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by Christy Bieber
October 24, 2017
by Christy Bieber
October 24, 2017
The best way to be effective at managing your money is to have clear goals, to prioritize them, and to take action to achieve them. If you're trying to do too many things at once, it can be overwhelming and important financial accomplishments could be harder to achieve. Setting your money priorities the wrong way could also make it more difficult to build your net worth and to make sure you're ultimately a financial success.
While everyone's personal situation dictates what steps they should take to get their financial life in order, there are three key money goals most people should have: buying a house, paying off student loans, and saving for retirement. But which should you do first and how should you allocate your cash? Here are a few suggestions for prioritizing your efforts.
1. Retirement comes first
The single most important goal you need to work toward throughout your entire career is saving for retirement. Today, most seniors are largely on their own when it comes to being financially secure as a senior. Defined benefit pensions, where employers provide guaranteed income, are rare and available to few private sector workers. The future of Social Security is uncertain, and you cannot comfortably live on Social Security benefits alone, even if benefits continue to be paid at current levels.
If you don't save, you're almost sure to live your senior years in poverty -- especially as working longer is not always an option because you may be unable to find a job when you are older or your health may prevent you from working. While you can always rent if necessary, and you can always put your student loans into deferment or forbearance if you cannot pay, you may not have any time or options if you've reached your 60s, have little money, and cannot work anymore.
If you do not start saving for retirement early on in your career, you will need to save far more to achieve the same retirement goals. If you save too little by setting aside too small of a portion of your income, you will be likely to run out of money during retirement. Almost half of all seniors are living paycheck to paycheck, and many older people are woefully unprepared to cover high medical costs they could incur during retirement. You cannot let this happen to you, so you should prioritize retirement savings as your primary goal as soon as you begin working.
Make a plan to save a sufficient amount for retirement, automate your investing and don't adjust your contributions downward or raid your retirement funds throughout your entire career-- only then should you move on to other financial goals.
2. Saving for a house is second
Once you've got your retirement savings working on autopilot, saving for a home may be a smart next step. Since you have to live someplace while paying off student loans, you're often better off living in a home you own, so you can benefit from real estate appreciation, tax breaks for mortgage interest if you itemize, and monthly payments that go toward enhancing your net worth rather than just providing a roof over your head.
Before you decide to prioritize saving for a home over aggressive student loan payoff, consider whether home ownership makes sense now or in the near future. Evaluate rental prices versus costs of ownership in your area, and consider opportunity costs of making a big down payment in locales with expensive housing. Home prices have historically produced a lower return on investment than the stock market, so sinking a fortune into a down payment may not make sense if you could rent for less than the cost to own and invest the difference.
For many, however, homeownership is a path to prosperity, as homeowners have significantly higher net worths than renters. If you do want to buy a home, you're planning to stay put, and housing prices are reasonable, it makes sense to prioritize saving for a home over aggressive student loan repayment -- especially since it takes millennials around 4.2 years to save for a house, while Generation Xers take only around 2.6 years.
Buying a home as soon as you can also allow you to begin paying down your mortgage so you'll have a paid-for place to live during retirement. Housing is the biggest expense for most seniors, and buying a home as early as possible means you'll maximize the chances of being able to pay off your house before you leave the workforce for good.
Determine how much you'll need for a down payment for an affordable house, create a timeline for home ownership, and allocate your extra cash toward a fund that will allow you to put 20% down on a home. Then, with any additional cash you've got left over after your retirement savings is taken care of and your home savings account is funded, you can focus on aggressively repaying student loans.
3. Repaying your student loans is third
Paying off student loans is another key financial milestone you'll need to achieve if you want to become financially secure. You should begin paying the minimum payment on student loans as soon as possible, as putting loans into deferment or forbearance does not necessarily mean that interest stops accruing on your loans. But, devoting extra cash to repaying your student loans faster can wait until after you have accomplished your other financial goals, like saving for retirement and saving for a home.
Accelerating student loan repayments is usually a lower priority for a number of reasons, including the fact student loan interest is usually tax-deductible. You can also opt for income contingent repayment plans on student loans, which gives you more flexibility in how your loans are paid back, and you could become eligible for loan forgiveness if you work in certain public service jobs.
There is an exception if your student loan payments push your debt-to-income ratio above allowable levels to buy a home. Mortgage lenders typically won't lend to you if your total debt payments -- including your mortgage and student loans -- exceed 43% of your income. If student loans push your debts above this level, you'll need to either prioritize student loan repayment until your balance is low enough you're not disqualified from a mortgage, or you'll need to buy a less expensive home to keep your ratio below the max.
Outside of this exception, paying those loans off early so you can become debt free is still an important goal but you have your whole life to pay them off. If you wait to save for retirement or buy a home, you lose years of time that could be spent building wealth from investment returns, home equity, and real estate appreciation.