Should I Pay Off my Student Loans or Mortgage First?
Most of the time it will make more sense to pay off student loans ahead of a mortgage, but there’s much more to consider than just interest rates. Your age and the asset that is obtained through debt impact how you should prioritize paying it off.
If you’re on or have been through Milestone 3 of the Next Dollar Roadmap, you’ve probably had to decide how to prioritize how you approach paying off debt.
Whether you go the debt avalanche or debt snowball route, you’re likely to end up with student loans and mortgage debt as the last two on your list to pay off.
The reason is each can have low-interest rates compared to other forms of debt and the balances tend to be much larger than say car loans or credit cards.
Why Some Debt Isn’t in Milestone 3
We also point out in Milestone 3 that you might want to delay paying off mortgages or student loans until Milestone 8 for a couple of reasons.
First, the interest rates on student loans or your mortgage could be low enough that it isn’t worth delaying your start on saving in order to pay them off.
If you can receive a return of 10.67% over the long run from an S&P 500 index fund, it doesn’t make much sense to spend years paying off your 3.5% mortgage instead.
Like we’ve said many times before, there’s no way to substitute time into your wealth-building plan.
Second, student loans and mortgages are debt issued for appreciating assets.
Yes, they’re still forms of debt, but they generally create value instead of quickly losing value as consumer goods do.
Over the long run, they tend to get easier and easier to pay off and, in the case of a house, aren’t likely to leave you with more debt than the retail value of the asset.
Determining “High” Interest vs “Low” Interest
The real trick in all of this is determining at what interest rate low-interest debt turns into high-interest debt.
I’ll use my favorite lawyer answer here.
It depends.
First off, interest rates move. I’m writing this in 2023 and believe me, we are all currently very well aware of this fact.
Presently, a 30-year mortgage will normally carry about a 5.75%-6% interest rate.
Just 13 months ago you could get the same mortgage at 3%.
So, what was low at one-time may not be that low anymore, and vice versa.
Second, you should consider your distance from retirement when deciding how to prioritize your debts.
The basis for this goes back to the tradeoff we discussed above between the time for your savings to grow and the value of being debt free.
The money saved by a 25-year-old in lieu of debt payment will have much longer to grow than that of someone making a similar decision at 55 years old.
Therefore, it’s more valuable for the 25-year-old to continue to carry the debt and save instead. While it would be less beneficial for the 55-year-old.
To account for this, the older you get the bar for what you consider high-interest debt should go down as well.
Framing this by Age
So, taking all of this into account here’s a ballpark response to the high vs low-interest question.
Under 35
If you’re under the age of 35 and you must choose between saving or paying off the mortgage or student loans, you should save.
In our post titled “How Much Would a Dollar Invested Today Be Worth in 10 Years?” we show how one dollar saved for just 20 years is worth $7.60. Over the course of 30 years that value climbs to $20.94 and at 40 it hits $57.70!
You can’t reap the top-level benefits of investing and saving unless you leave your savings invested for a long time. Start this while you are young.
Once you’ve reached Milestone 5 and you’re saving 15% or more of your income, then I’d move to student loans before the mortgage unless your interest rate is adjustable on the mortgage.
If you have an adjustable-rate mortgage, you should pay that off or consider refinancing when rates cool off a bit.
The reason I’d typically put student loans first is that they’re not connected to an appreciating asset.
If worse comes to worst, you can avoid killing your credit by selling your house and paying off the mortgage, but you can’t trade in your education for cash back.
From 35 to 50
If you’re between 35 and 50, the value of saving isn’t as high as it once was but that doesn’t mean you should stop altogether.
Keep working on the Next Dollar Roadmap and save the mortgage and low-interest student loans for Milestone 8.
As for prioritizing between student loans and a mortgage, all things equal I’d hit the student loans first for the same reasons I stated above.
The only real difference between this age bracket and 35 and under is the value of saving has decreased due to the reduced amount of time you’ll have to save.
As a result, if you have debt with an interest rate of 5% or higher, you should take a long look at moving back to Milestone 3 and paying it off.
There’s not a hard and fast rule here because it gets a little muddy depending on your personal situation.
Just remember that there’s more urgency at this stage in life for saving and paying off debt, depending on how well you’re doing in each area.
Over 50
Finally, if you’re over 50, I would again consider paying off the student loans first (unless you are in an ARM).
The key difference now is all your debt payoff efforts should be prioritized back up to Milestone 3.
Generally speaking, in your 50s your lifestyle won’t be pressuring you to buy larger houses or cars and I have serious doubts about the profitability of returning to school.
If you are already financially independent and want those things, so be it.
But, if you’re not where you want to be from a savings standpoint you can no longer afford lifestyle creep unless you want to work beyond normal retirement age.
And if you do plan to retire in your 60s or earlier, doing so without a mortgage will simplify your life and provide more flexibility for managing sources of income for tax savings.
So, if you have student loan debt in your 50s (I assume for your kids) pay it off quickly.
Summary
- Prioritize student loan debt over mortgages unless the interest rate on the mortgage is significantly higher (like 2% or more) or is adjustable.
- The older you get the more you should focus on paying off debt.
- A high-interest rate at age 35 and under for student loans or mortgages would be 7% or higher. Between the ages of 35 and 50, I’d consider anything over 5.5% as high.
- Once you reach 50, you should make paying off any debt a priority.
- A good sanity check on how “good” an interest rate is would be to check the interest rates on short and long-term treasuries. This will give you an idea of the direction fixed income interest rates are expected to move over a broader range of time.
And Then There’s Toxic Debt
I want to take a step back and clarify what we mean when we refer to “toxic” debt in Milestone 3.
Something that’s toxic means it’s harmful.
Most mortgages and most student loans improve quality of life and enhance one’s ability to build wealth. You’d be hard-pressed to convince me that those are toxic things.
On the other hand credit card debt, consumer loans, and even car loans all hinder or harm your ability to build wealth and should be avoided.
Even if you were able to get your hands on these loans at 0% interest (a quickly disappearing option), I’d probably avoid them. The reasons are two-fold.
First, the 0% rate usually is only temporary until it gives way to a much higher rate.
Second, even if you manage to pay back the loan before a higher rate kicks in, the amount you’re able to glean by using that money elsewhere probably isn’t worth the effort.
Mathematically, there may be an advantage, but it’s rarely worth the time and effort to manage.
Basically, what I’m getting to is you should focus first on the purpose or utility of the debt, then on the interest rate when you evaluate its constructive or destructive effects.
Conclusion
Most of the time, paying off student loans first makes more sense than attacking the mortgage, but it depends on a host of factors.
Your age, interest rates, and the amount of debt are all factors that should be considered before making your choice.
If you take nothing else away from this, please remember that you shouldn’t stop saving and investing completely to pay off low-interest student loans or a mortgage.
