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Savings vs debt repayment

Chris Farrell Jan 14, 2009

Question: So my wife just graduated with a masters and started working, and i just got a 25,000 promotion. Combined we are making about 3-4 times as much as we were last year. Our expenses have grown cause we were living in upstate NY, but now live in the bay area. But my question is should we try and pay off some of the college loans sooner, or should we try and save all the excess money for a down payment for a house? In reality it could take us a few years to save the 20% we would need for a down payment because of the outrageous cost of housing here. howard, los gatos, CA

Answer: You aren’t kidding when you say home prices in the Bay Area are outrageous. Home values are down sharply, but the median home price is still about $350,000. That means if you bought the median home you’d have to save $70,000 for a 20% down payment. (And really you’d need more than that considering closing costs, moving costs, and the annual costs of homeownership. You don’t want to be house poor.)

It’s wonderful you have the money and discipline to save. How about this for an approach? First, let’s put the bulk of the extra money toward savings. The money may go toward a home in the future. But the savings will work double duty in the meantime. The amount of money available will grow in case of a financial setback, such as a layoff. Plus, an emergency savings fund is also an “opportunity fund.” Savers eventually get to take advantage of good bargains during downturns. You build a strong financial safety net, have money to take advantage of deals and, create a nest egg for a home.

Second, I would then take some of the extra cash and accelerate your student loan payments.

The thought is not to treat this as an “either/or” question, something all too common in the world of personal finance. Instead, play with the percentages and decide how to divide the money pie. Because of the recession, I would lean toward putting more of the money into safe savings and only slightly accelerate the student loan payments. But you and your wife may be more comfortable dividing the money in half–half into savings and half into extra student loan payments. Or the two of you may decide to put the bulk of the savings toward student loans because you can’t stand living with a loan. There is no right or wrong course. You’re saving–and that is what’s critical in good times and bad.

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