Author Topic: Need opinions on prioritizing debt payoff  (Read 5567 times)

OnlyKetchup

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Need opinions on prioritizing debt payoff
« on: May 15, 2014, 10:26:51 PM »
So, I'm a fairly new reader but have always been frugal, and have quickly bought into the FI/early retirement concept. We definitely have some Anti-Mustachian luxuries, but are willing to make some changes.

Here is our debt situation:
Car 1 - 22k @ 2% = $630 per month
Car 2 - 35k @ 2% = $610 per month
Student Loan 1 = 25k @ 3.25%
Student Loan 2 = 9k @ 5.25%
Student Loan 3 = 5k @ 2.1%
Student Loan 4 =  4.5k @ 4.6%
Total Student Loan payments ~$600 per month
House  = 220k @ 4%

We are maxing both of our 401k's, have 30k we can use to payoff debt immediately, and 3k per month to put towards faster payoffs. I think the traditional logic would be to target the highest apr debt first, but I'm struggling with the idea of paying off the cars sooner to add to the money we have to payoff the other debt.

I'm currently thinking:
Use cash to payoff two highest interest rate student loans
Put remainder of cash towards Car 1
Use extra 3200 per month to payoff Car 1 in 2 months
Now I am struggling with whether to witch focus to the house, or payoff car 2 to add another $610 and then focus on the house?

Thanks in advance for any input!

SDREMNGR

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Re: Need opinions on prioritizing debt payoff
« Reply #1 on: May 15, 2014, 10:44:50 PM »
It is really simple.  Don't go Dave Ramsey on us and pay off things just so you can have a "win" and see things crossed off a list.  Making rational and smart decisions is what will make you money, not making emotional ones.

Based on your rates, pay off the 2 student loans with high interest then pay off your mortgage (if you don't benefit from the deductions) or the other student loans. 

You haven't mentioned it, but getting cheaper cars should be the next steps.  If you want / need to drive a fancy car for some reason, you can still find a nice one for less than 20k and your second car could be a more used one for under 10k.

MDM

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Re: Need opinions on prioritizing debt payoff
« Reply #2 on: May 15, 2014, 10:53:34 PM »
+1

There's a reason the logic is "traditional": because it is financially correct.  You could improve this a bit by calculating your after-tax interest rate (e.g., it may be better to pre-pay on a 2% non-deductible interest than a 2.1 % deductible), but otherwise....

OnlyKetchup

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Re: Need opinions on prioritizing debt payoff
« Reply #3 on: May 15, 2014, 11:04:19 PM »
Thanks for the responses. I was also wondering, with as low as some of the debt is, at what point would it be the right time to focus on after-tax investment?

AccidentalMiser

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Re: Need opinions on prioritizing debt payoff
« Reply #4 on: May 15, 2014, 11:11:14 PM »
Please, reconsider the wisdom of driving high-priced cars. 

The order in which you pay your particular debts will have little true impact in the long run, buying cars with $600/month payments will destroy you.

Also, I wouldn't pay your mortgage off early unless you intend to stay in the house long-term.  Home equity is dead money in many ways.

SDREMNGR

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Re: Need opinions on prioritizing debt payoff
« Reply #5 on: May 16, 2014, 12:10:24 AM »
Please, reconsider the wisdom of driving high-priced cars. 

The order in which you pay your particular debts will have little true impact in the long run, buying cars with $600/month payments will destroy you.

Also, I wouldn't pay your mortgage off early unless you intend to stay in the house long-term.  Home equity is dead money in many ways.

It's not dead money. It's 4% yield less any tax benefits.  Not very much but it's better than most risk free returns this day in age.

At the risk of beating a dead horse, the real dead money is in the cars.  It sounds like the OP is not ready to make the leap into serious fat cutting yet. But if they were willing to give up those then it would free up some serious cash. 

There should be a federal law that says if you have any student loans,  you are not allowed to pay more than 2 months salary for a car.

Eric

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Re: Need opinions on prioritizing debt payoff
« Reply #6 on: May 16, 2014, 12:59:09 AM »
Here is our debt situation:
Car 1 - 22k @ 2% = $630 per month
Car 2 - 35k @ 2% = $610 per month
This is INSANE!!  Seriously.  Here's a debt payoff idea for you.  Sell both of these cars.  Take your money and pay off these:

Student Loan 1 = 25k @ 3.25%
Student Loan 2 = 9k @ 5.25%
Student Loan 3 = 5k @ 2.1%
Student Loan 4 =  4.5k @ 4.6%

Any remaining money can be used to purchase two reasonably priced used cars for cash.  (Or better, one car and a couple of bikes)  And you now have no more non-mortgage debt AND no car or student loan payments.  You're welcome.

former player

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Re: Need opinions on prioritizing debt payoff
« Reply #7 on: May 16, 2014, 02:08:36 AM »
No credit card debt, no personal loans, and a significant amount of spare cash to spend paying down debts.  You are doing fine by most criteria.  (You haven't posted income and expenditure, so whether you are truly mustachian yet is between you, you paychecks and your bank balances!)

Here's my suggestion-

1.  Pay off student loans 2 and 4.
2.  Put $17.5K (the rest of your $30,000) into the mortgage.  (Unless you are going to walk away from the house and give the keys back to the lender, there is no financial downside to paying off this mortgage.  Whether you keep the house or sell it and rent is a separate question.)
3.  Put your $3,000 a month to student loan 1 and then student loan 3.  You'll have all your student loans paid off within the year.  (Yes, I know that you are paying higher rates on your mortgage.  But once your student loans are paid off, you have officially grown up, and will only have debts related to your current situation, not your past.)
4.  The two cars instantly refute the notion that "you have always been frugal".  But it is up to you to choose your priorities.  Even with the cars, you have $36,000 a year to put into paying off loans and then investing, so they are not a "hair on fire" problem.  If you like them, keep them.   However, as you are now interested in FI/ER, it might be worth your doing the sums on how much they are costing you in terms of extra years of work, and whether that is a figure that makes you happy.

nereo

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Re: Need opinions on prioritizing debt payoff
« Reply #8 on: May 16, 2014, 05:12:38 AM »

Here is our debt situation:
Car 1 - 22k @ 2% = $630 per month
Car 2 - 35k @ 2% = $610 per month
Student Loan 1 = 25k @ 3.25%
Student Loan 2 = 9k @ 5.25%
Student Loan 3 = 5k @ 2.1%
Student Loan 4 =  4.5k @ 4.6%

Ditto paying off loan SL-2 immediately and then SL-4.
Question:  why is Car 2's monthly payment less than Car 1 if it's 63% greater loan at the same interest rate?  Is one a 3 year and one a 5 year loan? Is $22k and $35k what you still owe on the cars?

I'd seriously consider selling at least one of the cars, buying a still-very-nice-used-car for ~$10k-12k and plowing the extra $600/month into debt reduction and/or savings.  This will chop YEARS off the date until you are FI.


Thegoblinchief

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Re: Need opinions on prioritizing debt payoff
« Reply #9 on: May 16, 2014, 07:00:46 AM »
My advice would be Eric's, word for word. That is a silly amount of money to have tied up in rapidly depreciating assets.

Then again, avongil will show up with his magic spreadsheet showing how this really "saves" money...

If you're not willing to change lifestyle, the optimal decision is to only prioritize debts over 4%.

OnlyKetchup

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Re: Need opinions on prioritizing debt payoff
« Reply #10 on: May 16, 2014, 09:31:43 PM »
Definitely wouldn't say I'm Mustachian yet, this is literally week 2. Our expenses are over the top, so I have worked a new budget to cut that back some.

I realize the cars are a bad idea, and have been thinking about dumping one of them. I'm a car guy, so getting rid of both would be a tough choice. I just looked at a savings calculator, and the savings is quite impressive though. On the plus side, Car 2 is worth slightly more than I paid a year ago.

No credit card debt, no personal loans, and a significant amount of spare cash to spend paying down debts.  You are doing fine by most criteria.  (You haven't posted income and expenditure, so whether you are truly mustachian yet is between you, you paychecks and your bank balances!)

Here's my suggestion-

1.  Pay off student loans 2 and 4.
2.  Put $17.5K (the rest of your $30,000) into the mortgage.  (Unless you are going to walk away from the house and give the keys back to the lender, there is no financial downside to paying off this mortgage.  Whether you keep the house or sell it and rent is a separate question.)
3.  Put your $3,000 a month to student loan 1 and then student loan 3.  You'll have all your student loans paid off within the year.  (Yes, I know that you are paying higher rates on your mortgage.  But once your student loans are paid off, you have officially grown up, and will only have debts related to your current situation, not your past.)
4.  The two cars instantly refute the notion that "you have always been frugal".  But it is up to you to choose your priorities.  Even with the cars, you have $36,000 a year to put into paying off loans and then investing, so they are not a "hair on fire" problem.  If you like them, keep them.   However, as you are now interested in FI/ER, it might be worth your doing the sums on how much they are costing you in terms of extra years of work, and whether that is a figure that makes you happy.

OnlyKetchup

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Re: Need opinions on prioritizing debt payoff
« Reply #11 on: May 16, 2014, 09:41:48 PM »

Here is our debt situation:
Car 1 - 22k @ 2% = $630 per month
Car 2 - 35k @ 2% = $610 per month
Student Loan 1 = 25k @ 3.25%
Student Loan 2 = 9k @ 5.25%
Student Loan 3 = 5k @ 2.1%
Student Loan 4 =  4.5k @ 4.6%

Ditto paying off loan SL-2 immediately and then SL-4.
Question:  why is Car 2's monthly payment less than Car 1 if it's 63% greater loan at the same interest rate?  Is one a 3 year and one a 5 year loan? Is $22k and $35k what you still owe on the cars?

I'd seriously consider selling at least one of the cars, buying a still-very-nice-used-car for ~$10k-12k and plowing the extra $600/month into debt reduction and/or savings.  This will chop YEARS off the date until you are FI.

One was a 4 year loan, the other a 6 year. Those are the amounts still owed...

You are correct, I ran the numbers now and it is significant.

milla

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Re: Need opinions on prioritizing debt payoff
« Reply #12 on: May 16, 2014, 09:54:10 PM »
The cars are ridiculous. Get rid of those immediately. I have a $1500 14 yr old Camry I could sell you if only I wasn't still using it.

SDREMNGR

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Re: Need opinions on prioritizing debt payoff
« Reply #13 on: May 16, 2014, 10:31:13 PM »
Do some car shopping outside of used car lots.  I bought my last car for cash at a government auction in Vegas last year.  I got it for about $6900 including tax and saw one sold on ebay with more miles for $10k.  You have to pay cash or you can use credit card but the 3% savings for cash makes the mile points less useful.

I've seen BMWs, Priuses, buses, lots of Crown Vics, harleys, trucks, etc come through.  You can get a pretty nice lower mile car (mine had 64k) for not very much.

horsepoor

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Re: Need opinions on prioritizing debt payoff
« Reply #14 on: May 16, 2014, 11:06:08 PM »
Agree on selling one, preferably both cars and downscaling (guessing with those price tags that they are not the most fuel-efficient models, either - double win dumping the less efficient one and getting a Prius or a Honda Fit or something).

Other than that, assuming they're all fixed rate, the only loans I would really worry about paying off are the two higher-interest student loans.  You're getting tax write-offs on the mortgage and SL's, presumably, so you're kind of at the tipping point where it makes more sense to invest your extra cash, rather than throwing it all at low interest debt.  Or do a hybrid approach and accelerate some of the debt payments, and do some investing with the leftover cash.

nereo

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Re: Need opinions on prioritizing debt payoff
« Reply #15 on: May 17, 2014, 09:08:48 AM »

I realize the cars are a bad idea, and have been thinking about dumping one of them. I'm a car guy, so getting rid of both would be a tough choice. I just looked at a savings calculator, and the savings is quite impressive though. On the plus side, Car 2 is worth slightly more than I paid a year ago.

Holy cow!  If that's true take advantage of it now and sell that car off!  You will rid yourself of a $610 monthly car payment over the remaining 5 years of that loan, and you will have cash in your pocket.  If you really must, use some of that cash and find something more reasonable - and invest the many-hundreds-of-$ difference each month. 
This alone will cut years off your FI and/or let you clobber that debt in just a couple of years.

Another Reader

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Re: Need opinions on prioritizing debt payoff
« Reply #16 on: May 17, 2014, 09:28:49 AM »
I would not pay off the tax advantaged mortgage.  In your shoes, I would sell the more ridiculous car and buy something more reasonable.  You can afford toys later, once you are FI.  I hate student loans because of the risk they pose, so I would pay off all the smaller ones.  The $25k loan may be deductible, so at that point I might start looking at pointing the fire hose at taxable accounts, unless you have more space in tax deferred or Roth accounts.  I would max out all of that space first.  Oh, did I mention selling one of the cars?

rmendpara

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Re: Need opinions on prioritizing debt payoff
« Reply #17 on: May 17, 2014, 01:56:55 PM »
So, I'm a fairly new reader but have always been frugal, and have quickly bought into the FI/early retirement concept. We definitely have some Anti-Mustachian luxuries, but are willing to make some changes.

Here is our debt situation:
Car 1 - 22k @ 2% = $630 per month
Car 2 - 35k @ 2% = $610 per month
Student Loan 1 = 25k @ 3.25%
Student Loan 2 = 9k @ 5.25%
Student Loan 3 = 5k @ 2.1%
Student Loan 4 =  4.5k @ 4.6%
Total Student Loan payments ~$600 per month
House  = 220k @ 4%

We are maxing both of our 401k's, have 30k we can use to payoff debt immediately, and 3k per month to put towards faster payoffs. I think the traditional logic would be to target the highest apr debt first, but I'm struggling with the idea of paying off the cars sooner to add to the money we have to payoff the other debt.

I'm currently thinking:
Use cash to payoff two highest interest rate student loans
Put remainder of cash towards Car 1
Use extra 3200 per month to payoff Car 1 in 2 months
Now I am struggling with whether to witch focus to the house, or payoff car 2 to add another $610 and then focus on the house?

Thanks in advance for any input!

In general, you should work toward paying off all debt; however, not all debt is bad debt. Just like a company, you can actually improve your overall financial progress by using debt strategically (e.g. student loan interest deduction and mortgage interest deduction).

If I were you, I would work to pay off (in this order) Student Loan 2, then Student Loan 4. At that point, I would just keep paying the minimum on all the remaining debt and then take your extra cash flow and invest it.

In the long term, 4% or lower rate debt is barely costing you anything.

In any case, to answer your specific debt question, attack them in descending order starting with the highest rate.

You didn't ask, but I do think you overspent on the car(s). Overspending is a much bigger problem than paying higher interest rates. You may have a reason (kids on the way, AWD if you live in a snowy region, etc).

Full disclosure: I also bought a nice car a few years back in 2009, I purchase a '08 Acura TSX with 30k miles for $24k. It was a little nicer than I needed, but I personally think the car is very high quality, and maintenance is barely higher than a Honda Civic (less the tires), and I do get more enjoyment out of it than something that I could have bought for $5k less. Right now, I have ~90k miles on it, and will likely keep it until at least 120k, longer if it keeps running smoothly and no costly problems come up. Also, I have total investments around $135k, so the $23k car doesn't really seem too outrageous. Also, I don't have any debt (pet peeve of mine).

I have realized that cars are just a money pit. They depreciate like crazy, are expensive to maintain, and are only really exciting for the first year or so. Then it's just life as usual.

On my next purchase, probably in ~5 yrs, I am targeting a $25k purchase used entry-level luxury car, sort of like the TSX I already have. It's a bit pricier, but the quality is there, and I appreciate the basic luxuries, plus it's not hurting my financial picture.

We're not all perfect, but I do commend you for re-examining your family's situation and starting to take action. That's always the first step.
« Last Edit: May 17, 2014, 02:08:19 PM by rmendpara »