Are You Paying Off the Right Debt? Your Mortgage vs Your Student Loans

Pay Off Mortgage or Student LoansPerhaps it was the lottery or a final bequest from a long-lost relative.

No matter how you suddenly ended up with a pile of extra cash, you may be wondering whether to target the mortgage or student loan balance.

After all, student loan debt and a mortgage are the biggest debts carried by the average American, and retiring either would make most people ecstatic.

Student Loans and Mortgages: A ‘Good’ Type of Debt

There are some types of debts that are cancerous, such as credit cards, which can grow easily, often have very high interest rates and are not tax deductible. These are the debts the average person should attack first.

That’s not the case with a student loan, which generally has a very low interest rate, creates value over time in your ability to qualify for a higher paying job and is tax deductible.

However, a mortgage is a good debt as well, particularly one with a competitive interest rate. That’s because the interest from mortgages also are tax deductible and the property secured by a mortgage is likely to increase in value over time.

Two Ways to Attack Debt

There are two ways to pay off debt that are most often suggested by financial experts. One is the “snowball” method. Under this technique, encouraged by financial guru Dave Ramsey, an individual attacks the smallest debt first.

This method can be used whether the analysis is focused on mortgages and student loans or whether a variety of different debts are involved. By attacking the debt with the smallest balance, an individual is going to have success fairly quickly.

This is important, according to Ramsey, because it’s exciting to pay off a debt. That enthusiasm makes it easier to stay disciplined. Also, paying off that first bill then frees up additional money to focus on the next smallest debt balance. Most people subscribing to this method would choose to pay off the student loan debt first because of the lower balance.

Play the Numbers Game

The second way many people decide which bills to pay off first relies on a very basic financial principle. Take a look at the interest rates of all your bills and target the bill with the highest interest rate first.

Student loans generally carry a very low interest rate, from about 2.5 percent to 4.5 percent. When deciding between paying down a student loan or a mortgage, choose the debt with the higher interest rate.

A debt with a higher interest rate takes longer to repay because the higher interest rate continually adds larger amounts to the debt. So, when you pay off mortgage early, for example, with a 6 percent interest, you are earning 6 percent for every dollar in debt you retire.

On the school loan, your money wouldn’t go quite as far because of the lower interest rate for many student loans. I’d love to read a comment from anyone who chose to pay off the mortgage first because of this reason.

Choose the Method That Suits You Best

The bottom line in paying down any debt is personally buying in to your debt-reduction choice. If you would find more motivation by relying on the snowball method, go that route.

Targeting the highest interest rate will always save you the most money, but if you don’t have the discipline to see your debt program through to the end, the statistics don’t really matter.

Editor’s Note: My wife and I have a mortgage, but we finished paying off our student loans last year. We had some extra cash and decided that it was best to tackle the low-hanging fruit, even though mathematically, paying on the mortgage probably made more sense. Another factor for us what the fact that we’d owned that debt (student loans) since we left college (over 10 years ago for me).

If you have both of these debts, how are you approaching paying them off? Which first?

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  1. After going through law school my student loan balance definitely rivals my mortgage. Also, my student loans have various interest rates, some at 8% and some less than that but my mortgage is at 4.5%! I agree with the risk assessment, if something happens to me my student loans die with me. However, the difference in interest rates makes this a much tougher decision. I’m still trying to decide…

  2. I have a slightly different reason for paying the mortgage off first. My wife is the one with student loans and we have the mortgage together in our names. If anything were to happened to my wife and she passed the student loans would not be my responsibility. They are forgiven. So I’d much rather be putting equity into a house than risking it in a loan payoff that doesn’t help our family in troubled times of need. Anything wrong with that logic?

  3. musiqtechnique says

    My wife and I decided to pay down the mortgage first then refinance when we are about a little more than 1/2 of the mortgage remaining to 1. get a lower rate (fixed fha less than our current 6% rate) and 2. because it is the higher interest debt. We have student loan but that we have budgeted in to our regular monthly expenses. We will end up with a low mortgage payment and then will attack the Student loan pay that off and pay the remainder of the mortgage at will and at our own non pressure pace.

  4. @Mike – Thanks so much for adding your perspective. It’s valuable since I know so many people are like you and going through Dave’s plan. The tax analysis was excellent. Thanks for taking the time to break that down. Very valuable insight.

  5. A couple of months ago I came up with a plan to pay off all of our debt, including the student loans and the mortgage. I followed the Dave Ramsey approach, and it has us paying off the student loans before the mortgage, although those debts are next-to-last and last, respectively. In addition to the psychological reward of retiring a debt (any debt) faster than pure math would dictate, in my mind I have a harder time wrapping my head around the fact I am paying for my degree, which is intangible, than the fact I am continuing to pay for my house, which gives a more tangible, ongoing benefit. Maybe that’s just me.

    I wanted to comment about the differences between the tax deductions for the two. Mortgage interest is a Schedule A deduction, which means it comes off adjusted gross income, but student loan interest (“SLI”) is a “page one” deduction, which means it comes off gross income. In that regard, dollar-for-dollar SLI appears to be a “better” deduction.

    However, you probably shouldn’t compare the two dollar-for-dollar, for a couple of reasons. One, you don’t get to deduct all SLI; rather, there is a cap of $2,500, and as income increases above certain limits (which aren’t *that* high in the scheme of things), the deduction begins to phase out. Two, if you are married, you should keep in mind the SLI deduction suffers from a marriage penalty in its purest form – even if both spouses have SLI, and even if each spouse has $2,500+ in interest, the marital unit is still limited to a total of $2,500 for the deduction (which, again, will be phased out at higher incomes). Taxpayers who file as “married filing separately” can’t take an SLI deduction, so that’s not a viable workaround.

    The deduction for mortgage interest, on the other hand, is unlimited. So unless your adjusted gross income is dramatically different from your gross income, and assuming you have enough Schedule A deductions to itemize instead of taking the standard deduction, your mortgage interest is likely to earn you more of a benefit than your SLI, from a tax perspective, since you can take all of it.

  6. You make a good point about hardship deferral, Jason. I didn’t think about that side of the equation. Makes sense to include that line of thinking though.

  7. Jason @ MyMoneyMinute says

    Good question. If your student loans have far less of a balance than your mortgage, I’d say pay them off. Like you said, the “low-hanging fruit”.

    But on the rare occasion where your student loans rival your mortgage balance, then you may want to pay off your house first, for two reasons. First, if it all goes south, I’d rather have a paid off home to live in, than a paid off degree with me in my cardboard box :). Second, you can put your student loans on hardship deferral, but your mortgage company will foreclose on you!

    Putting all interest rates aside, I look at it from a risk perspective. I’d rather have a paid off home and no student loan to pay due to hardship deferral; than have a paid off student loan and still have to come up with $2k/month for my house payment.

    Having said all that, we have this predicament and still pay down the loans first. I imagine it’s because our loans are broken up into 4 or 5 different smaller loan balances. But perhaps this little exercise will change our thinking on what we attack next? At the point where all we have left is so-called “bad debt” (which I may disagree with your premise, but the point remains), I switch my analysis from mathematics to risk aversion.

    Great post, PT.

    • I agree Jason. I look at debt from a risk perspective. My husband and I have been debating over which debt to tackle first, student loans or mortgage. And PT, here is the comment you’ve been waiting for… our mortgage interest rate is 4.65% while the student loans will be consolidated at about 4.75%. The mortgage balance is about 5x that of the student loans, however, if we were to fall on hard times I would rather default on my student loans than have my house foreclosed. Maybe I am comparing apples to oranges here because the loan balances are so hugely different, the monthly payments are so hugely different, and even tackling the mortgage first, it would take a good 15 years to get that one out of the way. I still want to tackle the mortgage, while my husband wants to tackle the slightly higher interest/lower balance student loans and cannot understand why this is not the only feasible option in my eyes as well.

      • Philip Taylor says

        @shannon82 Thanks for sharing this. I hope you guys come to agreement. Either way it sounds like you’re on top of things. Congrats on the financial success.