Should I Pay Off my Debt or Save Up for a Down Payment on a House?

(May 1st, 2007)

debt consolidation questionDear 3DebtConsolidation.com:

My spouse and myself are working very hard to pay off our current credit card debt by atleast 80% and then build up a good solid down payment for the purchase of our first home. We currently owe over $25,000 in credit card debt, student loans and auto loan debt. My question to you is, should we focus on paying off this big debt first before buying our house, or should we just make the minimum monthly payments on the debt and build up a larger down payment? Currently, we have saved up about $25,000 for the down payment on our house. The house we plan to purchase is valued at $275,000. I want to avoid having to pay Private Mortgage Insurance and build up a down payment of atleast 20% (which is equal to $275,000 x 20% = $55,000).

Dear Mindy:

You have to balance out between saving for the initial mortgage down payment and paying off your $25,000 debt. You should probably focus on paying off the $25,000 debt as soon as possible, before purchasing a home. For example, consider your following situation:

You and your spouse have an after-tax monthly take home pay of $5000. After paying off all the necessary expenses every month (including rent, groceries, utilities, student loan payments, car loan payments, entertainment expenses, etc), you have $1000 to save. Take a 5 year time horizon:

Scenario i) We assume you are paying 14% Annual Percentage Rate (APR) interest charge on your $25000 debt. Here is the amortization schedule assuming a fixed payment schedule. Your payment towards your debt is $625 / month and your savings every month equal $1000 - $625 = $375.

Month Payment Interest
Paid
Principal
Paid
Remaining
Balance
Monthly Savings
1 $625.00 $291.68 $333.33 $24,666.68 $375
2 $625.00 $287.79 $337.21 $24,329.46 $375
3 $625.00 $283.85 $341.15 $23,988.31 $375
4 $625.00 $279.87 $345.13 $23,643.18 $375
5 $625.00 $275.85 $349.15 $23,294.03 $375
6 $625.00 $271.77 $353.23 $22,940.80 $375
7 $625.00 $267.65 $357.35 $22,583.45 $375
8 $625.00 $263.48 $361.52 $22,221.93 $375
9 $625.00 $259.26 $365.74 $21,856.20 $375
10 $625.00 $255.00 $370.00 $21,486.19 $375
11 $625.00 $250.68 $374.32 $21,111.87 $375
12 $625.00 $246.31 $378.69 $20,733.18 $375
13 $625.00 $241.89 $383.11 $20,350.08 $375
14 $625.00 $237.42 $387.58 $19,962.50 $375
15 $625.00 $232.90 $392.10 $19,570.40 $375
16 $625.00 $228.33 $396.67 $19,173.73 $375
17 $625.00 $223.70 $401.30 $18,772.43 $375
18 $625.00 $219.02 $405.98 $18,366.45 $375
19 $625.00 $214.28 $410.72 $17,955.73 $375
20 $625.00 $209.49 $415.51 $17,540.22 $375
21 $625.00 $204.64 $420.36 $17,119.86 $375
22 $625.00 $199.74 $425.26 $16,694.60 $375
23 $625.00 $194.78 $430.22 $16,264.38 $375
24 $625.00 $189.76 $435.24 $15,829.13 $375
25 $625.00 $184.68 $440.32 $15,388.81 $375
26 $625.00 $179.54 $445.46 $14,943.35 $375
27 $625.00 $174.34 $450.66 $14,492.70 $375
28 $625.00 $169.09 $455.91 $14,036.78 $375
29 $625.00 $163.77 $461.23 $13,575.55 $375
30 $625.00 $158.39 $466.61 $13,108.94 $375
31 $625.00 $152.94 $472.06 $12,636.88 $375
32 $625.00 $147.43 $477.57 $12,159.31 $375
33 $625.00 $141.86 $483.14 $11,676.18 $375
34 $625.00 $136.23 $488.77 $11,187.40 $375
35 $625.00 $130.52 $494.48 $10,692.92 $375
36 $625.00 $124.75 $500.25 $10,192.68 $375
37 $625.00 $118.92 $506.08 $9,686.60 $375
38 $625.00 $113.01 $511.99 $9,174.61 $375
39 $625.00 $107.04 $517.96 $8,656.65 $375
40 $625.00 $101.00 $524.00 $8,132.65 $375
41 $625.00 $94.88 $530.12 $7,602.53 $375
42 $625.00 $88.70 $536.30 $7,066.23 $375
43 $625.00 $82.44 $542.56 $6,523.67 $375
44 $625.00 $76.11 $548.89 $5,974.78 $375
45 $625.00 $69.71 $555.29 $5,419.49 $375
46 $625.00 $63.23 $561.77 $4,857.72 $375
47 $625.00 $56.68 $568.32 $4,289.40 $375
48 $625.00 $50.04 $574.96 $3,714.44 $375
49 $625.00 $43.34 $581.66 $3,132.78 $375
50 $625.00 $36.55 $588.45 $2,544.33 $375
51 $625.00 $29.68 $595.32 $1,949.01 $375
52 $625.00 $22.74 $602.26 $1,346.75 $375
53 $625.00 $15.71 $609.29 $737.46 $375
54 $625.00 $8.60 $616.40 $121.07 $375
55 $122.48 $1.41 $121.07 $0.00 $375
Totals: $33,872.48 $8,872.48     $20,625

The result? In 55 months (approximately 4.5 years), you will have fully paid off your $25,000 debt and would have $20,625 saved up. This is not too bad considering you are saving only $1000 per month.

Scenario ii) We will assume you are paying 14% Annual Percentage Rate (APR) interest charge on your $25000 debt. Here is the amortization schedule assuming a fixed payment schedule. Your payment towards your debt is $1000 / month and your savings every month equal $1000 - $1000 = $0.

Month Payment Interest
Paid
Principal
Paid
Remaining
Balance
Monthly Savings
1 $1,000.00 $291.68 $708.33 $24,291.68 $0
2 $1,000.00 $283.41 $716.59 $23,575.09 $0
3 $1,000.00 $275.05 $724.95 $22,850.14 $0
4 $1,000.00 $266.59 $733.41 $22,116.73 $0
5 $1,000.00 $258.04 $741.96 $21,374.76 $0
6 $1,000.00 $249.38 $750.62 $20,624.14 $0
7 $1,000.00 $240.62 $759.38 $19,864.77 $0
8 $1,000.00 $231.76 $768.24 $19,096.53 $0
9 $1,000.00 $222.80 $777.20 $18,319.33 $0
10 $1,000.00 $213.73 $786.27 $17,533.06 $0
11 $1,000.00 $204.56 $795.44 $16,737.62 $0
12 $1,000.00 $195.28 $804.72 $15,932.90 $0
13 $1,000.00 $185.89 $814.11 $15,118.78 $0
14 $1,000.00 $176.39 $823.61 $14,295.18 $0
15 $1,000.00 $166.78 $833.22 $13,461.96 $0
16 $1,000.00 $157.06 $842.94 $12,619.02 $0
17 $1,000.00 $147.23 $852.77 $11,766.24 $0
18 $1,000.00 $137.28 $862.72 $10,903.52 $0
19 $1,000.00 $127.21 $872.79 $10,030.73 $0
20 $1,000.00 $117.03 $882.97 $9,147.76 $0
21 $1,000.00 $106.73 $893.27 $8,254.49 $0
22 $1,000.00 $96.31 $903.69 $7,350.79 $0
23 $1,000.00 $85.76 $914.24 $6,436.55 $0
24 $1,000.00 $75.10 $924.90 $5,511.65 $0
25 $1,000.00 $64.30 $935.70 $4,575.95 $0
26 $1,000.00 $53.39 $946.61 $3,629.34 $0
27 $1,000.00 $42.34 $957.66 $2,671.68 $0
28 $1,000.00 $31.17 $968.83 $1,702.86 $0
29 $1,000.00 $19.87 $980.13 $722.72 $0
30 $731.15 $8.43 $722.72 $0.00 $0
31 $0 $0 $0 $0 $1000
32 $0 $0 $0 $0 $1000
33 $0 $0 $0 $0 $1000
34 $0 $0 $0 $0 $1000
35 $0 $0 $0 $0 $1000
36 $0 $0 $0 $0 $1000
37 $0 $0 $0 $0 $1000
38 $0 $0 $0 $0 $1000
39 $0 $0 $0 $0 $1000
40 $0 $0 $0 $0 $1000
41 $0 $0 $0 $0 $1000
42 $0 $0 $0 $0 $1000
43 $0 $0 $0 $0 $1000
44 $0 $0 $0 $0 $1000
45 $0 $0 $0 $0 $1000
46 $0 $0 $0 $0 $1000
47 $0 $0 $0 $0 $1000
48 $0 $0 $0 $0 $1000
49 $0 $0 $0 $0 $1000
50 $0 $0 $0 $0 $1000
51 $0 $0 $0 $0 $1000
52 $0 $0 $0 $0 $1000
53 $0 $0 $0 $0 $1000
54 $0 $0 $0 $0 $1000
55 $0 $0 $0 $0 $1000
Totlas: $29,731.15 $4,731.15     $25,000

The result? In 55 months (approximately 4.5 years), you will have fully paid off your $25,000 debt and would have $25,000 saved up. This is MUCH better than the $20,625 you saved up in Scenario #1. Furthermore, you will have paid a lot less interest in Scenario #2 ($4,731.15) as opposed to paying $8,872.4 in interest charges in Scenario #2.

So Mindy, in your situation, I would recommend you allocate the whole $1000 savings every month to pay off your $25,000 debt in a 30 months period. After that, you can save the entire $1000 per month and not have any debt to pay off. Ofcourse we do not factor in things such as cost of living increases, loss of job, etc into this equation, but this should give you a good idea.