bonus money: use for student loan or for house purchase?

[ragamoffyn]

Hi, all. I'm going to be getting some unexpected money soon, upwards of $20,000 USD. I have a question about whether it's better to use that money to help pay off student loans, or to help pay for a house.

Some context will probably help with the advice, so here goes.

Student loan: I have about $43,000 remaining to pay. It's my only debt. The loan has a fixed rate of 2.25%, and I pay about $350/month on it.

House: I need about $50,000 USD for a down payment. With savings and investments, I can hopefully have that amount in 2-3 years. (I live in Norway, by the way.)

Here are my options, as I see it:

Option 1: Use my $20k bonus to pay down almost half my student loans. Then maybe focus my savings for the next 1-2 years on paying off the remaining amount. In 2 years, I'm guessing I could be debt-free, more or less. I could still save for retirement during those years, but I wouldn't be contributing much toward a house down payment. Pros: no debt. Cons: delayed house acquisition, continue wasting money on rent.

Option 2: Use the bonus for the house payment, so that I could probably buy in about a year or so. Continue paying off student loans as usual. Pros: quicker house acquisition, no more wasting money on rent, start building equity. Cons: having to keep paying student loan for the next 15 or so years.

Option 3: Use the bonus to knock down the student loan, then continue paying it off as normal. Pros: loan payoff time cut in half, house buying time stay on schedule. Cons: delayed gratification?

Any advice? Thanks much in advance for any help.

[Shewillbemine]

That's a good question (and situation to be in) and the biggest factor here is the expected house value versus the 2.5% loan interest. These are turbulent times for the housing market and although reports point that housing has bottomed out, there are still reports that some areas will continue to experience stagnant or even negative growth.

Personally, a debt load of $43,000 would be enough to keep me awake at nights but the good thing is that the interest is relatively low and constant. Some would advise you to invest the $20,000 because the average mutual fund should give you a better rate of return than 2.5% annually. That way, you could continue to pay off the student loan monthly and supplement that with the growth from investing the $20k. An average growth of 7% (and it could easily be more) with $20,000 is $1400 a year which is a decent chunk of change.

However, cutting the student loan in half will also lower your monthly payments (ask if this is true; some loans do not recalculate monthly based on principal) and help you save more towards your house.

Another factor to consider and why you should NOT buy the house with the money is this: buying a new house is like buying a new car in that you do not stop at purchasing the house itself. Once you are in your new home, you will purchase things ranging from flooring to paint to gardening to new bills to furniture to electronics to etc. If you delay the home purchase you also inevitably prevent exposing yourself to the temptation of spending even more money on your house.

[fruitbowlk]

Option 3. The quicker you pay down the student loan the better. In some cases having a student loan might effect you getting a house. And once the student loan is paid off you can put the payment you were making towards your house down payment. Being debt free and having a house would put you in a much better finanally spot. you could decorate the house the way you want to because you have more money to do so with.

[AshleyB]

Option 3: it sounds like the best of both worlds... you get the loan paid off quicker, and you stay on schedule for house buying.

[jpg7n16]

If your goal is to own a home one day, I'd invest the $20k in some mid-term bond fund and use it as part of the downpayment.

Put me in the "wow 2.25% tax deductible loan is so cheap I won't pay it off early" camp.

[DebbieL]

I would invest the money. Your student loan has an incredibly low interest rate. I don't know about how it works in Norway, but here in Canada interest paid on student loans is a tax deduction too. If you have such a low interest rate, that is also tax deductible, I wouldn't be in a rush to pay it off.

[KiwiJo09]

Personally, I'd prefer to pay off debt. Saving for a house is nice, but paying off debt is a better idea. Savings gains about what? 1.35% for me. And debt gains upwards of 2.25% for you. Pay off your debt, save for a house later.

[DebbieL]

I don't think anyone is recommending OP park the money in a bank account paying diddly-squat. My recommendation is to invest it.

[khosta]

I pick option 3!!!! If I had no more student loans to pay my life would less stressful every paycheck I had to pay it!!

[littleroc02us]

Option #1, there will always be another house you can buy. There's one on every block.. How expensive is your rent? Downsize if you have to while you tackle your student loan. I rented a Studio while we were saving for a house. Knock that sucker off and then save for your DP.

[ragamoffyn]

Thanks for the help, all. Based on the comments, I think I'm going to try paying off the loan first, and then tackle the house. But I will look first at investing it in some way.

Thanks again.

[b4freedom]

Buy house. Never pay off the student loan early at that rate. A lot of people in this forum hate debt, but this isn't bad debt. You'll never get less then 2.25%. Hypothetically, assume that you buy a house for $100,000 and get 4.5% rate for 15 years and you have 15 more years on your student loan debt. Your debt situation now looks like this:

Option "Buy house" with 20k: $80,000 mortgage @ 4.5% for 15 years and $43,000 @ 2.25 for 15 years.
Option "Pay of student loan" first: $100,000 mortgage @ 4.5% for 15 years and $23,000 @ 2.25 for 15 years.

In these two "hypothetical" situations, option "pay student loan" will cost you $4309 more in interest then using the money to pay down a home mortgage.

If you give me more realistic numbers I can tell you what the result will be.

EDIT: Just FYI, my wife has the same rate. Prior to the market meltdown of 08, that rate was below the inflation rate and rates I could earn in savings accounts. If your debts have an interest rate below the inflation rate that means that the bank is essentially losing money on their loans. Of course, inflation turned to deflation, and so that is no longer true. However, it's my opinion that inflation is coming back with a vengeance and with it we'll eventually see rates jump.

[DebbieL]

I'm surprised so many people are advising to pay off such a low interest rate (that is even tax deductible). Even I'm not that conservative (and I'm in accounting)! I have a natural aversion for debt myself, but I think the OP should be able to easily earn more than 2.25% return on this money. Heck, even a GIC could beat that (if the person has an extremely low risk tolerance).

[b4freedom]

I even a GIC could beat that (if the person has an extremely low risk tolerance).

What is GIC? How do I find out more?

[jpg7n16]

What is GIC? How do I find out more?

from Investopedia: Guaranteed Investment (Interest) Certificate (GIC) Definition

What Does Guaranteed Investment (Interest) Certificate - GIC Mean?
A deposit investment security sold by Canadian banks and trust companies. They are often bought for retirement plans because they provide a low-risk fixed rate of return. The principal is at risk only if the bank defaults.

Investopedia explains Guaranteed Investment (Interest) Certificate - GIC
The bank's profit is the difference between mortgage rates and GIC rates. If mortgages are at 8% and GICs are at 5%, then the bank makes 3%.

GICs offer a return that is slightly higher than T-bills

You should be able to contact your financial advisor to find out how to invest in one.