Author Topic: $20k Cash - How much toward student loans?  (Read 1734 times)

dash41

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$20k Cash - How much toward student loans?
« on: February 19, 2017, 04:34:30 PM »
I figured I didn't need to do a full case study for this. I am 27 year old single male. My job is currently stable. I can always get another job, but that could correspond with a pay decrease if I stayed in a field I enjoy. I started working full time in October of 2015. Since that time, I have managed to build up a little over $20k in cash. I was hoping to get advice on how to best to use the $20k in cash I saved up. It has essentially been acting as an emergency fund or a potential house downpayment. Keep in mind I saved this money before reading MMM.

However, I have student loans from undergrad/law school. I have started aggressively paying these off. The past three months I have increased my payments to $1500/month. I've been targeting my high interest rate loans first as I won't have to pay anything toward my loans until November due to Income Based Repayment. I'll have all of my loans paid off in about 2.5 years if I continue this.  Here are my current loan totals with corresponding interest rates.

Student Loan Debt:
$4,100:   6.8%
$16,325: 6.2%
$11,111: 5.4%
$5,500:   4.5%
$5,500:   3.4%
Total: $42,536

For simplicity sakes, let's say my current monthly expenses are $2,000/month without including any retirement investing/student loan payments. I'm overshooting that to be conservative. My gross income/month is approximately $7600. Take home pay is roughly $4800-$5200 if you eliminated any 401k contribution. 

According to the Investment Order, I should invest to my 401k company match (only 6%) and then be putting the rest into getting rid of my high interest student loans. After discovering MMM recently, I have wanted to increase my 401k contribution to the max which is $1500/month (currently only doing about $900/month). I can still afford to put approximately $1500/month toward my student loans this way.

How would you invest the $20k in cash currently sitting in my bank account? Save $5k as an emergency fund and put $15k of it toward the high interest student loans? $10k as an emergency fund and $10k toward the student loans? A part of me enjoys being very liquid, but I know it is dumb to have $20k sitting there. I was debating putting a lot of it into a Vanguard Fund, but I don't know if I'll want to use the money as a down payment within the next 3-5 years. Didn't seem prudent to invest in equity with that possible time horizon, and I'm unsure of the bond market.

Thanks for your help!

Hargrove

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Re: $20k Cash - How much toward student loans?
« Reply #1 on: February 19, 2017, 06:46:13 PM »
I use credit cards as my emergency fund. It's not really meant to be spent and left empty (the emergency fund, that is), so I wouldn't sweat putting 1 or 2k on a credit card and paying it back that month or even, if I had to, the next, but your cashflow will determine whether that's crazy or not.

I would wipe out the 6.8 and hit the 6.2 for maximum net worth gains. If it helps you to "snowball" and feel better about wiping out "more" loans, you could do the 6.8 and the 4.5 and 3.4s, but it will cost you some interest.

If you're 2k expenses and 1.5k on top of that goes to loan payments, you're making plenty of money to not worry about generating a house down payment in a year or a year and change, unless you're buying a Moneyfire Mansion.

ltt

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Re: $20k Cash - How much toward student loans?
« Reply #2 on: February 19, 2017, 08:18:02 PM »
I would max your 401k to the $1500 you mentioned.  I would take your $20k and put it toward the $4,000 and the $16,000 student loans.  And then I would take the other $1500 you have per month and put it all toward the $11,000 loan---you would have it paid off in 7 months.  That would leave you with the two smaller $5,000 loans to pay down, which you could pretty much have paid off by the spring of 2018---my 2 cents. :)

seattlecyclone

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Re: $20k Cash - How much toward student loans?
« Reply #3 on: February 19, 2017, 08:38:32 PM »
Your current emergency fund is sitting at 10 months of expenses, perhaps more since you say you're estimating your expenses on the high side. That's rather high. It may be the right amount for you if you have a really specialized job and would have a hard time finding another one if you lost it, but you can probably get by with less if you have a stable job, good prospects for finding another if necessary, decent health and disability insurance, etc.

If you are going to reduce your emergency fund, paying off those higher-interest (over 5%) loans is a very defensible thing to do with the money. A guaranteed 6.2%-6.8% return is nothing to sneeze at.

I do also think that increasing your 401(k) contributions to the max would be a great thing to do regardless of what you choose to do with the emergency fund. Paying off debt is very good, and it should be a high priority for you, but it's important to remember that 401(k) contributions are limited by year. If you go full speed ahead on the loans and pay them off this year, you'll be swimming in extra cash next year with the loans gone. You can't then go and use some of that cash to catch up on your 2017 401(k) contributions; the window of opportunity for that ends on December 31.

You can afford to max out your 401(k) and still have the loans paid off within a few years. You'll pay perhaps a few hundred extra dollars in interest by stretching them out a little longer, but the tax deferral you get over time by maxing out the 401(k) should make up for it and then some.

dash41

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Re: $20k Cash - How much toward student loans?
« Reply #4 on: February 20, 2017, 12:24:42 AM »
I use credit cards as my emergency fund. It's not really meant to be spent and left empty (the emergency fund, that is), so I wouldn't sweat putting 1 or 2k on a credit card and paying it back that month or even, if I had to, the next, but your cashflow will determine whether that's crazy or not.

I would wipe out the 6.8 and hit the 6.2 for maximum net worth gains. If it helps you to "snowball" and feel better about wiping out "more" loans, you could do the 6.8 and the 4.5 and 3.4s, but it will cost you some interest.

If you're 2k expenses and 1.5k on top of that goes to loan payments, you're making plenty of money to not worry about generating a house down payment in a year or a year and change, unless you're buying a Moneyfire Mansion.

I would max your 401k to the $1500 you mentioned.  I would take your $20k and put it toward the $4,000 and the $16,000 student loans.  And then I would take the other $1500 you have per month and put it all toward the $11,000 loan---you would have it paid off in 7 months.  That would leave you with the two smaller $5,000 loans to pay down, which you could pretty much have paid off by the spring of 2018---my 2 cents. :)

I've been leaning toward putting a lot of money toward the student loans. However, is it prudent to have zero cash on hand? I overshot my expenses on purpose for the exercise, so I probably would be able to build back some cash reserves in a reasonable amount of time. My job is guaranteed through the end of July. It is probably 99.9% guaranteed for another year after that as well. It would still make me slightly nervous. I do have a credit card with a $27k limit (thank you Chase Sapphire Reserve and your rewards) in the worst case. I can't exactly pay my rent using my credit card though.

Your current emergency fund is sitting at 10 months of expenses, perhaps more since you say you're estimating your expenses on the high side. That's rather high. It may be the right amount for you if you have a really specialized job and would have a hard time finding another one if you lost it, but you can probably get by with less if you have a stable job, good prospects for finding another if necessary, decent health and disability insurance, etc.

If you are going to reduce your emergency fund, paying off those higher-interest (over 5%) loans is a very defensible thing to do with the money. A guaranteed 6.2%-6.8% return is nothing to sneeze at.

I do also think that increasing your 401(k) contributions to the max would be a great thing to do regardless of what you choose to do with the emergency fund. Paying off debt is very good, and it should be a high priority for you, but it's important to remember that 401(k) contributions are limited by year. If you go full speed ahead on the loans and pay them off this year, you'll be swimming in extra cash next year with the loans gone. You can't then go and use some of that cash to catch up on your 2017 401(k) contributions; the window of opportunity for that ends on December 31.

You can afford to max out your 401(k) and still have the loans paid off within a few years. You'll pay perhaps a few hundred extra dollars in interest by stretching them out a little longer, but the tax deferral you get over time by maxing out the 401(k) should make up for it and then some.

My job should be good for at least the next 1.5 years. I am in a very specialized field though. Knowing that my job is locked in for the next 1.5 years, what amount in an emergency fund is reasonable?

marty998

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Re: $20k Cash - How much toward student loans?
« Reply #5 on: February 20, 2017, 03:00:05 AM »
I'm unsure of the bond market.

Others have spoken on what to do but I wanted to comment on this. Quite simply, your loans are effectively bonds, except in reverse. The plus side is that you have a guaranteed payoff for paying these "bonds" off.


ltt

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Re: $20k Cash - How much toward student loans?
« Reply #6 on: February 20, 2017, 06:08:20 AM »
Hmmm, a specialized field changes things. 

$2,000 roughly in expenses
$1,500 toward 401k
$1,500 toward loans
-----------------------
$5,000 total

Okay, here's what I think I would do now knowing a little bit more about your job situation.  Use $4,000 of your reserve money and pay off the $4,100 loan.  This would leave you $16,000 in reserve.  Then put $1,500 a month toward the $16,325 loan.  You would pretty much have this paid off at the end of 2017.  Not a bad deal.  Then as you move forward into 2018, put the $1,500 toward the $11,100.  That loan should be paid off roughly 7 to 7-1/2 months into 2018.  At which time you would know more about your position.  You'd still have a healthy reserve of $16,000 and have maxed out your 401k at this point and feel pretty good, plus you would have two really small loans going forward.


Hargrove

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Re: $20k Cash - How much toward student loans?
« Reply #7 on: February 20, 2017, 05:23:16 PM »

I've been leaning toward putting a lot of money toward the student loans. However, is it prudent to have zero cash on hand?

My answer to that is this: it takes 3 days for a stock sale to settle and 2 days to ACH to your bank account.

Stocks are way more liquid than most people act like they are unless they have gone down (in which case you don't want to liquidate them), but if you make a "mini fund" (I use Loyal3 for this) of 10-15 relatively stable stocks, you can just sell high stocks IF AND ONLY IF YOU HAVE AN EMERGENCY.

So how do you pay within that 5 day window?

A credit card. That you can always pay off in 5 days. Even if stocks take a disastrous turn, you pay a premium of what, 5%? 10%? 20% on a one-time emergency expense that you're otherwise throwing away all possible gains on, some people even indefinitely? That's worst-case (paying in 5 days), because assuming you have your job another 25 days, you just pay the credit card off with the cash surplus you're already enjoying from your savings rate.

But every single stock could crash and selling them could be at a huge loss and you could also lose your job at the same time and get cancer!

I mean, yeah, sure. But investing for 0% risk gets negative-inflation returns.

dash41

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Re: $20k Cash - How much toward student loans?
« Reply #8 on: February 20, 2017, 09:55:19 PM »

I've been leaning toward putting a lot of money toward the student loans. However, is it prudent to have zero cash on hand?

My answer to that is this: it takes 3 days for a stock sale to settle and 2 days to ACH to your bank account.

Stocks are way more liquid than most people act like they are unless they have gone down (in which case you don't want to liquidate them), but if you make a "mini fund" (I use Loyal3 for this) of 10-15 relatively stable stocks, you can just sell high stocks IF AND ONLY IF YOU HAVE AN EMERGENCY.

So how do you pay within that 5 day window?

A credit card. That you can always pay off in 5 days. Even if stocks take a disastrous turn, you pay a premium of what, 5%? 10%? 20% on a one-time emergency expense that you're otherwise throwing away all possible gains on, some people even indefinitely? That's worst-case (paying in 5 days), because assuming you have your job another 25 days, you just pay the credit card off with the cash surplus you're already enjoying from your savings rate.

But every single stock could crash and selling them could be at a huge loss and you could also lose your job at the same time and get cancer!

I mean, yeah, sure. But investing for 0% risk gets negative-inflation returns.

I understand this point. Do you think I should pay X dollars toward my student loans and then put the other X dollars into a Vanguard Index Fund that I can access if need be?

Hargrove

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Re: $20k Cash - How much toward student loans?
« Reply #9 on: February 21, 2017, 09:02:14 AM »
That's roughly what I would do.

I have 401k (maxed, indexes)
Roth (maxed, indexes)
Broker (taxable, for picking stocks occasionally and indexes for RE funding overflow)
Broker (Loyal3 - no commissions - taxable, for lowering my total fee ratio and for emergency money if I need it, almost all mega-cap - Microsoft, Apple, Berkshire Hathaway)

I have 1k in the bank and a credit limit I have never maxed or carried a balance on over $5 in almost a decade. If you can expect 1k+ available to you every month from your job, and you keep just a bit of cash on hand, you're basically set. What situations could cause you to need over 1k cash in under 3 days that can't be put on credit, or an amount over your credit limit in under 30 days? Don't gamble, and if you do, don't do it with mafia loan-shark money and you'll be ok.

eyePod

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Re: $20k Cash - How much toward student loans?
« Reply #10 on: February 21, 2017, 09:15:01 AM »
Emergency funds are very personal. We have bare minimum expenses covered for 3 months, and a host of other mini emergency funds geared towards specific things (hot water heater replacement, furnace replacement, major car repairs). This is what makes us feel comfortable.

If you put all of the money towards loans and then lose your job, you're not in a good cash spot. Personally, I'd keep 3-6 months expenses and throw the rest of it towards the loans. The only way I'd be looking at retirement would be if I had a match, otherwise, everything else and the kitchen sink would be thrown at the loans!

Laura33

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Re: $20k Cash - How much toward student loans?
« Reply #11 on: February 21, 2017, 09:38:55 AM »
ITA with eyePod.  I keep a larger EF because it helps me sleep at night.

It sounds like you are a lawyer, and that you have annual contracts.  I know the legal field, and it changes extremely quickly, and when it crashes, it could take months to find a new job.  IMO, I would not want to risk credit cards or stocks for money that I realistically might need within a couple of months, knowing that it might take me 6 mos. to find a new job.  However, your annual contract gives you some ability to time things, so I would target everything around that contract renewal date.  So for this year:

1.  Take $10-15K of your cash, pay off the highest-interest loan, throw the rest at the next one.
2.  Max out your 401(k) at $1500/mo. between now and the renewal date.
3.  Throw all the monthly excess between now and then at the 6.2% loan.

This leaves you with 2.5-5 mos. in EF and at least half of a fully-funded 401(k) if you aren't renewed (size of EF should be related to your comfort zone/likelihood of renewal).

Once your contract is renewed, though, you know you don't need a big EF for another 364 days.  So keep a little in cash and throw all the rest at the 6.2% loan.  Continue to max the 401(k); divert $750-$1K of what's left to the EF (again depending on your risk tolerance), and then the remainder to the next-highest loan (adjust as necessary to cover minimums once IBR kicks in).  Or you can front-load the loans and back-load the EF even more to minimize the amount of time you have cash just sitting there -- e.g., right after the contract is renewed, throw all the extra money back at the loans, and then a few months before your contract renewal date, reduce the loans to minimum payments and build the EF back up.  In either event, by your next renewal date, you'll have a decent EF built up again and over half the loans gone.  If your contract is renewed again, rinse and repeat. 

Note:  I'm a big fan of using the 401(k) while the getting is good -- not only is it use-it-or-lose-it, but it will decrease your taxes, so the $1500/mo hit is more like $1200 (as compared to the loan payoff, where $1500 is $1500).