Published: June 20, 2014 • Last updated: October 8, 2019 at 0:29 am
“What’s the Right Choice? Pay Down Student Debt, Or Save Down Payment For Investment Property?”
Today’s question comes from Alison in Mississauga:
“Hi Ross I currently have a $50, 000 CAD student loan which I must now start paying off. I have a short term work contract, making a $70,000 a year salary. I have about $10,000 in savings, but am unsure about how to use this. I would like to buy an income property in the next couple of years, so am unsure as to whether I should put the lump sum down on my student loan, or continue to save for a down payment on an income property. Any advice would be appreciated!”
This is often how a Q and A session begins online from this blog. When I received the above email, I sent an immediate reply, requesting more information. My questions below are in italics. Alison’s responses are (in blue), and then we got into the heart of the matter. If you have questions you’d like me to dig into, just drop me a line – I answer them all myself.
Ross: Thanks for reaching out Alison. Before I give you an answer, I need to ask you a few questions if you don’t mind. Do you have any other monthly obligations at the moment? Do you live rent free with parents, or do you pay rent and if so how much?
Alison: I live in an apartment and pay $1,500 a month.
Ross: How short is the short term contract, and what do you think are your job prospects after this position comes to an end? What kind of income can you expect then?
Alison: The contract is set to end in two months. In terms of prospects, I am reviewing job offers at the moment and would expect to make similar money (around $65 -$70,000). I am considering undertaking a PhD starting in Sept 2013, but would depend on various things.
Ross: Has your student loan begun repayment? If so, what is the scheduled monthly payment and what is the interest rate? How many years is it expected to last before paid off?
Alison: Repayment begins next month. The scheduled monthly payment is $500 a month at prime +2.5 for 114 months.
Ross: Do you have a car payment, and if not, do you see that happening in the next year or two?
Alison: I have no car and don’t expect to get one.
Ross: How old are you, are you single or married, and do you have any dependents?
Alison: I am 30, single, no dependents.
Ross: What city do you live in and do you plan to stay there?
Alison: I live in Toronto and am in the midst of deciding where to go based on job prospects. As I am uncertain of where I am going, the idea of an income property, or buying something in a city and renting it out, to have a base, is what appeals to me.
Ross: How much are your presently saving each month?
Alison: Not quite sure. About $1,200 a month.
Ross: What is your net income each month, after all deductions?
Alison: Net income is around $4,000.
Ross: Do you have any credit card debt or other lines of credit?
Alison: No lines of credit or credit card debt.
Ross: With this information, I will have a better picture of your situation Alison. Some financial experts would advise you focus on paying down your student loan first – if not all, then a big whack of it.I am not so quick to say that – I like balanced strategies which involve a combination of debt repayment and investment in your future. But again, it depends on your answers to the questions.
With Alison’s answers, I was able to come up with specific advice which I hope will help her as she decides her next steps. My advice follows below.
So, What Should Alison Do First? Buy Her First Home, or Pay Down Her Student Debt?
I like the idea of power-saving for the foreseeable future – as much as possible. And pay the minimum on your student loan each month of $500. I like a balanced approach – if you simply focus on paying off your debt first, you might have to wait five or six years before it’s gone, (9.5 if you stuck to the minimum payment plan) and only then you begin to save your down payment.
And you would miss out on the opportunity to leverage a small down payment into generous capital gains which may accrue from a real estate investment.
6 steps: From paying down your student debt to buying your first home
1) If you do not actually have a credit card, ask your bank for one – with a limit of at least $2,000. Ideally, I’d like to see you with two such cards. The reason is to ensure you have an amazing credit score when the time comes to buy.
2) As my original article suggested, I am a fan of first time buyers buying a property and renting out as much of it as possible while living there also. This approach allows you to consider a small (as little as 5%) down payment; gets you into the market sooner rather than later; and can really defray your monthly outlay for accommodation. Plus if you live in the property, it’s your principal residence, and any profits on future sale I would hope are tax free – this is not the case if it is a pure investment property that you do not live in.
I understand $1,600 a month does not get you a lot in the Toronto rental market, AND it is a lot of after tax dollars. I have a few young professional clients who have bought two bedroom condos in the past few years, and rented out the second room and lowered their monthly housing expense below yours.
That said, I am not a big fan of condo investment – I prefer houses or duplexes or triplexes. And I am not averse to having a partner to share the load of buying the property – ideally a life partner, but could be an old classmate or trusted friend. (If that ever seems possible, come back and ask me how to structure it wisely)
3) Technically it would be very difficult to qualify for a mortgage until your employment situation is more stable. Your income is good, but lenders are looking for permanent full time employment, without a probation period.
4) Anything you can do in the interim to reduce your monthly living expenses and increase your monthly savings rate will pay off in the future – so look for ways to be more aggressive in the realm of savings
5) Saving money in a Tax Free Savings Account is always preferable to a regular savings account or non registered GIC. It can be a good place to hold money pending decisions on making RRSP contributions.
6) If you decide to follow my advice and save for the down payment, it may make sense to plan to use the first time homebuyers’ RRSP plan. Your marginal tax rate is around 30 to 35%, so you may generate a healthy refund which can be plowed back into your savings, and when you are ready to buy, your RRSP can be a source of a large portion of your down payment. (You might want to research this plan online)
Before you do that you should speak with your tax preparer. You likely have a chunk of tuition/education deductions carried forward which could lower your marginal tax rate.
There is more to home buying than just this. There are various programs and credits available to first time home buyers to reduce the financial sting, but this response at least addresses your fundamental question.
Hope this helps Alison – it’s been a pleasure answering your questions – keep me in mind as you progress through your journey.