Question: I’m a millennial with more than $100,000 in student loan debt. I recently came into a small windfall of $10,000 that I’ll get tax-free. I’m trying to decide whether to use it to pay down the student loans or for something else.
My father and some co-workers suggest I invest it in a brokerage account and let it grow for five or 10 years toward a down payment on a house. If I found a house in the area where I’d want to live, it would probably cost around $600,000.
My undergrad loans total about $9,000 at 3.5 to 6.5 percent fixed interest. My grad school loans total about $115,000 with 5.3 to 6.8 percent interest. I have $5,700 in credit card debt from my grad school days before I was working, but I transferred that debt to a new card that has zero interest for 15 months, so I’m not concerned about paying that off right now. I have about $1,600 in savings, and my monthly expenses are about $3,000. I earn $89,000 a year.
What should I do with the $10,000 windfall, and what overall money management advice do you have?
Ric: First, ask yourself what would happen if you suddenly lost your income. You’d probably begin to build up heavy credit card debt again. Unforeseen events occur in every life. Your car could break down, you could have a major medical expense or what have you. That’s why having adequate cash reserves is crucial.
We usually recommend that you have enough in reserves to cover six months or more of expenses. For you, that’s at least $18,000, so put the $10,000 toward that and you’ll be more than halfway there. We might have suggested paying off the high-interest credit card debt first, but you’ve taken care of that with the zero-interest transfer.
Continue to pay down your student loans with regular monthly payments from your earned income. You’ll likely get promotions and raises over time, making the repayments easier.
Once you build up your cash reserves to cover six or 12 months of expenses, you could save for a house down payment, but that is probably going to be several years away, because a 20 percent down payment on a $600,000 house is $120,000. It will take you some time to accumulate that.
But don’t let that deflate you or lead you to assume that millennials like you will never own homes. It just takes time, and that’s how it has always been. Ask your father how old he was when he bought his first home. I’ll bet he wasn’t in his 20s — maybe not even in his 30s.
The notion that people in their 20s today should be able to afford expensive homes is ridiculous. Those who stretch to do so with little or nothing down wind up with high mortgage payments, hoping that their incomes will remain stable and their expenses won’t grow as they add children to the household. They set themselves up for pain and anguish, and that’s how financial strife leading to divorce can begin.
So don't be in a big hurry to own a house. That doesn’t mean, however, that you have to give up the idea of living in the house of your dreams. You don’t have to stay in a one bedroom or studio apartment in the basement of a building. You can enjoy a better lifestyle and live in a nice house, but just rent it. Don’t buy it right now.
Also, I suggest you and your father read the chapters about homeownership in my book The Truth About Money.
You’ll find a 10-question quiz there to help you determine when you’re ready to buy a house. Another chapter describes the Shared Equity Plan, in which your dad could help you buy a house not by giving or lending you money, but by participating with you in the purchase. He makes the down payment, and you make the monthly payments.
The two of you would own the property equally. When the house is sold, he gets his down payment back and half the profits; you get the other half and use it to buy your next house all by yourself. It can be a great deal for both of you.