Is it time for me to stop focusing on debt?

[fallstoclimb]

I'm at a bit of a crossroads and I could use some advice on making a logical decision.  I suspect this is a win-win either way, but I'm sick of debating and I just want a game plan moving forward.

A few years ago I had $70,000 in student loans, most of which was from a grad degree that maybe in some ways was a mistake.  These have been a major psychological burden and I have been super driven to pay them down, throwing $1500-$2200 at the loans in recent months.

Now we're just about there.  Relevant numbers below:


Student Loan 1: $1,725 at 6.5%   
Student Loan 2: $9,676 at 5.125%  (minimum payment $159)

Mortgage: ~$284,000 @ 3.75%  (don't really care about this)

Emergency fund: $4,000

My retirement contributions: 7% + 6% match, $766 a month total
DH retirement contributions: $140/month


Our annual household income is starting to edge close to the beginning of the phase-out for the student loan interest tax deduction, but I think we will just scoot in with full deduction ability.  This is the first year the amount of interest we will have to write off will actually be below the maximum allowed.  Being able to write off the full interest amount paid is making me consider a few options.


OPTION ONE: Aggressive
Continue aggressively paying down both student loans. There are a couple major expenses coming up (DH fall tuition, car insurance) that will slow it a bit but August is a 3-paycheck month.  If we empty our emergency fund to finish off the loans we should be done by September or October (with basically empty pockets at that point). 

I like this option because we will be debt-free relatively soon -- I really value maximum flexibility in my life, the kind that comes with no debt and an FU fund -- but we are definitely leaving tax benefits on the table doing this because we are not well-funding our retirement accounts.  DH has access to a 457 which I am itching to start contributing to.  This will also be a little stressful because I will keep putting so much money towards the loans that we will run out of money each month.


OPTION TWO: Moderate
Use the emergency fund to pay off Loan 1 today.  Celebrate mildly.  Then automate a payment somewhere between $500-$1000 for the remaining 5% loan and focus on rebuilding our emergency savings and retirement contributions.  Depending on the payment amount, we would finish off the loan sometime next year. (I would probably put any "extra" money -- 3-paycheck month, tax refund -- towards the loan to speed it up a bit in this scenario).

Part of me hates to slow down the payment because I just want it DONE, but this will be much less stressful than running out of money every month because we are throwing every spare cent at the loan, will still get us out of debt reasonably soon, and will allow us to take better advantage of tax advantaged accounts. 


OPTION THREE: Leveraged
Use the emergency fund to pay off Loan 1 today.  Celebrate mildly.  Then just automate the minimum payment of $159 and not spend any more time thinking about this debt.

I don't really like this option, because the repayment will drag on for just about forever, but I do understand the argument that 5% interest isn't terrible and that it may make more mathematical sense to ignore this debt and invest instead.  $159 won't be too tough a payment to make even if me or my husband loses/walks away from our job, and automating the minimum payment might mean I just don't think about the debt anymore, but I do worry about it hanging over my head a bit.  Plus the markets aren't a guaranteed return like debt payoff is.  But maybe lowering your taxable income is? 


So, I'm torn.  What would you do?

[MsSindy]

If I were you, I would go for Option #2.  It sounds like the other options would both cause you too much stress – Opt #1, you’re always running out of money, and Opt #3 would have it hanging over your head forever.

The other thing that you may want to look at when comparing the interest rate you’re paying on the loans, is your ACTUAL return from your investments.  If it is only a couple of points over your interest loan, I would def keep paying off the debt.  However, if it was somewhere like 10 points over your interest loan, then I would lean toward the slower repayment of debt and invest the rest.  But use your actual ROI, not something hypothetical.

Once you make your decision though, stick with it and don't give it another thought....no more stressing out. 

[homeymomma]

I also like option 2. We did option 1 not long ago and it felt great to get that debt down to 0, but we had a wild-feeling few months afterwards, while building our emergency fund back up. Thankfully no emergencies arose, but it was a little silly to cut it that close, in retrospect.

I don't like option 3 because your rate on the final loan is still quite high. 5.1% guaranteed return is pretty good in my book. I'd think minimums might be ok if they were in the 3% range, but 5.1% is too high.

Option 2 is especially good if you are already excited about putting money towards investments. You're still being relatively aggressive with the debt, but you're setting aside money for retirement as well. Best of both worlds.

Congrats on getting so close! You'll be there before you know it :)

[rmendpara]

I'd go with #2. You only have $11k in student debt remaining.

You mention "tax deduction", but it's basically nothing (barely more than $500/yr of deduction... plus it will phase out soon).

I'd set a target payoff 18 months from now for all student debt, and then just go at it. I would not spend your e-fund to pay off debt... that's not what emergency savings are for.

If you had $30k+, I may change my opinion, but given it's $11k, and you bring in ~$70k/yr gross, I think you can pay it off within 1-2 years without too much pain.

If it were me, I'd prioritize as such:

- Do not lower your emergency fund (at $4k it is low already... especially with a hefty mortgage you'd blow through that in a month or two of being jobless)
- Set a payoff date for next year, maybe 10/2015 (right before Thanksgiving!), and just go to town on it. It's around $700 in interest plus $11k in principal, so maybe ~$12k total (very rough math)... $1k/mo until you're done?
- Don't mention tax deduction on student loans... ever. It's a dumb reason to stay in debt... especially at 5%+
- Once your student debt is gone, you'll have an extra $1k/mo, maybe split extra $500/mo toward mortgage and the rest toward saving/investing? Imagine being completely debt free in 10-15 years and have monumental cash flow to save/invest/spend!
- With a mortgage and family, you typically want to have 6 mo. in liquid savings (as a general rule), and then never touch it. You could invest it, but what's the point on such a small amount.

Don't fall into the trap of just thinking only about your borrowing rates. What if you had a $1 million mortgage at 2.5%, would you still feel good about keeping it lying around?

My only addition to this would be to work toward maximizing your 401k contributions as you pay off debt.

In any case, my applause for getting your loans down from $70k to $11k. That's some serious commitment! I have no real worries about your situation now, and I'm sure you have a great financial future ahead.

[fallstoclimb]

Well, in our defense, we are both public employees in a state that's doing pretty okay at the moment -- no one's about to lose a job.  In fact we've both gotten a bunch of small raises this year to make up for the lean years.  We're also immune to car emergencies, and have no children, and have health insurance and lots of sick leave -- yes stuff could happen, but stopping loan payments brings in an instant influx of $2K monthly.  I'm really not that worried.  The only thing that is likely to go wrong would be a house thing.

So, I am planning on taking out 1700 from the emergency fund to pay off the smaller loan if we go with option 2, which is currently the unanimous winner.  Under option 2, I would then build up the e-fund to somewhere around 5-7K before starting to tick up retirement contributions.  I would like a 12K emergency fund eventually but I am really not too worried about briefly being cash-poor.  There's always credit card gaming (we have excellent credit), or a low-interest loan from family.

[AccidentalMiser]

Damn!  Nice job!

I'll be another vote for option 2. 

[Chranstronaut]

I recently paid off my $22,000 student loans @ ~5.5% fairly aggressively.  My reasoning was influenced because I had a well paying job, but lacked job security.  I wanted to know that I had enough savings to get me through a possible union strike and later layoffs, and I wanted to be as free as possible from my student loans so I had fewer required expenses to manage.  I didn't have a mortgage, but I would probably do it the same way again if I did.

Here was my plan, executed between Jan 2013 and May 2014:
1) Made sure I was contributing the matched amount into my 401k and saved 2 months of income.  This was before I read MMM, but I was naturally rather frugal.  This mini E-fund was meant to tide me over for a union strike, but was not a long term emergency plan.

2) Put my loan payments on auto-pilot for minimum amount.  My lender offered to lower my rate by 0.25% simply for signing up for direct payments, so that was a free money no-brainer.  It doesn't sound like you have this option, but it never hurts to double check.

3) Apply extra money to the loans every month except for a set amount to the emergency fund.  Everything was tracked in Mint.  I don't keep a strict budget, but I do have a solid idea of my expenses for the big three: Housing, transport and food.  I set aside a small set amount to gradually bring my emergency fund past the 2 month minimum I set (shooting for 6 months).  This is about the time I started reading MMM and realized I can increase my payments even more and decrease my expenses a lot.

4) Pay loans like crazy and start to cut expenses.  After my automatic minimum payments went through, I'd apply the rest I had allotted into the account.  All extra money went to the loans.  3rd Paycheck in the month? Student loans. Tax Return?  Student loans.   Birthday gift?  One humble dinner out and student loans. This pushed my payment due dates out by at least a year and paid off a bunch of the loan.  It also got me adjusted to living on a small amount of my income.  I got about halfway through my loans this way.

5) Find out there will be layoffs in late 2013 and begin to realize the value of having FU money.  Adjust payment schedule to allot more to savings to give me a bigger emergency fund and pay slightly less per month to loans (still way above minimum).

6) Meet my FU money goal of 1 year expenses.  Dump money into loans again.  Apply all gifts, tax returns, and windfalls to student loans in Jan-Mach 2014.  Pay off $11,000 in three months without touching emergency fund.  Kiss Sallie Mae goodbye.

6a) Immediately max out 401k to prevent lifestyle creep.  Adjust W-4 statement because I was over paying taxes.  Set up vanguard account.  Watch as my stache grows exponentially because I am saving all the cash I was sending to my loans.

When I found out about layoffs, I did the math and tried to figure out the cost of my different scenarios.  In the end, it would have saved me ~$700 in student loan interest to wait to build my FU stache, but emotionally it was a better choice for me.

Regardless of job security/mortgage/whatever, I feel that the trade off of your leveraging option isn't great when your interest rate is over 4%.  Like you mention, there's no guarantee of growth in the investments that will beat that rate, and this debt is a psychological burden for you.  I also agree with rmendpara, keeping loans for the tax deduction is a poor trade off.  Better to double check your exceptions on your pay account and make sure you are as close to perfectly paying your taxes rather than hoping for a big return (which is losing you interest money for every month you wait to get it back).

Out of your given options, I also support #2, but I wouldn't get rid of your emergency fund. I just read your reply and that actually sounds pretty reasonable.  If you feel okay doing the "credit card as emergency fund" for a short time, it's a gamble, but might work okay since you have a fairly low-risk lifestyle other than your mortgage.
I wouldn't worry to much about the delay you will see in retirement savings while you pay down your loans.  If you run the scenarios mathematically, it won't affect your FI date much.  I did this and it made less than 1 years difference using a rough approximation. However, having no loans is a HUGE weight off my shoulders.  Good luck!

[Prairie Stash]

I did option 1, I vote option 1.  It was wonderful to eliminate the loans from my name.  The added flexibility allowed me to get creative and have more options later on, that I didn't recognize immediately. 

Obviously kill the little loan today. 

[rmendpara]

Well, in our defense, we are both public employees in a state that's doing pretty okay at the moment -- no one's about to lose a job.  In fact we've both gotten a bunch of small raises this year to make up for the lean years.  We're also immune to car emergencies, and have no children, and have health insurance and lots of sick leave -- yes stuff could happen, but stopping loan payments brings in an instant influx of $2K monthly.  I'm really not that worried.  The only thing that is likely to go wrong would be a house thing.

So, I am planning on taking out 1700 from the emergency fund to pay off the smaller loan if we go with option 2, which is currently the unanimous winner.  Under option 2, I would then build up the e-fund to somewhere around 5-7K before starting to tick up retirement contributions.  I would like a 12K emergency fund eventually but I am really not too worried about briefly being cash-poor.  There's always credit card gaming (we have excellent credit), or a low-interest loan from family.

Emergency savings aren't just for a job loss... but could be for any number of things... usually as a homeowner something will come up eventually that costs a $ few thousand... or you break your ankle and need a cast... or you get drunk and punch someone in the face who sues you and you settle for $1k... or whatever.

It's more for peace of mind. You mentioned a credit card as a backup... which will work fine since you have good credit... but it's going to make you more prone to anxiety. Maybe not... if so, go for it.

$12k is a very solid target (again, no need to get to that level immediately), but a good idea to work toward.

I suppose the dream is in 2 years to have your student loans extinguished, have $12k in savings, and just have your mortgage and wonderful investable cash flow each month to play with. :)

[Cheddar Stacker]

First - Congrats! Second - either way is a winner so relax and celebrate, we are merely discussing optimization.

I already let you know my thoughts elsewhere, but I'll chime in here as well. I like fixed interest debt, and I carry quite a bit of mortgage and SL debt at 2.875% and 4%. I'd rather invest. So obviously I would rank the options in order of optimization as: #3, #2, then #1.

If you go with #2 and plan to build up the EF, make sure you consider utilizing the rest of this year to maximize your tax deferrals. That window closes on 12/31 for the 401K's/403b's/457's. I'm not saying you shouldn't have an EF, just maybe delay the full funding of it slightly in order to take advantage of 2014 tax deferrals.

- Don't mention tax deduction on student loans... ever. It's a dumb reason to stay in debt... especially at 5%+

This is a bit too certain of a statement IMO. I hesitate to say don't, ever, dumb, etc.

I've also had other conversations previously with fallstoclimb about this and it may have been mentioned specifically because I mentioned it previously, so I feel the need to defend it. I agree that staying in debt simply to get a tax deduction is likely a mistake. I mentioned it should be considered in the optimization strategy. If you are in the 25% tax bracket, your interest rate is really not 5.125%, it's 3.844% (5.125% * (1-25%)).

So, when comparing the return you could achieve in the market, or the employer match, or maxing out your 401K and yielding tax savings, all of these things should be compared on an after tax basis. If your AGI is $140K, making a $15K contribution to your 401K becomes so much more important if you are also paying SL interest due to the phase-outs. I believe this is why OP mentioned the tax deduction, and rightly so IMO.

[dragoncar]

Another(?) vote for option 4: Don't touch your emergency fund.  Agressively pay off loan 1, then loan 2 in the exact same fashion that's been working for you so far.  They should be gone within a year anyways, right?

[fallstoclimb]

Ha, right, I didn't even put the option of just continuing what I've been doing on the table.  I think I'm just getting impatient.  It also makes me a little nervous to carry an e-fund of just 4K for another year -- I'd rather finish off the one loan and let the e-fund drop to 2K for a month (or be a grown up about it and just wait until next month to finish it off, leaving the e-fund alone), and then focus on increasing e-fund and retirement while trying to give myself permission to not think so much about the one last remaining loan. 

The benefit of just one loan is I can automate an overpayment that is (obviously) applied 100% to the loan in question.  Previously the automated amount was divided weirdly and automatically among all loans, varying the ones that were overpaid, so I couldn't snowball the debt.  Instead I let the minimums be paid automatically and then manually put all our money (sometimes too much of our money) to the targeted loan. 

So what's changing is now I can set an automated amount for the targeted repayment, and maybe do a better job of living my life/ saving more. 

Obviously this is a win-win, I'm in a great position here, but I am having a surprisingly difficult time landing on a strategy.

[rmendpara]

Ha, right, I didn't even put the option of just continuing what I've been doing on the table.  I think I'm just getting impatient.  It also makes me a little nervous to carry an e-fund of just 4K for another year -- I'd rather finish off the one loan and let the e-fund drop to 2K for a month (or be a grown up about it and just wait until next month to finish it off, leaving the e-fund alone), and then focus on increasing e-fund and retirement while trying to give myself permission to not think so much about the one last remaining loan. 

The benefit of just one loan is I can automate an overpayment that is (obviously) applied 100% to the loan in question.  Previously the automated amount was divided weirdly and automatically among all loans, varying the ones that were overpaid, so I couldn't snowball the debt.  Instead I let the minimums be paid automatically and then manually put all our money (sometimes too much of our money) to the targeted loan. 

So what's changing is now I can set an automated amount for the targeted repayment, and maybe do a better job of living my life/ saving more. 

Obviously this is a win-win, I'm in a great position here, but I am having a surprisingly difficult time landing on a strategy.

I don't subscribe to all his (somewhat extreme) views, but I think Dave Ramsey makes a good point. In response to a caller arguing that it's advantageous to defer paying on a low interest loan, I think he said something along the lines of "If you understood math, you wouldn't have a debt problem."

Keeping student loan debt.. or a mortgage.. or a car note.. or whatever.. seems to make little sense if you have backup savings, adequate investments, and debt that needs to be paid off. Also another Dave Ramsey quote (which I'm sure I dno't have exactly right), but "So you telling me you want to keep paying the lender $1 so you can save $.05?".

Again, losing the forest looking for the trees.

Fallstoclimb:

You hit the nail on the head. Another poster mentioned this, but you really are just "optimizing" at this point. I'll say just go with whatever helps you sleep at night. The difference between the options is minimal... so if any makes you feel better, just go with that.

Congratulations on making it to the last mile!

[Cheddar Stacker]

I would not spend your e-fund to pay off debt... that's not what emergency savings are for.

Keeping student loan debt.. or a mortgage.. or a car note.. or whatever.. seems to make little sense if you have backup savings, adequate investments, and debt that needs to be paid off.

I don't mean to pick on you rmendpara but these two quotes from you seem to contradict one another. Should falls spend the efund to pay off debt, or keep the student loan debt while maintaining backup savings?

I would rather carry debt so I know my answer, but if you plan to get rid of debt why would the EF be sacred?

[rmendpara]

I would not spend your e-fund to pay off debt... that's not what emergency savings are for.

Keeping student loan debt.. or a mortgage.. or a car note.. or whatever.. seems to make little sense if you have backup savings, adequate investments, and debt that needs to be paid off.

I don't mean to pick on you rmendpara but these two quotes from you seem to contradict one another. Should falls spend the efund to pay off debt, or keep the student loan debt while maintaining backup savings?

I would rather carry debt so I know my answer, but if you plan to get rid of debt why would the EF be sacred?

Ahh, missed negatives totally throw off the intended meaning. That would give my middle school language arts teacher a heart attack. :)

Should have written that it's not a great idea to spend an emergency fund to pay off debts (again, assuming they are not emergency debts like credit cards which are costing you an arm and a leg to hold onto... since this isn't the question, I'll ignore).

#2 is just a poorly written sentence. I should have said that it doesn't make sense to hang onto debt if you do have backup savings and some sort of investing plan (e.g. 401k... invest enough to get the match at least). Keep the savings and the automatic investments that are optimal (like getting a 401k match), and then throw all extra money toward the debt. Maybe during a final payment it makes sense to draw on e-funds to pay off, since you'll have positive cash flow very shortly. It would be a real struggle to use up all your savings while still having substantial debt left, AND then coming up with an emergency and not having a way to pay for it. Not sure what I was thinking when I wrote it the first time around. :)

To your second question: my point about keeping an e-fund is that if you use it to pay off debt, and then run short on cash, you're stuck with nothing but credit cards for a little breathing room. The idea is to obviously set up a plan/goal, and then start marching toward it. Unless the debt truly is an emergency, and you have nothing to lose, I wouldn't advise someone to use up their e-fund to payoff debt.

The counter to this is if Fallstoclimb (or anyone, really) had $11k in credit card debt (which was costing him/her 19% interest)... while sitting on a $4k e-fund... different risks to consider.

[fallstoclimb]

Discussed this with the husband last night.  Option 2 it is, but he was actually pretty dismayed that our plans went from finishing up the loans this fall with empty pockets to living with this debt for another year-ish.  I think we are going to re-evaluate on the big loan after paying the major summer bills and getting our third paychecks in August - with scheduled raises this may be more doable than I was calculating. 

Finishing off the smaller loan at the end of the month - thrilled about that. 

[Cromacster]

I agree that option 2 seems like a good way to go, a lot less stress on you guys.  But I'll bet it will get down to 3,000 or 4,000 remaining balance and you'll say fuck it and just pay it off.

Not to side track too much but...

We paid my wife's last student loan off about 6 months ago.  This week we got the copy of the document in the mail which she had signed when she was 18 years old with a big red stamp on it "Paid in Full".  She was pretty pumped to see that.

[fallstoclimb]

Not to side track too much but...

We paid my wife's last student loan off about 6 months ago.  This week we got the copy of the document in the mail which she had signed when she was 18 years old with a big red stamp on it "Paid in Full".  She was pretty pumped to see that.

You guys should frame that :)

[Cheddar Stacker]

You mean this?



I'm sure that felt great. Congrats!