so fast that you can't continue to add to your cash savings. At the same time, start looking at houses. But don't just look for any old house that might be satisfactory--look for an incredible deal on the perfect house in an ideal location.

Go into the whole thing with a two-year timeframe in mind. Maybe this will turn out to be the bottom of the market and maybe mortgage rates will turn up--but maybe there's another big down leg yet to come and maybe the Fed will push mortgage rates down even further. Start with your standards really high--looking for a once-in-decade deal on a best-you-can-imagine house--and then let them decline gradually so that two years from now you're just looking for a good deal on a good house.

Basically, as long as rates and house prices are still heading down, there's no need to jump in and buy. There's time to wait. Even after house prices turn around there will still be sellers anxious to unload their house--people who have been cutting their price but getting no offers for years. They'll take your offer, even if it comes after the market has already turned.

[willdude]

Originally Posted by Philip Brewer

Go into the whole thing with a two-year timeframe in mind. Maybe this will turn out to be the bottom of the market and maybe mortgage rates will turn up--but maybe there's another big down leg yet to come and maybe the Fed will push mortgage rates down even further.

I guess I'm approaching this decision by considering the worst case scenario. If I buy now, the worst case would be that the housing market stagnates or goes down in the next two years, such that there's no real gain in buying now, and that the interest rate on my student loan increases in its remaining 8.5 years such that the interest over takes the $8k tax credit I'd get now. This case seems more likely, given how the economy is, and that the student loan part is over a longer period of time. But it's less impactful, as we're talking about a smaller loan.

However, if I pay off the loan now and buy in two years, the worst case is that house prices and interest rates go way up, which would cost me a lot more in interest on the mortgage. This is maybe less likely, but much more impactful in terms of interest it'd cost me on the mortgage.

[Philip Brewer]

You're of quite an optimistic bent when it comes to worst-case thinking. Plenty of people would call a tidy rise in house prices and modest climb in interest rates a best-case scenario.

As worst-cases go, how about a continuing downward spiral in the economy that costs you your job while pushing housing prices down so much that it's impossible to sell your house (so you can't move to get a new job or sell the house to get out from under the mortgage)? It's hardly a far-fetched possibility--there are millions of people in that situation right now.

If you choose to pay off your student loan and accumulate additional cash, you'd be in pretty good shape, even if things did get worse: You'd be able to move to seek work or to find a cheaper place to live, and you'd be debt-free so that you'd have the option of cutting your cash expenses as low as necessary to get by on whatever you could earn.

I'm not predicting an ever-worsening economy, just suggesting that such a scenario ought to be considered when "worst-case" is what you're looking for.

[MNfrugal]

Advantages to nibbling away at your student:
+ lowering your overall interest payments on the loan
+ improves your credit score for when you do decide to buy a house

I agree with Philip on possible worst-case scenarios. Unless you're absolutely sure of your job or location, this isn't the best economy to make this kind of long-term commitment. But only you know your own situation well enough to make that decision.

[khorrell]

As much as I agree with the logic that this is a great time to buy, I also agree that your worst case isn't very bad. My own mother called me in a tizz today because she JUST realized that she is in deep doodoo if her job disappears, which it could. Mortgage, car payment, no savings.

If you can construct a truly worst case scenario and still buy, then maybe it is a good idea. Otherwise, I'd wait a little longer. I like the idea of looking now. It will save a few months of learning when you are ready to buy.

good luck to you!

[Philip Brewer]

Unlike the stock market, where you can miss a lot of the upside simply by being out of the market when it happens to soar, the real estate market isn't like that: any one property might get an offer and suddenly move out of your price range, but the influence of that sale on the market price of other houses is going to muted and gradual.

Even if a general recovery in property values prompts many sellers to start holding out for better offers, there will be many others--people who have been stuck in a property that they don't want for years--who simply want to sell. They'll take your low-ball offer, even if other sellers won't.

So I think there's much less danger of "missing the bottom" in real estate than there is in more liquid markets.

[Julie Rains]

I agree that the potential for job loss is probably the biggest risk factor to manage -- much of that depends on your ties to the area and the vitality of your local market.

The tax credit does seem attractive though, as others mentioned, you need to look at houses first and so you have time to make decisions. Actually the biggest mistakes I've made were in hurrying a decision rather than taking my time. You'll have plenty of chances to make (or lose) a lot of money in the future.

[nkthen]

As a general rule, keep your loans to the minimum. So I guess you've got to focus on clearing the loan amount.