Case Study: Focus on Interest Rate or Cash Flow?

[skuzuker28]

Interest or Cash Flow?
Hello all.  I recently became introduced to your fine community, and need some face-punching.

Life Situation:  Married, one dependent with another coming in July.  Me: 28, Wife: 29, Kid 1: 5 months.  Marginal tax rate: 15% Fed, 9% State

Gross Salary:
   Me: $3,520 Base, plus overtime from Feb-April and Aug-Oct (roughly 10k annual)
   Wife: $4,223 (cushy state job)

Pre-tax Deductions:
   Me: HSA of 281.25 a month
   Wife:
      Union Dues: 61.32
      Dependent Care FSA: 416.00
      Parking FSA: 70
      Dental Ins.: 5.33
      Health Ins.: 60
      Misc: 4

Other Ordinary Income:
   (Very) Side Hustle: Part out Miatas.  Rougly $2k net a year for tax purposes.

Budgeted Net Income: $5,450

Budgeted Expenses:
Mortgage                                    1,250.00 (859.59, 382.52 Escrow, includes PMI, budgeted high for inevitable tax increases)
Electronics                                 30.00
Utilities                                       225.00
Home Repairs/Maintenance       160.00
Gasoline                                       180.00
Cell Phone                                 70.00
Internet/Cable                              67.00
Insurance                                       100.00
Supplies                                       200.00
Grocery                                       300.00
Entertainment                               100.00
Student Debt                               784.19
Education                                       100.00 (working towards licensure in my field)
Clothing                                         50.00
Medical                                         10.00
Miscellaneous                               105.00
Automotive Repair                         80.00
Tithe/Giving                               583.00
Extra to Debt                               508.63
Auto Payment                               527.18

Assets:
My 401k: roughly $1,800, all from employer non-elective 3% safe harbor contribution
Personal Residence: Appraised in Oct. at $206,000
Emergency Fund: $2k
Savings for Future Expenses: $4,900

Liabilities:
Mortgage:
   Current Balance: 182,261
   Rate: 3.875
   Term: 30 years (just refinanced one year into original mortgage to get a lower rate)
   Payment: 1,242.11 including escrow (See above)
My Fed Student Loans:
   Current Balance: 7,990
   Rate: 5.5-6.5 depending on loan
   Payment: 158.xx
Wife Fed Student Loans:
   Current Balance: 16,162
   Rate: 5.5-6.5 depending on loan
   Payment: 207.33
Wife Private Student Loan:
   Current Balance: 22,517
   Rate: 4.25 (VARIABLE)
   Payment: 169.25
Wife Private Student Loan:
   Current Balance: 26,213
   Rate: 4 (VARIABLE)
   Payment: 201.61
Wife CC:
   Current Balance: 844
   Rate: 0 (forever on current balance)
   Payment: 15
Auto Loan 1 (FACE PUNCH):
   Current Balance: 11,830
   Rate: 2.99
   Payment: 283.43
   Term Left: 3.5 years
Auto Loan 2 (FACE PUNCH):
   Current Balance: 13,768
   Rate: 2.49
   Payment: 244.67
   Term Left: 5 years (Recently purchased)

Specific Questions:
1.   We are currently focusing our extra cash flow towards paying down my Federal student loans due to the higher interest rate.  Should we instead focus on the auto loans to free up cash flow and give us vehicular flexibility?  While our most recent purchase will serve our needs for a decade or more, the earlier purchase is a little small for our growing family (hence the most recent purchase).
2.   Should we look into refinancing my wife’s student loans?  This would get us a lower rate on the fed side, but probably increase the rate on the variable rate loans.  However, we would go for a fixed rate loan which would make me feel a lot better.
3.   Included in the $4,900 savings for future expenses is a little over $2,200 for future home repairs.  This balance usually grows by the $160 a month in our budget.  Our home was built in 2001, do you think this is a good idea, or would you think it is overly conservative given our current debt situation?

Thanks for your advice!

[skuzuker28]

Well, checked the refi rates for my wife through Sofi.  Doesn't look like that is going to be a good option for us.  Didn't see what rates we'd get if I cosigned, but I'd rather not do that if we can help it.

Questions 1 and 3 still apply though, interested in your input.

[Travis]

The rule of thumb I was taught was to have 1% of the home's price set aside for repairs and judging by your mortgage payment I'd say you're already there.  Is the $508 "extra to debt" already allocated to something or is that money you can shift around?  If so, I'd go after your student loan and knock it out over the next year.

[MDM]

1.   We are currently focusing our extra cash flow towards paying down my Federal student loans due to the higher interest rate.  Should we instead focus on the auto loans to free up cash flow and give us vehicular flexibility?

Trust your original instinct.  See http://www.vertex42.com/Calculators/debt-reduction-calculator.html and download the calculator to see how much difference it makes.

3.   Included in the $4,900 savings for future expenses is a little over $2,200 for future home repairs.  This balance usually grows by the $160 a month in our budget.  Our home was built in 2001, do you think this is a good idea, or would you think it is overly conservative given our current debt situation?

If the repairs are known needs (e.g., roof shingles are peeling off) then put the money into the house.  If this is for unspecified possible home repair needs, you do have the catch-all emergency fund so paying off the high interest loans could be better.

[JLee]

Penfed is usually running 1.99% for 3 years - it may be worth refinancing your 3.5yr-remaining loan to cut that rate by 1/3.

[skuzuker28]

The rule of thumb I was taught was to have 1% of the home's price set aside for repairs and judging by your mortgage payment I'd say you're already there.  Is the $508 "extra to debt" already allocated to something or is that money you can shift around?  If so, I'd go after your student loan and knock it out over the next year.

The $508 can shift around, currently it is all going towards my student loans.  Mine should knocked out by May hopefully, February to April is my big overtime season.

[skuzuker28]

1.   We are currently focusing our extra cash flow towards paying down my Federal student loans due to the higher interest rate.  Should we instead focus on the auto loans to free up cash flow and give us vehicular flexibility?

Trust your original instinct.  See http://www.vertex42.com/Calculators/debt-reduction-calculator.html and download the calculator to see how much difference it makes.

3.   Included in the $4,900 savings for future expenses is a little over $2,200 for future home repairs.  This balance usually grows by the $160 a month in our budget.  Our home was built in 2001, do you think this is a good idea, or would you think it is overly conservative given our current debt situation?

If the repairs are known needs (e.g., roof shingles are peeling off) then put the money into the house.  If this is for unspecified possible home repair needs, you do have the catch-all emergency fund so paying off the high interest loans could be better.

My two main concerns with the house are the roof and HVAC system.  Both are original to the home from what I can tell.  Neither have given any signs of worry yet (roof was given at least 5 years at the purchase inspection two years ago), but I know both of those are costly to replace.  Unfortunately I'm not very handy around the house.  Could probably bumble through a furnace replacement though.  Would you say the current $4k is sufficient for now until something comes up?

[skuzuker28]

Penfed is usually running 1.99% for 3 years - it may be worth refinancing your 3.5yr-remaining loan to cut that rate by 1/3.

I'll look into that, thanks!  Practically free money, even more so than our current loans.

[MDM]

My two main concerns with the house are the roof and HVAC system.  Both are original to the home from what I can tell.  Neither have given any signs of worry yet (roof was given at least 5 years at the purchase inspection two years ago), but I know both of those are costly to replace.  Unfortunately I'm not very handy around the house.  Could probably bumble through a furnace replacement though.  Would you say the current $4k is sufficient for now until something comes up?

The likelihood is that you will be fine with both the roof and HVAC for at least several more years, and perhaps longer.  Of course the heat exchanger could crack, the compressor could break, or the shingles could blow away or be hail-damaged in a month.  There is always a scenario that makes your emergency fund inadequate, no matter how large, but from what is given in your OP the $4k seems sufficient for now.  Good luck knocking out those loans!

[skuzuker28]

Thanks guys for the feedback.  Sounds like the general consensus is to keep focusing on the interest rate for determining payoff priority.

As far as home repairs: based on some cursory Googling it sounds like I have sufficient funds available for any major HVAC repair/replacement.  That makes me feel better!  However, it sounds like I will be well short of what I would need for a roof replacement.  That doesn't give me warm fuzzy feelings, but a more aggressive debt payoff may mean we can handle it when the time comes.  Given our climate our roof should last toward the high end of the typical lifespan for asphalt shingles, which would give us another 10 years.

[skuzuker28]

Well, got a wrinkle today in our planned Debt Payoff Extravaganza.  As mentioned in the OP, we are expecting another kid this July.  My wife had applied for short term disability insurance during open enrollment, prior to the pregnancy.  Just learned that because she had a "pre-existing condition" she will only be covered for 4 weeks instead of the full 8.  That means we'll have a $3k gap in income, assuming she takes the full 12 weeks of FMLA.

Not the end of the world, and still an improvement over kid #1, but annoying.

Other than my "high"-yield Capital One 360 savings account (0.75 interest rate), anywhere else you'd park $3K for 7 months?

[slugline]

The best "parking spot" might be a bank that gives out signup bonuses for customers opening new checking or savings accounts. The typical "catches" might be requirements to leave the account open for three to six months and maybe a minimum number of transactions. But the bonuses are usually much higher than any interest you'd get the normal way in a bank account.

[ysette9]

Given that this is the MMM forum, I am surprised that no one has smacked you upside the head for the cars and the car loans yet. Given the debt you have and the shear number of loans you have outstanding, carrying loans on two cars is nuts. I get needing a vehicle for the whole family but that can be done much more cheaply. As an example, my husband recently swamped one of our cars out for a 2005 Rav4 that cost us something like $6k. I'd recommend looking into selling your current car or cars and get something cheaper for all cash. That would free up some important cash flow to throw at those student loans.

[skuzuker28]

Given that this is the MMM forum, I am surprised that no one has smacked you upside the head for the cars and the car loans yet. Given the debt you have and the shear number of loans you have outstanding, carrying loans on two cars is nuts. I get needing a vehicle for the whole family but that can be done much more cheaply. As an example, my husband recently swamped one of our cars out for a 2005 Rav4 that cost us something like $6k. I'd recommend looking into selling your current car or cars and get something cheaper for all cash. That would free up some important cash flow to throw at those student loans.

Thank you!  I thought I had posted on the wrong forum or something. :)

It is no doubt a less than ideal situation, but one I think we are going to have to live with.  We would at best break even if we sold right now, but probably not.  I tried to convince my wife to drive a cheaper minivan, but didn't win her over.

However, the cash flow situation was part of the impetus for posting: would you suggest putting our current extra cash flow towards the auto loan(s) versus the student loans (as I have been doing)?  From a comparative interest rate standpoint that wouldn't appear to be the right move, however it would free up some cash flow relatively quickly as well as make it easier (psychologically) to sell the vehicle. (Wouldn't have all the proceeds go to the bank, or more likely have to write a check to the bank on top of the proceeds and still want a replacement vehicle).

[formerlydivorcedmom]

When your new baby comes, your child care expenses will likely go up by a lot.  How is that going to effect your budget?  (If your costs are similar to mine, it will eat up the $500/month extra you are currently putting towards debt.)

Roughly 25% of your budget is going to the minimums on your non-mortgage debt!!  Adding in your mortgage expenses, and you're at almost 50% of net income going to debt.  That's a hair on fire situation.

Is it possible to reduce your tithing for now as you work your way out of your debt?  When your debt is paid down, you'll be able to increase your charitable giving.
Can electronics and/or entertainment be cut?  You could probably come up with an extra $1k a year towards debt.

I know you don't want to sell one or both cars because you'd barely break even, but think about it this way. Say you sold Auto 1 for $10k.  That means you would need to pay the bank $1k out of pocket (2 months of the amount going to extra debt repayment).  Then you get a new loan for a used car worth $5k.    Yes, you had to pay the bank a little money.  Yes, you still have a car loan, but you've now shaved almost $6k off your debt and likely reduced your monthly payment, giving you more money to put towards debt.

[OvertheRainbow]

I think it is honorable to give, but you and your wife really aren't in a position to be giving away 10% of your net income. I would take that $500 or so and use it to tackle the higher interest rates. Then I would consider getting rid of the cars and getting one or two cash cars worth 3k. If you can find away to get rid of car payments and stop tithing temporarily, you could end up getting rid of quite a bit of student loan debt within two years (more than 1k/month extra to throw at the loans). You also need to at least be contributing up to the match for your 401k.

[skuzuker28]

Thanks for the responses!  Rather than quote (since multi-quoting is apparently beyond my ability) I'm going to address the items brought up in the latest posts.

Tithing:  Honestly, the thought had crossed my mind about suspending this temporarily.  After discussing this with my wife and prayer, we decided to keep tithing.

Cars:  Our most recent purchase (a Honda Pilot) I'm afraid we will be stuck with.  My wife isn't fully on board with Mustachianism, and she REALLY likes the Pilot.  I pushed for a minivan when we were shopping, but to no avail.

Our other vehicle is a 2013 Ford Focus.  On the plus side it is relatively new, has only 45,000 miles, and gets 40 MPG on the highway.  Negative: higher depreciation than expected due to transmission quality issues, won't be able to fit all four of us at one time due to car seat bulkiness and my size, and the loan.  This vehicle has no emotional attachment, so the only pushback from the wife would be the financial side of things.  However, with the right replacement vehicle I'm sure that can be overcome.

Just did a cursory look at CraigsList for vehicles in both the 2-3k price range and the 5-6k range.  I'm thinking I'd want to get at least a mid-size vehicle so there is a hope of having two adults and two car seats fitting.  Unfortunately in the 5-6k range it looks like I would be dealing with high mileage, a rebuilt title, or both.  Same issues in the 2-3k range of course, but you don't really care because hey, the car was only $2k.

If we do go this route, we'd have the option to pay cash at either of the two price points.  We are heading in to my big overtime season, so accumulating several thousand dollars for a vehicle would not be a problem.  Since I don't know of any banks that will finance vehicles in my proposed price range with decent terms, that could be my only option.

401k: Both of our employers do non-elective contributions in lieu of matching (3% for me, 6% for her).  Therefore we have not been doing any deferrals for now in order to have more cash for debt repayment.  Should we move into the 25% fed tax bracket I will probably reconsider.

EDIT: Forgot about childcare.  That will be an extra $400 a month starting in October, so yes our extra available to put towards debt will be reduced.

[zephyr911]

If swapping cars is an option, look at paying the loans down just enough to sell.

If you decide to hold what you have, just go by APRs from the top down for the fastest total paydown. It appears your smaller student loans have the highest rates, so you will achieve a coincidental snowball effect there.

[skuzuker28]

If swapping cars is an option, look at paying the loans down just enough to sell.

If you decide to hold what you have, just go by APRs from the top down for the fastest total paydown. It appears your smaller student loans have the highest rates, so you will achieve a coincidental snowball effect there.

Might look into that for Auto #1.  Like I said, it's primary virtues are the fact that we have it and that it gets good fuel mileage, which is nice to have when my wife wants to visit her family in Washington.

[GrowingTheGreen]

I'm sorry man, but I can't just can't see how giving $600/month is a smart move in your situation.

I realize that religion plays a big role in a lot of people's lives, but you shouldn't be putting yourself in a hair-on-fire position over tithing. I'm not saying quit it all together, but you should seriously reconsider reducing it temporarily.

Once you're in a position to give $600/month, then go for it! Explain your position to your prayer leader: you've got significant debt, a kid, and another on the way. Once you knock the number of loans down, you can jump right back to giving--perhaps even more.

If you dedicated $300/month of that to your accelerated debt payoff amount, you could have your student loan paid off even sooner than May. Boom. Instant cash flow increase. You would still be giving almost $300/month during this time. $300/month is a lot to give!

I want to reiterate that I'm not calling your tithing "stupid" or unnecessary. It isn't. You just need to adjust it to a more realistic level while you're drowning in debt.

It is all about sacrifices. You've got to make them and I'm not seeing any. You're not selling a car and you're not reducing tithing, so what are you going to sacrifice? It sucks. But you've gotta pick something to sacrifice.  The alternative is you'll be in serious debt for a significant part of your life. Pull the trigger!

[skuzuker28]

Again, thanks for the replies!

We will revisit the tithing, no guarantees.

After a long talk with my non-Mustachian wife, the current plan is to aggressively pay down the loan on the Ford Focus in preparation of selling it.  Realistically we probably won't get it paid off until the summer.  I'd list it before then, but I don't know how many people would be interested in the car when I don't have a title in hand.  I know I wouldn't.

After that we should be able to "float" with one car and my bicycle until the right, less expensive car becomes available on CL.  A little frustrating, as there is one on there right now that I think would be a really good fit but can't pull the trigger until we have the money.

[skuzuker28]

Thinking forward to later this year, what are some cars that you suggest I look at?  Honestly I feel much more comfortable with the $6-7k range than the $2-3k.  Some options that I will be considering:

-Honda Fit
-Honda Accord
-Toyota Matrix/Pontiac Vibe
-Mazda 6 (wagon preferred)
-Mazda 3 Hatchback (though fuel mileage is less than I'd like for the size)

Any others that I should throw into the ring?  I consider myself a car enthusiast, so I'm most interested in cars that at least have a modicum of sportiness and fun-to-driveness.  I'm generally biased against domestics (build quality and reliability) and Toyota (yawn-to-drive).

One other consideration: any of you have experience with salvage/rebuilt title vehicles?  While I was looking on CL I saw a lot of them, and in a non-hair on fire situation I'd avoid them, but since I will be paying cash I can consider them to save some money.

[GrowingTheGreen]

I've got a Toyota Corolla. Love it.

Dude. Say no to cars in with a modicum of sportiness. You're up to your eyeballs in debt!

[skuzuker28]

I've got a Toyota Corolla. Love it.

Dude. Say no to cars in with a modicum of sportiness. You're up to your eyeballs in debt!

I'm not necessarily looking for something fast.  For example: instead of the Toyota Corolla, I would prefer the Honda Civic due to its better (in my opinion) suspension damping, manual transmission feel, and steering feel.  Same size, same fuel mileage, similar reliability reputation, but the Civic is more fun to drive.  You will notice that none of the vehicles in my post are exactly hot rods.  By the time I'm in the position to buy I should have some flexibility to wait for the "right" vehicle as the weather will be nicer making it easier to ride my bike (which I only recently got as a result of finding this fine site).

[skuzuker28]

Started a Journal thread, so further updates will be posted there.  Thanks again for your help!

http://forum.mrmoneymustache.com/journals/putting-out-the-fire/

[JLee]

Thinking forward to later this year, what are some cars that you suggest I look at?  Honestly I feel much more comfortable with the $6-7k range than the $2-3k.  Some options that I will be considering:

-Honda Fit
-Honda Accord
-Toyota Matrix/Pontiac Vibe
-Mazda 6 (wagon preferred)
-Mazda 3 Hatchback (though fuel mileage is less than I'd like for the size)

Any others that I should throw into the ring?  I consider myself a car enthusiast, so I'm most interested in cars that at least have a modicum of sportiness and fun-to-driveness.  I'm generally biased against domestics (build quality and reliability) and Toyota (yawn-to-drive).

One other consideration: any of you have experience with salvage/rebuilt title vehicles?  While I was looking on CL I saw a lot of them, and in a non-hair on fire situation I'd avoid them, but since I will be paying cash I can consider them to save some money.

You may be able to find a Mazdaspeed3/6 in that price range, though it may be tough. A salvage/restored vehicle's viability really hinges on the quality of the repair.

[skuzuker28]

Getting to the end of the month, and looks like I'm going to have about $1500 to put towards accelerated debt paydown.  If people have other thoughts regarding paying down the car and selling vs. focusing on the higher rate student loans, speak now!

[JLee]

Getting to the end of the month, and looks like I'm going to have about $1500 to put towards accelerated debt paydown.  If people have other thoughts regarding paying down the car and selling vs. focusing on the higher rate student loans, speak now!

I would go for the highest rate first.  If you want to sell the car(s), you can do that when they are still financed. It's a little more complicated, but really not bad.