Author Topic: WWYD: Lots of low interest debt  (Read 1273 times)

dleavitt

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WWYD: Lots of low interest debt
« on: March 06, 2017, 11:57:06 AM »
My wife and I have recently renewed our financial focus, but have a little bit of disagreement as to our priorities.  First, I'll set the stage with the pertinent facts:

Debt in question:
$21k student loan (4.25% variable)
$24k student loan (4.25% variable)
$22k HELOC (used to refinance more student loans, 4.15% variable)

All interest paid is currently tax deductible.

Over and above minimum payments, we have roughly $1300 a month we can put towards debt after our planned spending.

All of the remaining student debt is from my wife's education.  She is the only person in the history of her family to earn a degree, the only one to not declare bankruptcy (save for a younger sister), and therefore did not know/think of the financial ramifications of her school choices.  Over the past 5 years we have paid off $60k of her total debt, plus the $25k from my schooling. 

She feels responsible for holding our family back financially, and is fixated on eliminating her debt.  I, on the other hand, look at those interest rates (effectively ~3% given the tax bracket we land in) and think it might be better to get going on retirement savings, which has hitherto been limited to maxing my HSA and employer contributions.  In such a scenario we would contribute to Roth IRAs first for penalty-free access to our contributions should the need arise.

Given the above, what would you do?

BobTheBuilder

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Re: WWYD: Lots of low interest debt
« Reply #1 on: March 06, 2017, 12:16:33 PM »
Maybe you could compromise: Pay off the $21k as the smallest loan, so you have one item crossed off your to-do list and earn the risk free 3% net interest. In 16 months or less you have more free cash flow to look at! Personally I like having fewer contracts meaning less stuff to worry about. Your wife and you could enjoy this achievement and subsequently re-focus on investing knowing you already diversified by killing one loan early

Bracken_Joy

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Re: WWYD: Lots of low interest debt
« Reply #2 on: March 06, 2017, 12:20:11 PM »
The variable rate thing is the snag there. If it were fixed, I would no question let it ride (which we are in fact doing with the remaining ~$24k of my student loans). Personally, I wouldn't sleep as well with variable rate loans around, so I would work to pay them off. BUT only after meeting any employer matches- ie, for me, that is 6% into my 401k.
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dleavitt

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Re: WWYD: Lots of low interest debt
« Reply #3 on: March 06, 2017, 12:23:53 PM »
Maybe you could compromise: Pay off the $21k as the smallest loan, so you have one item crossed off your to-do list and earn the risk free 3% net interest. In 16 months or less you have more free cash flow to look at! Personally I like having fewer contracts meaning less stuff to worry about. Your wife and you could enjoy this achievement and subsequently re-focus on investing knowing you already diversified by killing one loan early

That's one compromise I considered.  Going that route I'd probably pay off the HELOC first, as the minimum payment is determined by the ending balance so we'd get a cash flow "bonus" every month.

moonpalace

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Re: WWYD: Lots of low interest debt
« Reply #4 on: March 06, 2017, 12:29:14 PM »
If those were fixed rates I'd say it's a no-brainer to just pay minimums and focus on retirement savings. That's what I'm doing with my $69k student loans @ <3.8% fixed. And $283k mortgage @ 2.75% fixed.

It's probably still mathematically optimal to let your loans ride, but there's some risk to that approach with the variable rates.

So it seems like a compromise strategy might be both (a) easier for the relationship, and (b) financially reasonable. :-)

BobTheBuilder

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Re: WWYD: Lots of low interest debt
« Reply #5 on: March 06, 2017, 12:30:26 PM »

That's one compromise I considered.  Going that route I'd probably pay off the HELOC first, as the minimum payment is determined by the ending balance so we'd get a cash flow "bonus" every month.

Aah I see, seems to be the smartest choice! And Bracken_Joy has a point, the variable interest on your loans is most likely to rise in the coming Fed Rate cycle

merula

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Re: WWYD: Lots of low interest debt
« Reply #6 on: March 06, 2017, 12:30:47 PM »
I'd do some math, if I were you. If you put $1,300/month towards that debt, it should take you roughly 6 years to pay it off. (Check me on that one; also check to make sure there's no prepayment penalty.)

What do your finances look like in 10 years if you pay off the debt first and then invest? What do they look like if you invest now while paying the minimums on the debt? What do they look like if you split Roth contributions and extra debt payments 50/50?

You may also want to check yourself on the tax benefits. My math is saying that your total interest payments are <$3,000/year. MFJ standard deduction is $12,700 for 2017. Unless you have more than $12,7000 in state tax, property tax, mortgage interest and charitable giving, your interest payments on this debt are NOT fully "tax deductible" because in the absence of those payments, you'd claim the standard deduction.

For example, let's say your tax deductible expenses are $3,000 in state tax, $2,000 in real estate taxes, $4,000 in mortgage interest and $1,000 in charitable giving, totally $10,000. Now you add in the $3,000 in student loan interest. $13,000. You itemize because $13,000 > $12,7000. But if you paid all that debt off, your deductible expenses become $10,000. You would claim the standard deduction, which only lowers your taxable income by $300 compared to having the debt. The amount of interest that's EFFECTIVELY tax deductible is only $300.

Another consideration is that ALL of that debt is variable interest rates. You can probably assume we're at an interest rate floor right now, and if you're planning to stretch the debt payment out for a decade or more, you will need to account for an interest rate increase. 

dleavitt

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Re: WWYD: Lots of low interest debt
« Reply #7 on: March 06, 2017, 12:31:13 PM »
The variable rate thing is the snag there. If it were fixed, I would no question let it ride (which we are in fact doing with the remaining ~$24k of my student loans). Personally, I wouldn't sleep as well with variable rate loans around, so I would work to pay them off. BUT only after meeting any employer matches- ie, for me, that is 6% into my 401k.

I know exactly what you are talking about!  We've looked into refinancing at a fixed rate a couple times, but even places like Sofi and Credible were giving her rates in the 7-9% range.  Her credit is in the mid 700s, so they must have had issue with her debt to income or something.

One of the users here (MDM I believe) has a post regarding investment/payoff priorities that gets referenced here pretty often, with "high" interest being defined by 5% points above the treasury rates.  Since the interest rates on the loans should correlate pretty closely with changes to treasury rates, I'd anticipate these loans staying in the "let them ride" range regardless of rate changes.

Bracken_Joy

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Re: WWYD: Lots of low interest debt
« Reply #8 on: March 06, 2017, 12:38:56 PM »
I don't have experience with consolidating debt, but do you have better credit? Can you see about consolidating the loans with your credit being the one checked? I mean, if you're married, these loans are impacting both of you (as evidenced by your post, lol).

And as for the payoff priorities, part of it depends on your level of comfort. Personally, I decided to pay off anything 5% and above. You'll see than number vary person to person, depending on their expectations for investment returns, inflation, etc.
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rugorak

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Re: WWYD: Lots of low interest debt
« Reply #9 on: March 06, 2017, 12:40:51 PM »
This is one of those things were the math is probably less of the issue and more of personal preference. Obviously all of those debts have potential pitfalls. You cannot discharge student loans in bankruptcy (not that you want to) and the HELOC is basically against your home. On the flip side the interest is lower so you could potentially do better. And if you are contributing to 401k/403b there is a tax benefit there too.

One question is you have debts in question at low interest rates. Do you have other debts at higher rates? Obviously if so pay them off ASAP. If you do not then you both need to decide what will make you sleep better at night. Will more in retirement accounts or less debt help you feel better? Whichever will do that. The math is kind of inconclusive.

If I woke up in your shoes I'd pay off the debts. That would help me sleep better at night. But I don't think you can really make a wrong answer here given the information and choices. As long as you stay out of new debt, make payments, and put money into retirement you'll end up better than most.

dleavitt

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Re: WWYD: Lots of low interest debt
« Reply #10 on: March 06, 2017, 12:41:33 PM »
I'd do some math, if I were you. If you put $1,300/month towards that debt, it should take you roughly 6 years to pay it off. (Check me on that one; also check to make sure there's no prepayment penalty.) No prepayment penalty, hooray!

What do your finances look like in 10 years if you pay off the debt first and then invest? What do they look like if you invest now while paying the minimums on the debt? What do they look like if you split Roth contributions and extra debt payments 50/50?Don't have the numbers in front of me, but the numbers will depend on assumed returns and predicted interest rates.  I've seen 7% historical returns quoted, but I'd need to look more closely at periods of interest rate increases since that is the main risk with the debt.

You may also want to check yourself on the tax benefits. My math is saying that your total interest payments are <$3,000/year. MFJ standard deduction is $12,700 for 2017. Unless you have more than $12,7000 in state tax, property tax, mortgage interest and charitable giving, your interest payments on this debt are NOT fully "tax deductible" because in the absence of those payments, you'd claim the standard deduction.

For example, let's say your tax deductible expenses are $3,000 in state tax, $2,000 in real estate taxes, $4,000 in mortgage interest and $1,000 in charitable giving, totally $10,000. Now you add in the $3,000 in student loan interest. $13,000. You itemize because $13,000 > $12,7000. But if you paid all that debt off, your deductible expenses become $10,000. You would claim the standard deduction, which only lowers your taxable income by $300 compared to having the debt. The amount of interest that's EFFECTIVELY tax deductible is only $300.We itemize every year with just our state taxes, property taxes, and mortgage interest (not including HELOC).  One risk is tax code changes, as our current Pres. has proposed increasing the standard deduction.  Student loan interest is an AGI adjustment, but does have income limitations (which we are not exceeding in the near future).

Another consideration is that ALL of that debt is variable interest rates. You can probably assume we're at an interest rate floor right now, and if you're planning to stretch the debt payment out for a decade or more, you will need to account for an interest rate increase. That's why we've tried in the past to refinance at a fixed rate, but the rate increase was just too much for us to swallow.  Might look into it again.

dleavitt

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Re: WWYD: Lots of low interest debt
« Reply #11 on: March 06, 2017, 12:46:27 PM »
This is one of those things were the math is probably less of the issue and more of personal preference. Obviously all of those debts have potential pitfalls. You cannot discharge student loans in bankruptcy (not that you want to) and the HELOC is basically against your home. On the flip side the interest is lower so you could potentially do better. And if you are contributing to 401k/403b there is a tax benefit there too.

One question is you have debts in question at low interest rates. Do you have other debts at higher rates? Obviously if so pay them off ASAP. If you do not then you both need to decide what will make you sleep better at night. Will more in retirement accounts or less debt help you feel better? Whichever will do that. The math is kind of inconclusive.

If I woke up in your shoes I'd pay off the debts. That would help me sleep better at night. But I don't think you can really make a wrong answer here given the information and choices. As long as you stay out of new debt, make payments, and put money into retirement you'll end up better than most.
Other debt is mortgage @3.875 fixed, and a vehicle loan @ 1.9 fixed.

We use credit cards for most purchases which are paid in full every month.

frugaliknowit

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Re: WWYD: Lots of low interest debt
« Reply #12 on: March 07, 2017, 11:53:40 AM »
Do any of your investments or retirement portfolios contain bonds, bond funds, or C/D's?  If so, you might replace them with stocks at the same rate that you aggressively pay down the loans.  Kind of like "buying a bond" at 4.0%+.  Also, if you were thinking of downshifting risk in general, paying down loans with these interest rates is a way to do so.

Beyond that, it's mostly a preference.  Generally, the older one is, the more one "hates debt".  While MMMers don't market time, if you are "less optimistic" about the stock market in the near term, aggressively paying off the loans (i.e. "buying bonds" at 4%+ yield) makes a lot of sense.

Oil Patch Adams

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Re: WWYD: Lots of low interest debt
« Reply #13 on: March 07, 2017, 12:34:34 PM »
What would I do?

Max out company match 401k
Max out HSA
Can you sell car and buy one without a note?
Pay off variable notes 1x1 ASAP starting with the first to increase.
Soon you'll have more cash flow...and probably earn more money too (and market will probably be less inflated by then); I didn't really start to see wealth build until I erased consumer debt; as your car insurance will lower too.

dleavitt

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Re: WWYD: Lots of low interest debt
« Reply #14 on: May 19, 2017, 03:03:32 PM »
I know it has been awhile, but I wanted to give some closure to this.

My wife and I were able to refinance her student loans at 4.71% through PenFed!  I came on as a cosigner, but we'll see if we can get that dropped in a year.

The plan then is to pay off the HELOC, but let everything else ride as they are low fixed rates.  Hopefully by this time next year we will be making regular IRA contributions!