Where to Start: Paying off Student Loans, Buying a House, Saving for Retirement
Ideally in our culture, you should go to college, start your career, get married, buy a house and then raise a family. (And we all know life doesn’t always follow that schedule.)
In the same way your life doesn’t have to follow that exact schedule, your money doesn’t need to be a strictly linear process either. Many people think: “I’ll pay off my student loans, then save up to buy a house, and once that’s done I’ll start planning for retirement.”
Not only is that way of thinking wrong, it can cost you serious money.
The best way is to put a little bit of money each month towards each of your goals simultaneously, in order to get the most bang for your buck.
Student Loans: The Earliest Loan You Can Get
There’s no denying that student loans can be a burden, but they do come with a few redeeming qualities: With student loans, you’re building credit history and getting tax deductions.
One of the components of your credit score is length of history. By having an account in good standing from early in your adult life, you’re demonstrating good credit.
In case you’re not familiar with tax deductions, they work like this: If you make $40,000 but have tax deductions totaling $5,000, then you’re only taxed on $35,000. For a single filer, that means not only are you not getting taxed on that $5,000 but you go down a tax bracket and are taxed overall 5% less.
That amount isn’t enough to cover your total cost of what you’re paying in interest, but having a higher credit score could help you down the line significantly. Keep in mind that you should always make the minimum student loan payment or risk jeopardizing your credit. The other two goals should be in lieu of paying extra towards your student loans to pay them off faster.
Your Home Will Be One of Your Biggest Assets
While you’re paying off your student loans, you should also put money aside for a down payment on a house. Paying a mortgage is investing in an asset that can go up in value rather than simply paying rent to someone else.
A loan gets paid off in the end: the interest ends and its effects on you end. However, for as long as you have a home, you have the opportunity to gain equity, and the collateral you have on it, the real estate, can appreciate in value. Not only that, once your mortgage is paid off, you can retire without having to pay rent somewhere.
Just like paying off your student loans takes quite a bit of time, saving up to put a down payment on a home takes time. The sooner you save up that magical 20 percent down-payment needed to buy a house, the sooner you can be investing in your future. Plus, with the average mortgage being 30 years and most people retiring around 65, this gives you plenty of time to pay off your mortgage before you retire.
However, getting a mortgage can still be challenging even with 20 percent down if you have a large amount of outstanding student loans because of a factor called debt-to-income ratio. Getting a private mortgage, also called seller-financing, can be a path to homeownership for those who have a high debt-to-income ratio, since private mortgages often don’t have to meet the same standards as traditional mortgages.
Early Retirement Savings Pays Off Big-time
If you find you have extra money after making your student loan payments and saving money for buying a home, you should start saving for retirement. Ideally this should happen as soon as you leave college.
The reason you want to start early is how much money grows over time. Once paid off, your student loan is gone and done. Your degree will hopefully help you continue to make more money. Similarly, money invested for retirement will continue to increase in value. The earlier you start putting just a little bit into savings, the more money you will have, even if you put double into savings later.
Here’s the math on how that works: Let’s assume an annual 5 percent return on your retirement savings. If you were to start saving $50 a month starting at the age of 25 you would end up with more than $70,000 by age 65. However if you were to wait until age 45, but then invest $100 a month, you only end up with a little more than $40,000 by age 65.
Plus, you’ll feel better knowing your financial future is more secure.
In short, by paying off your student loans, saving to buy a house and saving for retirement all at the same time, you put yourself in the best position to seize control of your finances and live life to the fullest on your own schedule.
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Catherine J. Byerly is a staff writer at MortgageNote.org. Her passion for personal finance has led her to create advice articles on money. Follow her on twitter @CatherineByerly.
