Should I Pay Off My Mortgage or Student Loans First?

pay off debtsStudent loans and mortgage debt are often considered to be “good debt,” as they are forms of debt you take on in order to purchase something that should increase your net worth. “Bad debt,” on the other hand, includes credit card debt, auto loans, and other consumer debt incurred to make purchases that depreciate in value.

Regardless of the classification, debt needs to be paid off at some point. And if you have a little extra money every month, you may ask yourself: Should I accelerate payments on my mortgage or student loans? And, if so, which should I aim to pay off first?

Determining Whether to Pay Off Student Loans or Mortgage Debt

While there is a great deal of debate as to whether student loans or mortgage debt should be paid off early, there is little debate about when not to do it. You should not make extra payments for either of these debts until you first do the following:

  • Pay Off Consumer Debt. If you have a car loan, credit card balances, personal loans, or any other types of debt with higher interest rates and non tax-deductible interest, you should always pay off such debts before tackling an early mortgage or student loan payoff.
  • Establish an Emergency Fund. An emergency fund containing three to six months of living expenses protects you from having to take on consumer debt to pay for an emergency, such as a home or car repair. It doesn’t make a lot of sense to send your extra money to repaying student loans or mortgage debt if it will leave you without the cash to handle an emergency.
  • Fund Your 401k to Your Employer’s Match. If your employer matches your retirement contributions and you aren’t contributing at least the amount matched, you are essentially giving away free money.

If you are in good financial shape, have your other debts paid off, and are taking advantage of the 401k match, the question of whether to pay off your student loans or mortgage early becomes a bit more tricky.

Reasons to Pay Off Your Debts Early

There are plenty of arguments to be made for paying off your student loans and mortgage early. For example, when you pay off your mortgage or student loans, you enjoy the following benefits:

  1. No More Wasted Money on Interest. While you can take a tax deduction for mortgage and student loan interest (if your income falls below a certain threshold), the deduction does not completely cover interest costs. Money spent on interest is wasted, while money saved on interest provides a guaranteed return on your investment.
  2. More Financial Freedom. Without a mortgage payment or a student loan payment, you can do what you want with your money – including building wealth and saving for retirement.
  3. Less Risk. If you have debt payments, you must have income to cover them. If you are debt-free, a job loss, disability, or other temporary loss in income doesn’t put you at risk for losing your home or ruining your credit.
  4. Elimination of Non-Bankruptable Debt. While bankruptcy can resolve some debts as a last resort, student loans are not dischargeable in bankruptcy. You also can’t erase your mortgage debt in bankruptcy if you want to keep your house. Since you can’t wipe out mortgage or student loan debt, the only way to eliminate it is to pay it off.

Arguments Against Paying Off Your Debts Early

While the arguments for paying off your mortgage and student loans early can be pretty persuasive, there are also plenty of arguments against paying them as well. For example:

  1. Student Loans and Mortgages Are Low-Interest Debt. This is the biggest argument against pre-paying mortgages and student loans. With low student loan and mortgage interest rates and the ability to deduct interest, it is easy to find investments that pay more in interest than you pay on your debt, especially if you invest in tax-advantaged accounts, such as a Roth IRA.
  2. Pre-Payment Comes With Opportunity Costs. When you invest and earn a return on your investment, that money can be reinvested – and you can earn money on that investment as well. This is referred to as compound interest. Compound interest can make a big difference in your retirement and long-term savings, and the more you invest when you are young, the more your money will grow. For example, if you invest $100 per month from age 20 to age 40 and earn 8% compounded annually, you’d invest $24,000 and have almost a million dollars when you turn 65. If you waited and invested from age 30 to 50, investing the same amount of cash and getting the same return, you’d have only $205,875 when you turn 65 – or $750,000 less. This is because, in the latter example, your money has less time to grow between when you stop contributing and when you start withdrawing for retirement. Putting that extra $100 a month into retirement savings instead of student loan repayment makes a big difference.
  3. Loan Repayment Isn’t a Liquid Investment. Once you’ve paid off your mortgage or your student loans, it is usually very difficult to get your money back if you need it for any other reason, such as for an emergency or to cover income loss due to unemployment. You can’t reclaim the cash at all with student loans, and while you could sell your house, there would be closing costs and fees – and the home could sit on the market for months.

pay off debts mortgage

Determining Which to Pay Off First

If you’ve weighed the pros and cons and decided that early payoff is right for you, the next question becomes whether to pay off the mortgage first or the student loans. The answer to this question depends on a number of factors:

  • Interest Rates of Your Debts. Many people want to pay off higher-interest debt first. This can be a good idea, but isn’t always the best idea. Be sure to consider all factors, especially the tax treatment of the debts. Mortgage interest is usually tax deductible for everyone, while the ability to deduct student loan interest phases out at higher incomes ($75,000 as of 2012). Student loan interest deductions are also capped at $2,500 per year. Compare the effective after-tax interest rates on your debt to determine which debt truly costs more.
  • Amount Owed for Each Debt. Dave Ramsey’s debt repayment method suggests repaying smaller debts before larger ones in order to remain motivated with your debt payoff plan. If you owe much less on your student loans than your mortgage (or vice versa), then it might make sense to pay off the smaller debt first so you have only one remaining debt to focus on.
  • Risks of Adjusting Rates. If you have an adjustable rate mortgage, there is a risk that the interest rate – and monthly payments – will go way up when interest rates rise. Paying off an adjustable rate mortgage or paying it down enough so that you can refinance if you need to can be a smart bet.
  • Flexibility of Repayment. When you have student loans, you can usually put them into deferment or forbearance if necessary due to job loss, disability, or a return to school. While the interest continues to accrue in most cases, you don’t have to make payments for a while. You can also choose to tie your payments to your income or use a graduated repayment schedule in some cases. With so much flexibility, tax deductible interest, and low interest rates, it almost never makes sense to pay off student loans before other types of debt.

Final Word

Ultimately, everyone needs to make the choice themselves about whether early mortgage payoff or early student loan payoff is right for them. For those who want to live a debt-free life, who are risk-averse, and who want a guaranteed return on their investment, early mortgage or student loan payoff may be the best answer. For more aggressive investors who are willing to carry the risk that goes along with a little debt, skipping the early payoff can be a viable option.

Have you accelerated your student loan or mortgage payments? Why or why not?

(photo credit: Bigstock)

  • pharmboy

    we’re in the same boat. it’s 5.5% fixed five-year mortgage (60K) and consolidated student loans at 1.875% (45K).

    we paid S10,000 down on principle just the other day…on the house.

  • Jason Dragon

    Well just because it is going to adjust why would you assume it would adjust UPWARDS, with the current interest rates it will most likely adjust DOWNWARDS and save these people money.

    There is no reason that they should take liquid fund and put them into paying off any of these debts faster than the minimum allowed. They should separate their equity from their house (Remember the 20% rule, you should never have more than 20% of your net worth as equity in your house.) I would suggest to them that they save, the money in some sort of investment. It is easy to find investments that will do much better than the interest rates they are paying, and the interest they are paying is tax deductible.

    For most situations paying down on a house is one of the worst things they can do.

  • author

    if the five-year is your second mortgage, but it’s a fixed rate, I would say that paying down either one first would be fine. Neither one is killing you at this point and their both a similar amount.

  • Joe Fugly

    Of the debts, personally I’d pay down the ARM as it has the potential to be the most volatile. Otherwise this is a simple yield arb question. Which gives the better zero risk return? Sticking the spare money somewhere with a higher return or reducing the most interest-intensive debt.

    Yes, you could up your risk exposure by investing the pay-down money in something more speculative, but then it wouldn’t be comparing apples with apples. Though owing dollars is a form of short on the currency since you are expecting it to under perform whatever else you’ve put those dollars in. Despite any short-term bounce, long-term the dollar is heading south, which means price inflation heading way, way north … that means living expenses are going to continue to take a bigger share of income.

    You have also got to bear in mind that with house prices expected to trend lower for some time, the lower your aggregate debt, if you ever get the opportunity to refinance at an lower interest rate, the better. Lending criteria are going to remain tighter for a long time. You’d need your mortgage debt to reduce at the same rate as your house price to retain the same debt-to-value ratio.

    On the flip side of the coin, is the inflation/yield arb. If a depression is avoided and the Fed’s policy of trying to achieve significant inflation is successful then the more debt you have at a low rate the better, since even the interest you earn on your money will be way higher than the net interest incurred on mortgage debt. But that is where you have a long term fix. Anything variable rate will kill you.

    Under that scenario house prices will, with the exception of the occasional fillip, under perform inflation but a net-of-relief long-term fix will also be less than inflation, let alone the interest rates of that time. Inflation cuts the debt – an average 6% compounded for 25 years makes the nominal debt worth less than a quarter in today’s money. And the higher interest rates grow your cash/savings.

    Best case scenario, it is a Credit Crunch that lingers only until sometime in 2009. Which might explain why EuroDollar June 2009 futures are pricing in a Fed Funds Rate of 2.75%. My money, though, is this is a Credit Revulsion. Which means the Great Unwinding still has a great deal of unwinding to do.

    All this said there is one purely non-financial aspect. Peace of mind. Which strategy allows you to sleep better at night?

  • Just Visiting

    Why not save/invest it in a reasonably liquid way, then if the ARM resets too high, and your reserves are still solid, transfer the savings to pay it down then? Even if you match the current ARM rate with the investment earnings (accounting for taxes on earnings and tax deductibility of the loan interest), you’re in the plus column because you’ve retained your flexibility.

    Don’t forget to save for your next car – there should be an account building to cover the replacement cost, even if it is 5 years away. And, be sure to take full advantage of the match on your 401k.

  • [email protected]&More

    Student loans are not always low interest rates. They key I think is that you can’t discharge them in bankruptcy so that is what I would aim for unless they are at less than 3% interest.

    • Thomas Farrell

      I agree with this. Spoken like someone who realizes that it’s possible to lose your job. Also, above a certain income student loans no longer provide a tax break.

  • J-Chap

    Great Article! This made me realize I am putting too much towards paying off good debt. I need to invest more than I am. Thank you for this

  • Joe Wood

    When did “student loans” become not “consumer debt”? Another casualty of America’s slow decline in common sense, I suppose. It’s not securitized, it was for something intangible (in the case of B.A. graduates, a completely useless luxury to boot). Worse, you often can’t rid yourself of it as a result of bankruptcy. The answer, therefore, is to pay off student debts first, if you’re money-dumb enough to have them in the first place. Go to a cheaper in-state school for goodness sakes and WORK during university. I’m sure every idiot with student debt has an excuse why they couldn’t do that (“But this private college offered this WONDERFUL program…”) and that’s all poor people will ever have an abundance of: excuses, excuses, and excuses.

    • Guest


    • Student Loan

      What? Don’t assume everyone who has student loan debt didn’t work. I was homeless from age 16 on and had no contact with my parents…went to college by taking student loans, worked 12 hour shifts at a factory the first 2 years while attending college full time, then worked 30 hours a week the next 2 years, graduated with high honors after 4 yrs of working and taking loans because I didn’t have parents to pay for it, went on to get a masters and a doctorate degree in Education—with over 100K in student loans. I was not lazy. Do not lump everyone together.

  • Dannielle @ Odd Cents

    My mind is just programmed to avoid paying ridculous interest. I would definitely get rid of the high interest items first.

  • Ohio First Time Home Buyer

    Great article. Way to many people think its as simple as throwing extra money at random debt, rather than coming up with a game plan, which should involve paying off credit card debt.

  • Thomas Farrell

    There is no “good debt”. Seriously – how many people buy in to this bank promoted hype? Yes, there is necessary evil debt, but it isn’t good.
    Another article written by a young person that has it all figured out. Get back to me in about 20 years when you have determined that this philosophy works for the masses.

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  • Randolph

    This article is old, but i just came across it so…. One thing I think is important, that it seems almost no one mentions is to pay at least a little extra on your mortgage every month, especially early. Although I agree not to dump a lot of money into it, as it is not liquid. $20 a month extra directly towards your principle goes a long way, because you are not paying interest on that $20 for the remainder of your mortgage. That small amount will knock off a year or two of payments.

    But yeah, student loans are crap. I came out pretty well with only 30k. I worked through school, and that pretty much payed for living expenses (beer/pizza/car). I could have lived cheaper, and worked more, but I had my fun. Honestly i doubt I made 30K total working part time in a Deli 4 years. $7/hr doesn’t go very far. I don’t see how people say college is useless (below), it is what you make it. I wouldn’t have been able to pay off my loans in 8 years without the education i received. I build industrial equipment for a living; I would say that is pretty useful to society…