Author Topic: Is it ever mustachian to be in debt for 8 years? Or income based loan repayment  (Read 4951 times)

Fuzz

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Mustachians:

My dilemma puts the badassity of paying your own way against a government program that rewards my staying in debt. I'm talking about the income based repayment program for Federal Student loans for attorneys engaged in public service.

Here's my situation. I am government attorney with annual salary of 60K. After taxes, I take home $45,288 per year. In the last 10 months, I have paid off about $15K in debt. Right now, of the $3,774 I take home each month, I save or apply to debt about 50% or $1800.

If I continue in government service, I can apply for income-based repayment. At my salary, I would be looking at less than a $500 payment each month. Under the program, I would need to make 120 months of qualifying payments, after which point all my debt would be forgiven. I'm 20 months into my job, so I would need to make another 100 payments while working for the government. My question is would a mustachian participate in the program?

My student loans are as follows.

$1900 at 5% (to be paid off in the next 1.5 months, this is the first to be paid off even though the interest rate is the lowest. Bite my debt snowball).
$15,312 at 7.55%
$37,364 at 6.55%
$24,062 at 6.55%

Total: $78,620

I have $2500 in savings right now and another $1000 in my checking out for expenses. Retirement is locked up in the State pension plan.

This is a quick and dirty post, so I am going to guesstimate with an online calculator. If I pay 1800 a month toward my loans, I will pay these off by August 15, 2016. 4 years, 3 months. Ugh. I will have made interest payments of $12,286 and total payments of 90K.

In contrast, if I just paid the income based repayment amount, and I'll give my future self a raise and assume my payments averaged $600 a month over the life of the loan, I would make another 60K in payments (100 months left for me at 600 a month). This route "saves" me 30K and takes an extra 4 years, 11 months.

I put the probability of me working in government for the next 8 years at 40%, something less than half but a real possibility. I like my job, but am looking to move to a new city. Because I am a lawyer, there is a also a distinct possibility that I could earn 100K plus a year in private practice. If I moved to the Federal government, I would be at 100K a year in 3-4 years. At that point the IBR payments would be high enough not to save anything.

Would a mustachian even take a government handout like this, when he could do it on his own? Without an unexpected source of income, I don't see early retirement in the cards for me. I enjoy work, but I don't enjoy the idea of working the next 100 months in a row. I'd like to have flexibility to take 3-9 months away from an office job in the next 10 years, ideally I'd teach at a foreign university for 6 months at some point. I also hope to work in the private sector. Right now, I am single and healthy so I could try to improve my savings by 10% and kick $2000 a month toward debt, but I think I would burn out before the debt does.

MMM talked about how most people with a middle class income are better off cutting expenses than trying to earn more money. I think I may be the exception. Alternately, maybe I should participate in the program and be in debt for 8 years. I could use the savings from reducing my monthly payment to invest. But then I'd be locked into the program and when an awesome nonqualifying job comes along in year 7, I'm screwed. Any thoughts for me?

Thanks,

Fuzz

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I don't think it's UN mustachian to take advantage of a gov't program.  For instance we advise people to use tax advantaged retirement vehicles such as 401k and Roth IRA's. 

So I guess you have to make the decision based on whether you like your job enough to lock yourself in it for 8 yrs.  I take it if you decide to use the gov't repayment plan you can't leave after making your decision? Is there a penalty?

I don't think your income qualifies as "middle class".  Maybe for a family of 4? 

So extra work for a white collar employee is probably a great way to knock this debt out.  Let's say you get that 100k job, so that adds up to let's say 25k post tax income.  Don't allow for lifestyle creep and bam!  That loan is gone in less than 3 years!

DA

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I'm with DA. Loan forgiveness is an employee benefit, and one would be stupid not to take advantage of it if it fits one's situation. There's not a huge moral dimension to it for me-- it's just a defined benefit of the job. So the question is, does it fit your situation?

I take it if you decide to use the gov't repayment plan you can't leave after making your decision? Is there a penalty?
It's the same as for other student loans. The government isn't paying part of your loans as you go along. Either you make it to 10 years, and they forgive all remaining balances, all at once, or you don't make it to ten years and you don't get any balance forgiven (and you've only been making the minimum payments, perhaps).

Right now, I am single and healthy so I could try to improve my savings by 10% and kick $2000 a month toward debt, but I think I would burn out before the debt does.

MMM talked about how most people with a middle class income are better off cutting expenses than trying to earn more money. I think I may be the exception.
I think there are a lot of ways you could trim fat from your budget without your lifestyle suffering too much. It's scarier to think about cutting your budget before you start, but much of it doesn't materially affect your quality of life, and due to hedonic adaptation, any changes you don't like won't actually affect your happiness after they're not new anymore. You can make big changes in your budget, especially at first, without making big changes to your lifestyle.

Taylor

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I have about the same amount of student loans, and I take advantage of this program. I don't think this is a "handout" at all. I make considerably less by working in the non-profit sector, and one of the few 'perks' is this program. It frees up capital that I am saving to put into investments and I also put it into my side business.

James

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Based on what you said about thinking about 40% chance of changing jobs, I'd absolutely keep going the way you are going.  Nothing wrong with using the program if you were planning on staying, but I'd get rid of your loans if you are thinking of leaving.  Also, if you paid the $600 per month what would you do with the $1200?  If you invested all of that then I don't think it's a big deal which way you choose.  But if you think you might spend that money, then you are probably a lot better off paying them off in 4 years and then redirecting much of that money into savings.


Also consider the raises that will come, paying it off asap means you will apply those raises to the loans as well.  So that might drop the payoff well under 4 years.  Think of how free you will be in 4 years with no student loans, vs 4 years with a shit load of loans sitting out there, $600 a month still going toward them, and no freedom to change your job and take risks without having those monthly payments hanging over you.


Applying 50% of take home into your loans is absolutely awesome, and I'm sure it absolutely sucks, but I think you will end up looking back and being extremely happy about paying it off like you are right now.

Lars

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I think it is Mustachian to use income based loan repayment if, based on your estimated probability of future behavior, the numbers come out in your favor (Emergency funds being a good example of a similarily addressed issue). FinAid offers some nice calculators to estimate the benefits or costs of income based repayment as you dig deeper.

I see the problem as
Option 1: Pay $1800/month to loan until payed off and invest surplus from that day on
Option 2: Go into income based loan repayment and invest balance of $1800/month with a 60% chance you will move to private sector in x years (I used five).

Value of Option 1 vs 2 = NPV of $1800/month payments until loan is payed off - (NPV of first 5 years of income based loan repayments + 0.4*NPV of next 3 years of income based loan repayments + 0.6*NPV of the lowest cost option of quick loan paydown or continuing income based loan repayments when move to the private sector in 5 years)

Three things stand out:
The income based repayments act like an additional 10% marginal tax on income so pre-tax retirement accounts become even more valuable. I recommend investing significant amounts if you choose option 2.
The income based payments probably wont cover the interest on the loan so loan values will grow over time.
With my assumptions, I calculate that it will cost you $30k work of payments to get your $78 loan forgiven (all net present value). Per year, this is roughly 3/4 of the interest costs.

My back of the envelop calculations say it will be a wash between option 1 and 2 (based on the information provided) so I'd recommend basing it on where you see yourself working in five or ten years especially since choosing option 2 will probably bias you toward staying in the public sector.

pennypincher

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I am so glad you asked this! My husband and I have the same train of thought... We both have significant student loans, are in IBR and he is working for a nonprofit and likely to stay the 10 years.

Even though we have a plan, and are saving the extra money we would be putting towards the loans, and don't want to pass up what will be a significant benefit... it somehow feels wrong to leave debt just sitting there!

Fuzz

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Thanks everybody. I appreciate Lars putting the dilemma into an equation, somehow I think we were both econ undergrads. And James point about how good I'll feel when I have it paid off and how much I'll value the freedom that comes with bucking a student loan payment is well taken.

I'm leaning toward putting everything I can toward it. It's hard to imagine where I'll be in 8 years, so for now I'll keep busting out the loan. I might build a little more a savings cushion 3-4K in liquid savings and just keep plugging away at the loan.




jpo

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I would pay them off considering your uncertainty towards committing the next 8 years to working for the government.

James

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I'm leaning toward putting everything I can toward it. It's hard to imagine where I'll be in 8 years, so for now I'll keep busting out the loan. I might build a little more a savings cushion 3-4K in liquid savings and just keep plugging away at the loan.

Sounds good, make sure you update us along the way!

It's amazing how massive they seem now, how painful it is along the way, how fast you get there, and how quickly your attention changes to looking forward to other goals once you reach that point. 

arebelspy

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I would pay them off considering your uncertainty towards committing the next 8 years to working for the government.

Yeah, but couldn't you just as easily invest the money and keep it liquid?  Then, if you do work long enough to have it repaid, great, look how much extra money you have!  And if you don't (quit for something else), then you can pay them off with all the money you've saved?

I vote to pay the minimum.

pennypincher's doing it correct, IMO.
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Lars

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Yeah, but couldn't you just as easily invest the money and keep it liquid?  Then, if you do work long enough to have it repaid, great, look how much extra money you have!  And if you don't (quit for something else), then you can pay them off with all the money you've saved?


But if it came to paying them off because you quit for something new, wouldn't there be significantly less money than if the student loans had been payed off as fast as possible?

arebelspy

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Yeah, but couldn't you just as easily invest the money and keep it liquid?  Then, if you do work long enough to have it repaid, great, look how much extra money you have!  And if you don't (quit for something else), then you can pay them off with all the money you've saved?


But if it came to paying them off because you quit for something new, wouldn't there be significantly less money than if the student loans had been payed off as fast as possible?

Depends on the interest rate of your student loan versus your return investing.

Looking at the OP's situation (7ish percent) I'd say there's a 50/50 chance he can get that return over the next 8 years, maybe better.

Plus the interest is tax deductible. And if you have a better rate, or can consolidate to a lower one, even stronger for investing.

I'd say it's worth investing if there's even a fairly small chance of still working there and getting them paid off. Yes, you'll pay interest, but every dollar you pay it off is a dollar not earning interest as well.

Again, your risk tolerance may vary, but I'll go for the option that's likely to give me the most money in 8 years, even if it means paying interest.
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Lars

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Arebelspy -
Thanks for the reply. I can definitely understand how you came to your conclusion, which in my mind, is  equally valid. I differed from you in two primary points to get to my conclusion:
Between student loan interest deduction covering less than half of the interest and the fact more money would probably be saved in pre tax accounts once the loan was payed, I considered the deduction a wash.
Lower risk tolerance - With the leverage inherent to the situation I felt a risk premium was needed so I lowered expected return rate used for the estimate.

Fuzz
I'd like to add one additional detail to my recommendation. If you were 60+% sure you'd be staying in the public sector my recommendation would be the same as arebelspy.