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Learning, Sharing, and Teaching => Ask a Mustachian => Topic started by: reader2580 on November 13, 2015, 03:09:10 PM

Title: Pay off under 5% debt or save the money?
Post by: reader2580 on November 13, 2015, 03:09:10 PM
I just saw a post here that recommended only immediately paying off debt that is over 5% or 6% interest.  All my debt is under 5% interest, but I was still thinking I should put every penny to paying it off.  The post recommended instead putting money to 401K and emergency fund over paying off low interest debt.

Do readers recommend debt payoff or savings instead?
Title: Re: Pay off under 5% debt or save the money?
Post by: Goldielocks on November 13, 2015, 03:25:41 PM
If you can get over 5% (after tax) in an account that is  not locked in until you are 59.5 yrs old...    save it / invest it..

 If your returns dip, or you have another life changing opportunity, then you have the money ready to deploy to the debt or otherwise.


OR,

If your cash flow is very tight, then you need to pay off some of the debt to give you buffer / wiggle room.

Title: Re: Pay off under 5% debt or save the money?
Post by: MDM on November 13, 2015, 04:52:08 PM
I just saw a post here that recommended only immediately paying off debt that is over 5% or 6% interest.  All my debt is under 5% interest, but I was still thinking I should put every penny to paying it off.  The post recommended instead putting money to 401K and emergency fund over paying off low interest debt.

Do readers recommend debt payoff or savings instead?

In the lists below, thinking "first your 457 (if you have one), then your 401k and/or 403b" wherever "401k" appears is likely correct.   
Differences of a few tenths of a percent are not important when applicable for only a few years (in other words, these are guidelines not rules).   
   
WHAT   
0. Establish an emergency fund to your satisfaction   
1. Contribute to 401k up to any company match   
2. Pay off any debts with interest rates ~5% or more above the 10-year Treasury note yield.   
3. Max HSA    
4. Max Traditional IRA or Roth (or backdoor Roth) based on income level   
5. Max 401k (if 401k fees are lower than available in an IRA, or if you need the 401k deduction to be eligible for a tIRA, swap #4 and #5)   
6. Fund mega backdoor Roth if applicable   
7. Pay off any debts with interest rates ~3% or more above the 10-year Treasury note yield.   
8. Invest in a taxable account with any extra.   
   
WHY   
0. Give yourself at least enough buffer to avoid worries about bouncing checks   
1. Company match rates are likely the highest percent return you can get on your money   
2. When the guaranteed return is this high, take it.   
3. HSA funds are totally tax free when used for medical expenses, making the HSA better than either traditional or Roth IRAs.   
4. Rule of thumb: traditional if current marginal rate is 25% or higher; Roth if 10% or lower; flip a coin in between (or see   
   http://forum.mrmoneymustache.com/investor-alley/deciding-between-roth-and-traditional-ira-based-on-marginal-tax-rate/
   if you want even more details on that topic.)
5. See #4 for choice of traditional or Roth for 401k   
6. Applicability depends on the rules for the specific 401k   
7. Again, take the risk-free return if high enough   
8. Because earnings, even if taxed, are beneficial   
   
The emergency fund is your "no risk" money.  You might consider one of these online banks: http://www.magnifymoney.com/blog/earning-interest/best-online-savings-accounts275921001   
      
If your 401k options are poor (i.e., high fund fees) you can check http://forum.mrmoneymustache.com/investor-alley/to-401k-or-not-to-401k-that-is-the-question-43459/ for some thoughts on "how high is too high?"   

See http://pages.stern.nyu.edu/~adamodar/New_Home_Page/datafile/histretSP.html for some data on historical returns.
Title: Re: Pay off under 5% debt or save the money?
Post by: reader2580 on November 13, 2015, 08:10:54 PM
My cash flow is pretty good.  I have $500 to $600 a month left after all is said and done.  This is after making automatic deposits to savings and 10% to 401k.  My checking account fluctuates between $3000 and $7000 depending on what is going on in my life.  I have a side gig in the warmer months that brings in extra cash.  I haven't bounced a check or anything like that in close to 20 years I figure.  I end up spending that extra $500 a month on mostly silly things and sometimes on medical bills for my 20% co-pay.  I don't necessarily buy stuff like electronics or anything like that.  Most of it is very practical spending, but now I realize paying down debt or savings is more important.

MDM posted the article I had read where I realized maybe debt repayment at all costs is not necessary based on my debt being under 5%.
Title: Re: Pay off under 5% debt or save the money?
Post by: davef on December 08, 2015, 03:56:55 PM
Great List MDM.
Where does variable interest fall in your scale.
I have maxed out 0-4 I have 3.125 Home loan that's a 5:1 ARM. In four more years it could go up by as much as 2%
This year I put a lot of money in a taxable investment account. I want to be able to pay off my home debt in 4 years if the rate spikes. Since it only returned a couple percent however, I find myself wishing I had I had paid down that home debt instead.
Title: Re: Pay off under 5% debt or save the money?
Post by: MDM on December 11, 2015, 12:10:15 PM
Great List MDM.
Where does variable interest fall in your scale.
I have maxed out 0-4 I have 3.125 Home loan that's a 5:1 ARM. In four more years it could go up by as much as 2%
This year I put a lot of money in a taxable investment account. I want to be able to pay off my home debt in 4 years if the rate spikes. Since it only returned a couple percent however, I find myself wishing I had I had paid down that home debt instead.
If anyone's crystal ball is better than mine, it's a great idea to put your money where one knows the best future returns will be.

Lacking such foreknowledge, the best we can do is look at the current conditions we do know and our best guess at the future.  Sometimes those guesses will be correct and sometimes not.  We all see things perfectly clearly through our hindsight glasses.