Author Topic: prioritizing among low-interest debt  (Read 568 times)

egdebtfree

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prioritizing among low-interest debt
« on: November 24, 2017, 09:00:12 PM »
Hello!
I am in the middle of my goal to be debt-free before age 35 (I'll be 33 next month... two years to go!) I have no credit card debt, own my car outright, and have paid off my high-interest student debt. My highest-interest debt at the moment is a $95,000 consolidated student loan that I refinanced to 4.7% (DISCLAIMER: yes, this is HUGE debt-- I'm a health care professional... I graduated with $210k of student loan debt from undergrad and graduate schools, now down to $110k). My next highest-interest debt is $25,000 at 4.5% interest, which was from a home equity loan I took out when I uncovered significant water damage in my condo and insurance only covered half of the costs necessary to repair the work (and I did not want to liquidate a savings investment account that earns closer to 7-8% on average to fund the repairs).

So I write to the Mustachians out there to ask: do I continue to make extra payments on my highest-interest loan, or is it better to get the home equity loan paid off first? I earn too much income to qualify for any tax credits for student loan interest.

Thank you for your thoughts!

MDM

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Re: prioritizing among low-interest debt
« Reply #1 on: November 24, 2017, 09:37:05 PM »
...I did not want to liquidate a savings investment account that earns closer to 7-8% on average to fund the repairs.
If you expect that historical performance to continue, why pay faster on any ~4.6% loans?

Catbert

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Re: prioritizing among low-interest debt
« Reply #2 on: November 25, 2017, 09:20:28 AM »
The difference between 4.5% and 4.7% is negligible so I would work on the home equity loan.

Dicey

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Re: prioritizing among low-interest debt
« Reply #3 on: November 25, 2017, 09:42:40 AM »
Prioritize any loans that do not have fixed interest rates.
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Malkynn

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Re: prioritizing among low-interest debt
« Reply #4 on: November 25, 2017, 11:11:02 AM »
...I did not want to liquidate a savings investment account that earns closer to 7-8% on average to fund the repairs.
If you expect that historical performance to continue, why pay faster on any ~4.6% loans?

Because as medical professionals we often are self employed with little to no job security and high risk of losing income completely if we get ill or injured. Depending on how procedural the personís profession is, the risk can be astronomical. For my first 3 years, had I broken a finger or gotten a bad sprain, I would have been in serious financial trouble.

OP, if both are LOCs then it really doesnít matter because itís all movable money in the end.
My student loan is a loan, not an LOC, so I canít access any of it for cash flow if needed, and it has a repayment schedule, not just interest payments as a minimum payment.

So yeah, it really depends on what your risk is with your career (some medical professionals could still work if they lost an eye, an arm and a leg others like me canít work with a sprained finger) and how your student debt is structured (Revolving credit/LOC vs fixed repayment schedule).

Debt vs investment is always just a question of which pays more in the end. Risk tolerance is a significant factor as well, especially for certain careers.


MDM

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Re: prioritizing among low-interest debt
« Reply #5 on: November 25, 2017, 12:59:38 PM »
...I did not want to liquidate a savings investment account that earns closer to 7-8% on average to fund the repairs.
If you expect that historical performance to continue, why pay faster on any ~4.6% loans?
Because as medical professionals we often are self employed with little to no job security and high risk of losing income completely if we get ill or injured.
...
Debt vs investment is always just a question of which pays more in the end. Risk tolerance is a significant factor as well, especially for certain careers.
If one expects returns in liquid investments to exceed the interest rate on debt, and is also concerned about loss of income, that is even more reason to invest instead of draining available funds to pay towards debt.

Of course, if one makes the assumption that the investment return will be lower than the interest rate, that favors debt payment.  But if one is simultaneously concerned about liquidity, it doesn't make as much sense to pay on the debt - unless the debt can be completely paid and the remaining liquid assets are sufficiently large for comfort.

Malkynn

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Re: prioritizing among low-interest debt
« Reply #6 on: December 05, 2017, 09:09:36 AM »
...I did not want to liquidate a savings investment account that earns closer to 7-8% on average to fund the repairs.
If you expect that historical performance to continue, why pay faster on any ~4.6% loans?
Because as medical professionals we often are self employed with little to no job security and high risk of losing income completely if we get ill or injured.
...
Debt vs investment is always just a question of which pays more in the end. Risk tolerance is a significant factor as well, especially for certain careers.
If one expects returns in liquid investments to exceed the interest rate on debt, and is also concerned about loss of income, that is even more reason to invest instead of draining available funds to pay towards debt.

Of course, if one makes the assumption that the investment return will be lower than the interest rate, that favors debt payment.  But if one is simultaneously concerned about liquidity, it doesn't make as much sense to pay on the debt - unless the debt can be completely paid and the remaining liquid assets are sufficiently large for comfort.

I donít disagree with you and I see that my post could be misleading.
If the student debt is a loan, not an LOC, then it makes sense not to make additional payments unless you have enough to pay off the entire thing, because yes, that would negatively affect cash flow in the short term.
That doesnít mean that someone canít prioritize paying off that loan as quickly as possible though.
I personally wonít make an additional payment onto my student debt until Iíve saved enough to pay off the entire amount, which will take about two years because itís a top priority for me.
Not having a ~3K/mo payment hanging over my head will be very nice.

The reason itís riskier for me to invest instead is because I prioritize investing in tax deferring accounts, which I canít just take money out of if Iím in a cash flow crunch. The penalties are massive, so thatís not really liquid at all, but gives the best return by far because my tax rate now is substantially higher than it will be in retirement. (Iím in Canada, I donít know how tax deferred accounts work in the US, but they really arenít liquid here).

If more liquid investments made sense, then yes, I would have to look at everything differently, but as it is, my debt isnít revolving and my investments arenít liquid, so cash flow is a concern for the next two years and then Iím golden. Until then, I keep an empty LOC as an emergency fund.





ChpBstrd

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Re: prioritizing among low-interest debt
« Reply #7 on: December 05, 2017, 11:59:56 AM »
Mathematically, you should retire the highest-interest debt first. But let's consider some other ideas first:

1) Do you have enough home equity to potentially get a loan at an even lower interest rate? If you could consolidate one or both of these loans as a 2nd mortgage and reduce the interest rate, that would probably be the way to go, especially if your credit is good and you can get a low rate. Then make the minimum payments and invest like mad.

2) Depending on your level of risk aversion, there are investments that yield just over your loan rates. Examples: The preferred stock exchange traded fund PFF yields 5.75%, and is less volatile than the stock market. The Vanguard REIT fund VNQ yields 4.8%. You can find closed-ended funds on cefconnect.com that use leverage and discounts to squeeze higher yields out of bonds, such as BBN (taxable muni bonds) which yields 6.59%, or PCN (corporate bonds) which yields 8.88%. All of these are risk arbitration moves - you're borrowing and investing in something riskier than your loan. However, chances are good that you'd come out ahead by investing as much as possible in a portfolio such as this and making the minimum loan payments. Be warned that this strategy will feel like a loser if there is a correction. 

Neither of these options meets your stated goal of being debt-free in 2 years, but I bet either one puts you ahead in terms of net worth. Be careful what you wish for. Two + years spent earning four percent and some change might not be the fastest way to FIRE.

frugaliknowit

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Re: prioritizing among low-interest debt
« Reply #8 on: December 05, 2017, 02:04:20 PM »
You don't mention whether you have an EF.  I probably would want one.  Beyond that, I would:

1.  Liquidate the investment account (maybe some of it for EF).  Expected return 7% versus debt of 5%:  Blah!  Bad risk management (~7% before tax versus ~5% after tax), pay off ~5% debt.
2.  Pay any floating rate debt first (heloc?).
3.  Then pay highest rate first. 

Kill the debt, and kill it quick!

boarder42

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Re: prioritizing among low-interest debt
« Reply #9 on: December 05, 2017, 02:10:32 PM »
You don't mention whether you have an EF.  I probably would want one.  Beyond that, I would:

1.  Liquidate the investment account (maybe some of it for EF).  Expected return 7% versus debt of 5%:  Blah!  Bad risk management (~7% before tax versus ~5% after tax), pay off ~5% debt.
2.  Pay any floating rate debt first (heloc?).
3.  Then pay highest rate first. 

Kill the debt, and kill it quick!

its ~10% vs 4.75% fixed - almost double.
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bognish

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Re: prioritizing among low-interest debt
« Reply #10 on: December 07, 2017, 11:31:08 AM »
I personally did not consider prepaying any debt until I had 5 years expenses in emergency funds to taxable investment accounts. My rational was that if I had a prolonged job loss I could make debt payments out of investments, but I would not be able to miss debt payments because I had prepaid principle. My debt was pretty low interest too, not credit card rates. So I would suggest putting excess cash into an investment account. Once you have saved enough to lump sum pay off the 2 loans you can reevaluate your decision to be debt free.