Ask LH: Should We Pay Off Our Other Debts Before Saving A House Deposit?

Dear Lifehacker, My fiancé and I recently moved back with our parents to save money for a house. We currently have a car on finance, and a personal loan for wedding deposits. My parents are advising us to pay off our loan FIRST before even looking at a house, however my fiancé’s parents are simply advising us to save up a deposit for a mortgage and then roll the loan into that mortgage so it's only one payment. Thanks, Lil Aussie Battler.

Dear AB,

This is actually a more complex situation than it seems, with a lot of factors based on your specific financial situation, location and the numbers involved.

That said, we have some general advice on the pros and cons of each options, but you are best to speak to a financial adviser before making any decisions.

That car finance and personal loan is costing you money in interest, which can add up to a significant amount over time. In terms of pure savings, it’s best to pay off the loans as quickly as possible, then save a deposit. Make sure to pay off the loan with the highest interest rate first. This reduces the overall amount of money spent on interest, and will give a bigger deposit over time.

The flip side is that by not paying off the other loans, you can save that house deposit sooner. It will cost more overall, but spread out over a longer time period.

This is important as there is a potential cost to not buying a house sooner, rather than later. In a rising property market, waiting longer to buy a house can mean it will end up costing more overall than buying earlier. Of course, depending where you live, prices may not increase much while you save.

One downside is that having a personal loan and car finance will impact your borrowing capacity. The bank will take the car fiance and personal loan repayments into account and offer you less than if you had no loans at all. Of course, if the bank will still lend you enough to buy your property of choice, this is not a problem.

As your fiancé's parents have mentioned, another potential benefit to not paying off the loans first is that you may be able to roll them into your mortgage. This is called debt consolidation, and the benefit is not that it makes for a single payment, but that you can often reduce the amount of interest you pay overall.

Say your car and person loans have a 10% interest rate (this is an example only), while your mortgage is only 5%. By paying off the 10% interest loans with money from the mortgage, you halve the amount of interest payable. Over time, this can quickly add up and save decent amounts of money.

The are a few caveats though. Some car and personal loans have penalties for early repayments. You need to take these into consideration when crunching the numbers on what options saves the most money.

It’s also very important to consider how your consolidated debts are structured, and how you plan to pay them off. If you only make the minimum repayments, consolidation of debts can actually cost more in interest over the life of the loan.

This is because while that 10% interest on a personal loan is higher than the 5% of a mortgage, the personal loan might have a loan period of 5 years, versus the 30 for a mortgage.

By paying the loan over at a reduced interest rate over a longer period, the minimum payments are reduced, and you have more useable cash flow. But to actually save interest, you need to pay off the consolidated loan faster than the minimum repayments.

For example, if you keep paying the same higher 10% loan repayments after consolidating it into the 5% mortgage, then you will pay less interest overall. If you just pay the minimum amount, the amount of interest over 30 years might be more than what would have been payable on the original loans.

Another factor to consider is that not all banks will allow you to consolidate your loans, and even if they do, they may charge more interest than if the loans are not consolidated.

In the end, the potential options are a mess of calculations based on your specific financial situation.

That said, rolling the loans into a mortgage can be a very useful way to save some money, and is well worth considering. Just speak to a financial adviser about your exact situation before making any decisions.


Do you have multiple loans or a mortgage? Tell us about your financial choices in the comments.

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Comments

    Something else to consider is that those existing loans act as a sort of character reference. By showing good diligence with them, you're showing the banks your ability to service the loans accordingly, which does matter.

    What I'd suggest is that you talk to the bank and see what they are willing to do. They might be happy to fold the existing loans in immediately, or they might suggest paying one off before the other and coming back, or something like that.

    For me, I went into a mortgage owing as little as possible. I think I had a redraw on a line of credit (technically wasn't considered a loan...) and that was it. It simplified my position to the point I just had to worry about that single (fortnightly - on payday) payment to the bank, plus living expenses.

    It simplified things so much I got preapproved in a matter of hours, and final approval when I eventually bought took 24 hours.

    Another factor to consider is that not all banks will allow you to consolidate your loans, and even if they do, they may charge more interest than if the loans are not consolidated.

    This is a very important point. I bought a house a few years back and effectively the only thing they'd do was give me money for the house (checked with all the big four). One bank said no problem we can consolidate because the capital will be high enough, but literally the day before signing with them for the loan they backflipped. Needless to say I didn't go through with them.

    For the people asking the question, first thing you should do is figure out how much "spare" money you can accumulate each payday so you can work out how long it'd take to reach a deposit amount. Assuming your balance is zero at the moment then it's going to take that many weeks before you'll be able to get a loan. Let's call that date "X"

    Then work out how much you're paying each payday to your existing debts and work out how long it'd take to pay them off using that "spare" money. If you pour all your spare cash into them you're typically reducing the interest and the amount of time it'll take to pay them off. Which means once they're gone the amount of "spare" money increases. So lets call the debt clearing date "Y".

    You can then work out how long it'll take to save a deposit based on the higher amount of "spare" money you're saving. Lets call the date you reach the deposit that way "Z".

    If "Z" is earlier than "X" it's a no brainer. You're going to be in your house quicker and you'll be decreasing the amount of interest you pay by paying off your debts before saving the deposit. If it's not then it gets a bit hazier.

    If "Y" is quite a bit earlier than "X" I'd still pay off the debts first then save for the deposit since you're minimizing interest and (probably) not pushing your home purchase date back that much. Conversely if "X" is earlier (or around the same time) I'd talk to the bank about consolidating and if they agree then go that way.

    And of course maybe the biggest question should be, can you bear living with parents in the meantime?

    The tl;dr is always pay off loans with the highest interest first.

    A mortgage is (usually) the cheapest way to borrow money and a smart way to pay off other loans. Many lenders have even lower "package" or "preference" rates available if you bank with them. The natural extension is to then run an offset account for all daily use/income.

    Other loans may have penalties for getting our early, but savings from the lower mortgage interest may still wind up better value in the longer term. And this may still apply even if mortgage insurance is applied.

    Last edited 14/06/16 4:48 pm

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