Invest/max 401ks vs payoff huge student loans

[Lady SA]

I’ve lurked for a bit and finally bit the bullet to post my question. I’m curious: for our situation, is it smarter to pay off our (huge) student loans ASAP, or scale back and increase our 401k contributions and investments?

Life Situation:
Tax status: MFJ
My DH and I (for clarity I’ll be LLB) are both 23 y/o
DINKs
LLB salary: $72,800
DH salary: $78,000
Total pre-tax income: $150,800

Current debts (which are pretty hefty…)
No CC debt (we never carry a balance)
No Car loan (we bought our single car for $3000 cash a year ago)
LLB student loan 1: $-26,800 @ 4.96%
LLB student loan 2: $-10,100 @ 3.30%
DH student loan 1: $-53,000 @ 5.50% (this is just… ugh)
DH student loan 2: $-25,400 @ 5.00%
DH student loan 3: $-5,300 @ 4.24%
DH student loan 4: $-5,900 @ 5.00%
Total student loan debt: $-126,800 (OUCH)

However, there’s a bright side. We found MMM, but before that we were already living pretty frugally. Currently, we are throwing massive amounts of money at our loans now, concentrating one-by-one on the highest interest loans (~$4500/mo, $3500 of which going toward DH’s big loan). So we are currently paying the minimum payment on all loans except the 53k loan. With this plan, we will have our full balance paid off in ~3.5 years from now. Yay!

But we want to pay our loans off even sooner, if we can, so we can start making headway on FI. Considering that both our jobs are very stable and we can comfortably pay this amount per month, we are considering consolidating DH’s four loans into one very large loan (~$90,000) so less of the payments go towards interest. This consolidated loan we can pay off in ~2 years, and all loans will be completely paid off in under 3 years with the same monthly payment (we have run the numbers). The time difference is small so I'm on the fence as to if its worth it. On one hand, we pay off the loans a few months sooner and save just a few thousand in interest, but on the other we lock ourselves into a scarily large loan (but that might just be an emotional response to a 90k number vs 50k+25k+10k or whatever the numbers are) and have little wiggle room with monthly payments (but again, this is likely to not be a problem with our current jobs).
(If we did this, we would have 3 loans:
90k @ ~5.5-6%
26.8k @ 4.96%
10k @ 3.3%)

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On the flip side, we are contributing close to the minimum % to our 401ks to capture our employer match (our employer matches up to 5% in our 401ks, so we are contributing only 6%). This is to free up more money to throw at student loans now. We have no other investments because we don't have money in the budget to devote to it, its ALL going towards loans.
My concern is that we are losing out on 3 years worth of 401k contributions and other investments that we can never catch up on. Also, we are dangerously close to a higher tax bracket and contributing to our 401ks would reduce our taxable income.

But I’m confused. What is the line between a hair-on-fire debt emergency, and debt (ex a mortgage) with low enough rates that paying it off asap might not make sense if you invest instead? Where along this range do our student loans fall?
Is it better to solely focus on paying off massive student loans if doing so means neglecting investing for 3 whole years?

I would like to ask mustachians what you think about this.
1.   Considering our interest rates and principles, would it be financially smarter to scale back slightly on student loan payments (extending our time to pay off) and increase 401k contributions/investments?
2.   Does it make sense to consolidate DH’s loans? Ie currently we can concentrate on paying off certain loans with certain rates at a more granular level, but if we plan to pay off everything within 3 years anyway, interest rates become less important because of the timeframes involved. But if we decrease payments, interest rates suddenly matter a lot more and we would have less flexibility with what to pay off/when. Make sense?
3.   Does our current plan, with consolidation of loans and putting everything towards loans look good? Are we missing something?

I just have a weird feeling that we must be forgetting something obvious haha. At this point, I’m just kind of overwhelmed. DH and I want to get out from under this debt ASAP, but we also want to save for and buy a home, have kids, *and* FIRE as early as possible to spend as much time as possible with our kids (we like our jobs, but we like freedom more!)
After we free up monthly loan payments and invest them instead, we will be set to FIRE ~11 years after loans are repaid – depending on how much our mortgage payment is in the future.

I know we have a solid plan to knock out our debt (and I’m damn proud of it!). But it’s disappointing and annoying that even with such a sizable chunk of our income going towards loans, it will still take 3.WHOLE.YEARS to just zero out and THEN we can finally start from scratch on FI. Ugh.

I think I’m sounding like a complainy-pants, and I know we are in a better spot than a lot of people at our age, and 3 years isn’t actually all that long. I’m just kind of in shock that we will be working our butts off for 3 years and the result is “just” a net worth of basically $0, and then staring down the scope of 11 years after THAT we can finally be truly free. I think I just need some encouragement and some outside eyeballs to look at our situation. Thanks!

[nereo]

very detailed post LadyLB

Personally, with your high income I would concentrate on increasing your 401(k) contibutions as well as funding an IRA.  You'll get a sizable tax break from doing this which will be more benefital that the added interest on your loans.  Plus, none of your loans are above 5.5%  I would max out my tax-advantaged accounts long before I considered paying off any loans early that are under 5%.

For refinancing, have you checked out SoFi?  https://www.sofi.com/.  I'm wouldn't be surprised if you could refinance DH's loans into something that was lower than the ~5.5% that you are expecting.  As it stands right now, I'm confused why you are more afraid of a single loan due each month than four smaller loans.

to address your questions directly:
1) yes, I would scale back overpayments on loans slightly to increase your 401(k) contirbutions
2) refinancing makes sense if you can reduce the overall interest rate.  There's a very good chance you can do exactly that (and keep the same protections on student loans) using SoFi
3) you don't appear to be missing anything.  You realize that you have a crap-ton of debt and a lot of things you want to start saving for plus reaching FI.  Keep living on as little as you can and bank the rest and with your income you will be sitting pretty in 3-5 years.  The key of course is to spend as little as you can until your debt/savings situation improves dramatically.  Keep living like broke college students, in other words, and you can retire in your 30s with that income, even WITH your massive student loans.

[Lady SA]

Thank you for your reply! That definitely makes sense. I'm completely new to the finance world so a lot of this is really new to me. I have a few clarifying questions:

Personally, with your high income I would concentrate on increasing your 401(k) contibutions as well as funding an IRA.  You'll get a sizable tax break from doing this which will be more benefital that the added interest on your loans.

I agree with your assessment, and I think increasing our retirement account contributions would give us a better return than blindly throwing money at our debts. I'm confused on how much to scale back our loan payments by to get the best outcome. We can run some numbers this weekend, but do you (or anyone else) have any guidance on how much 401k contribution we should increase while also making major headway on at least the highest interest loans? Should we attempt to max out our 401ks or try to hit a lower target (and any guidance on how to determine the most beneficial "target" would be most appreciated!)

none of your loans are above 5.5%  I would max out my tax-advantaged accounts long before I considered paying off any loans early that are under 5%.

So for loans that are at or above 5%, should we pay those off ASAP (using our current plan), and then when we are left with only loans that are below 5%, scale back and put that money towards 401k and IRA?
Or should we concentrate on the highest interest loans, but immediately scale back payment amounts (by how much? Not sure) until all loans at or above 5% are paid off, then lower payments towards the lower interest loans after that? The difference going to our 401ks.

For refinancing, have you checked out SoFi?  https://www.sofi.com/.  I'm wouldn't be surprised if you could refinance DH's loans into something that was lower than the ~5.5% that you are expecting.

We are looking at refinancing through Earnest, which is very similar to SoFi, and we used them to refinance my 26k loan (we looked at both SoFi and Earnest and earnest offered me a better rate). We will look at SoFi this weekend to see if they can offer us better.
Since they look at individual debts/income, DH has a much worse debt/income ratio than I do, and doesn't get offered as good rates, unfortunately.
The ~5.5% was an estimate that Earnest gave us based on DH's preliminary information.

I'm confused why you are more afraid of a single loan due each month than four smaller loans.

I think it is just the big, huge number all at once freaks me out. Logically I know that ~53k+25k+5k+5k=90k, so its totally in my head. I also think I was unsure if we were missing something important that would screw us later - your response reassured me though. :)

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I guess I'm looking for some advice on how to balance maxing 401k and IRA contributions vs paying off these big loans. Should we shoot for a max-401k plan, a payoff-loans-ASAP plan, or a half-payoff-loan, half-some-towards-401k plan? Does that make sense? So we are currently at the "X" on this continuum:

Max 401k <----------------------- halve loan payments, 50% max 401k --------------------------X--->Blindly payoff loans ASAP

Where should that "X" be instead?

[Mother Fussbudget]

Your take home pay may not be affected much by paying more into your 401K because of the offset in tax withholding. 
I think your plan to attempt to maximize your 401K is a good way to go.  Do the math over the weekend.  Run your spreadsheet models, then take baby steps - add another $100 next month to the 401K and see how that affects your paycheck(s).  You don't have to do everything all-at-once.  Take a breath, plan your work, then work your plan.

Have you considered a consolidation loan for ALL your student loan debt via lenders such as the ones featured on studentloanhero.com?   [I have no connection with StudentLoanHero, but have heard good things about them. SoFi, Earnest and 4 other options are featured there.]

Assuming 5 year payoff [stretching the payments out to 5 years, and put more cash toward 401K/retirement/tax deferral]

• $126,500 in loan principle
• 5.03% average interest rate
• ~$32,000 in interest payments over 5 years

If you can consolidate your loans to something under 5.03%, you'll be saving overall.  But be careful of adding to the principle with loan origination fees which WILL get tacked on.   If you can't find something below 5.03%, you're better off paying them off one-at-a-time as you do today.

Some who are fed up with the credit industry would NEVER take out a consolidation loan (why take out ANOTHER loan when you have six loans already?).  But the same people often pay off their credit card & student loan debt, then quickly take out a mortgage loan  putting themselves right back into a different form of debt.

In short - live life, and follow your happiness. 
If the $53K loan gnaws at your happiness, then a $126K loan might be maddening.  However... you're at $126K in debt today. 

Fortunately, you're doing the right things, and asking for free help.  It sounds like you're on the right track... keep at it, and best of luck.

[seattlecyclone]

But we want to pay our loans off even sooner, if we can, so we can start making headway on FI.

Contributing to your 401(k) is also making headway on FI. To be FI, you need to pay off your loans and amass a stash at least 25 times your annual expenses. Do these things in whichever order gets you to the overall goal soonest.

Considering that both our jobs are very stable and we can comfortably pay this amount per month, we are considering consolidating DH’s four loans into one very large loan (~$90,000) so less of the payments go towards interest. This consolidated loan we can pay off in ~2 years, and all loans will be completely paid off in under 3 years with the same monthly payment (we have run the numbers). The time difference is small so I'm on the fence as to if its worth it. On one hand, we pay off the loans a few months sooner and save just a few thousand in interest, but on the other we lock ourselves into a scarily large loan (but that might just be an emotional response to a 90k number vs 50k+25k+10k or whatever the numbers are) and have little wiggle room with monthly payments (but again, this is likely to not be a problem with our current jobs).
(If we did this, we would have 3 loans:
90k @ ~5.5-6%
26.8k @ 4.96%
10k @ 3.3%)

Am I reading this correctly that the consolidated loan might have a higher interest rate than any of the individual loans? If that's the case, consolidating makes almost no sense. You would be voluntarily increasing your monthly interest expense for the minor convenience of not needing to make quite as many individual payments. Don't pay more interest than you have to!

But I’m confused. What is the line between a hair-on-fire debt emergency, and debt (ex a mortgage) with low enough rates that paying it off asap might not make sense if you invest instead? Where along this range do our student loans fall?
Is it better to solely focus on paying off massive student loans if doing so means neglecting investing for 3 whole years?

Your loan balance is certainly large, and the interest rates are high enough that paying the loans off should be a high priority. However the interest rates aren't ridiculously hair-on-fire high. I think you should max out your 401(k) and IRA accounts first, then put every last cent toward the loans (make minimum payments on all but one of the loans, and then put whatever's left toward the loan with the highest interest rate).

A few reasons for this:
1) You have a relatively high income that likely puts you near the top of the 25% tax bracket. Saving this tax money and getting some money working for you is likely worth spreading your loan payments over a slightly longer period.
2) At your income level, once you pay off your loans you'll be able to easily max out your retirement accounts and then have some funds left over for post-tax investing. Once that time comes there's no way to go back and make 401(k) contributions for 2015; it's now or never.
3) With your current rate of 401(k) saving, you're likely somewhere in the phaseout range for the student loan interest deduction. By maxing out your 401(k), you will certainly move toward the bottom of that phaseout range and might even get yourselves below the threshold where you can deduct the full amount. You'll not only save 25% on your base taxes by making 401(k) contributions, but you'll also effectively decrease the interest rate on your loans by making the interest more tax-deductible!

1.   Considering our interest rates and principles, would it be financially smarter to scale back slightly on student loan payments (extending our time to pay off) and increase 401k contributions/investments?

Yes. See above.

2.   Does it make sense to consolidate DH’s loans? Ie currently we can concentrate on paying off certain loans with certain rates at a more granular level, but if we plan to pay off everything within 3 years anyway, interest rates become less important because of the timeframes involved. But if we decrease payments, interest rates suddenly matter a lot more and we would have less flexibility with what to pay off/when. Make sense?

As long as you can easily afford to make minimum payments on your current set of loans, only refinance if you'll be getting a lower interest rate. While the interest rate becomes less important when you're planning to pay the loan off sooner, there's no compelling upside to refinancing that would offset the downside of a higher interest rate.

3.   Does our current plan, with consolidation of loans and putting everything towards loans look good? Are we missing something?

If debt reduction will help you sleep better at night, you won't go too wrong by focusing on that as your top priority. I highly suspect that you'll be better off in the long run by maxing your tax shelters and then making debt reduction your secondary priority.

[Lady SA]

So, I thought I'd come back and let everyone know what changes we've done. It's been just under a week since I posted.

First, DH and I looked into various options for refinancing his loans - Earnest, SoFi, and our credit union. We are waiting for offers from a few, so we don't have a decision yet. But regardless, we will be refinancing with one of them to get a lower interest rate (ie we could refinance only certain loans in order to get the best rate).

Second, we increased our 401k contributions for the rest of this year and scaled back SL payments to the minimum, to put as much as possible into 401ks. We will adjust for 2016, but thought your recommendations for capturing tax savings for 2015 was a great idea, so we are focusing on that for these last few months of the year.

Going forward in 2016, our priorities will look like this:

1. Make minimum payments on student loans
2. Come close to maxing 401ks - our goal is $30k, more would be a bonus.
3. Our leftover money each month goes to supplement student loan payments (and according to the revised budget, we will have a couple hundred leftover each month)

Its a good compromise - dh is very debt-adverse and wants to pay off student loans asap, while I was leaning more toward maxing 401ks and other retirement accounts. This way makes us both happy.

Thanks for all of your help! You guys put into words how to think about our finances. We didn't really understand much about tax-advantaged accounts so I'm really glad I reached out to you for help.

[Lady Fordragon]

My husband and I had a similar compromise a couple years ago when we were paying off our mortgage.  (I am the more debt adverse person in the relationship.)  Sounds like you've got a good plan in place.  Good luck!

[MDM]

Its a good compromise - dh is very debt-adverse and wants to pay off student loans asap, while I was leaning more toward maxing 401ks and other retirement accounts. This way makes us both happy.

For the small difference remaining this is good - even though each spouse knows the other is "wrong". ;)

[Zaga]

That sounds similar to what we did.  Saving money on taxes by using a 401-K is limited each year, so if you don't use that tax advantaged space, you lose it.  Some additional thoughts for you:

Look carefully into each of the loans, particularly the ones with higher interest rates.  Are there individual loans within the larger loan?  If there are then you may be able to direct any extra payment you make each month to just one of the internal loans, your minimum payment will go down faster that way and even if it's mathematically the same you'll feel better having paid off something.

Is your tax withholding correct?  Do you get a large tax refund or owe a lot at tax time?  If so you might want to adjust your withholding to compensate. 

I think that once you get going on your plan you will find that you're able to toss more money at your loans than you are currently expecting :-)

[rmendpara]

With that income, you are squarely in the 25% federal bracket, and depending on where you live another few % in state taxes (somewhere in the midwest, is my guess).

If you maximize 401k's, that gives you 114k in pre-tax income (150 - 18  - 18), which in Illinois (I think ~4% state tax) would leave you with ~7k in aftertax income.

Even if you are barely frugal at all, in most midwest cities (except probably Chicago), you could probably land a:
- 1 or 2br for ~$1,500/mo
- Add in $500 for food
- $400 (200 x 2) for 2 cheap car leases
- $300 for gas/maint./car ins.
- $300 for health ins, life, etc.
- $700 being stupid and spending a LOT eating out and at bars
= 1.5 + .5 + .4 + .3 + .3 + .7 = 3.7k in total expenses (excluding debt)

Now, let's also say you get robbed once a month for $300 like clockwork on the first of each month. That brings your total expenses to 4k/mo for living and stuff, with a solid amount of wiggle room.

http://www.paycheckcity.com/cokronos/netpayCalcResult.asp

Based on 114k pretax and 2 allowances (federal and state), you make 7k/mo take home. After spending 4k, you have 3k left over to save and/or pay off debt.

I'm not sure what your loan structure is, but let's call it 127k @ 5%, meaning you pay 6.35k ($530/mo) in interest. This will decline slowly each month as your balance decreases, but let's just assume it stays around the same. If you pay the full 3k/mo, that means ~2.5k is going toward paydown. 30k/yr reduction in the amount due gets you debt free in just under 4 years (30 x 4 = 120), a few months more quickly due to the interest shrinking each month).

Based on the above example, maximize the 401k's NOW. Keep putting the max toward them. Seems you are both in well paying careers given you make 70k+ each right out of school, so maybe you even get 3% raises each year, that helps a bit too. The acceleration of contributing to 401k's fully for 4 years will likely be better than trying to get out of debt ASAP.

Hope this helps!

Oh, btw, that 36k you put into your 401k starting in 2016 - 2022 (age 30) should be at least $300k by your 30th birthdays, assuming a 6% annual return, or a fairly moderate conservative investment allocation. This excludes any additional savings once the debt is paid off.
 -       -       36,000     36,000
 36,000     2,160     36,000     74,160
 74,160     4,450     36,000     114,610
 114,610     6,877     36,000     157,486
 157,486     9,449     36,000     202,935
 202,935     12,176     36,000     251,111
 251,111     15,067     36,000     302,178

Fortunately, your debt is not crippling your cash flow. Far from it. You make enough to fully contribute to 401k, maybe even a bit left over for Roth accounts for both of you (I'd confirm the income limit first), and still be debt free within ~4 years. Then, start saving for a house, invest more and keep renting, upgrade your lifestyle (just a bit) to maybe a home, or whatever you want.

Happy Sunday! :)