Author Topic: Reader Case Study - most efficient way to spend cash flow  (Read 3513 times)

adgmustache

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Reader Case Study - most efficient way to spend cash flow
« on: August 24, 2014, 12:29:54 PM »
Hi all,

I’m looking to get some advice on my goals.  Growing up less than middle-class, I’ve always been pretty frugal (most people say “cheap,” but ‘merica is ‘merica).  My wife and I are looking for an independent opinion on prioritizing our cash flow.  I admit I haven't made it all the way through the MMM posts yet, so I apologize if this kind of thing has been explicitly covered.  Here are our current stats:

Background/income
•   24 years old.  Been working over a year now with a major U.S. retailer (above-average evaluations, steady raises, and a recent promotion – I don’t have much concern about losing my job sans a major economic incident).  I make a bit over 60k per year, no bonus.
•   Wife is also 24 years old.  She’s a teacher, making 34k per year (lolnobonus).

Savings
•   I contribute 8% to my 401k, with a 4.25% employer match.  Wife has a defined benefit pension plan through the state.  I also contribute 5% of my pay to an ESPP where I get a 15% discount on my company’s stock.  Thinking about starting an IRA for my wife just in case the state decides to bone us on the pension.
•   We currently have about 15k in cash, 6.5k in stocks (one big index fund and some dividend stocks like GE and DUK), and about 4.5k in my 401k (all target maturity/growth oriented funds).
•   We currently prepay on all of my loans: about $400 (additional) on my student loans, and about $300 on my car loan. I also paid off about 5k in student loans (ones that weren’t consolidated to one servicer), and used about 4k as a down payment to replace an old, nearly dead, gas guzzling Jeep with a newer, fuel efficient car.  This is why there’s not more saved after a year.

Loans/Credit Usage
•   35k in student loans, all at 6.8% interest.  These are all mine, used for a double major in finance and accounting, and a master’s degree in accounting.
•   18k in a car loan, 5% interest (it was a new car, rookie mistake I know).
•   Credit cards: $3,500 available credit, paid in full each month.  Typical usage has been 30-40% (bills and such), but going forward we’re going to keep it <20%.  I have a $3,000 limit rewards card, and my wife has a $500 secured card through our credit union.  We put recurring bills (Netflix, internet (no cable), pageplus phone bill) on my wife’s card to build her credit, and use my card for gas, groceries, misc. other things.  She’s also an authorized user on my card (as well as other bills).
•   Our credit scores are both average.  Neither of us have negative indicators on the report, but we don’t have much history either.  I have a 670ish score, but my wife doesn’t have enough history to even pull through Creditkarma.com.
•   My wife is also working on her master’s in education, which we are paying for outright.  I’ve been thinking she could get a few student loans just to have something on her record, then we could pay it off relatively soon.  Punch me in the face for thinking about this.

Housing situation
•   Renting - cost is $1,200 per month.  Hard to find much cheaper around here in decent areas.  I do some travel for work, so I don’t want to sacrifice on the neighborhood when my wife will be here by herself some of the year.



Our long term goals are to have 2 kids, own our own home in a rural area, and retire/semi-retire by age 50ish.  My request for you guys: which of the following options makes the most sense?  Punch me in the face for even suggesting options 1 or 2?

•   Option 1:  Continue current prepayment amounts on loans, concurrently save for a 20% down payment for our home.  Once we get the mortgage, we’ll go ahead and blast out the last of the student/auto loans, then funnel the rest into 401k/stocks.
o   This option gives us additional average account age while concurrently improving our debt-to-income leading up to the mortgage application.  At the amount of mortgage we anticipate getting our cash flow will be minimally impacted, but our equity will increase over time unlike renting.  Downside is we miss some compounding gains on the 401k contributions.
•   Option 2:  Pay off student loans, pay off car loan, save towards a 20% down payment, then after getting the mortgage begin maxing 401k contributions.
o   My concern here is that if we pay off the loans over the next 2 years, our credit scores will still reflect a shorter average account age.  This could hurt us when getting rates for our mortgage, even though we’d be debt free.  Would a bank weigh credit score or debt-to-income more?
•   Option 3:  Pay off student loans, pay off car loan, begin maxing 401k contributions, any extra goes towards a down payment.
o   “Do I want to pay $1200/mo in rent for the next 8 years?”  Same concerns as Option 2, and if I got a similarly priced mortgage, payment would be the same for 15/30 years, whereas rent is likely to increase over the coming years.  Note I haven’t actually done the calcs to come up with 8 years, just a number I threw out there.

Any advice is greatly appreciated!!!  Thank you MMM for this amazing community.

Catbert

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Re: Reader Case Study - most efficient way to spend cash flow
« Reply #1 on: August 24, 2014, 02:05:38 PM »
I'd vote for option 2.  No sense paying 5-7% interest on loans while you stockpile cash for down payment at sub-1% interest.

If your credit doesn't have any dings, just lack of credit/longevity I think your score will increase substantially while you pay-off debt and amass a down payment. 

Joshua

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Re: Reader Case Study - most efficient way to spend cash flow
« Reply #2 on: August 24, 2014, 02:09:40 PM »
1 - Stop splitting the extra payment on the loans. Your student loans are 1.8% higher interest and are non-dischargable. Put all of the extra payments toward this first.

2 - Can you sell the car and get something cheaper? You can knock out this debt and replace it with a used Prius/compact hatchback for half what you owe on it. You have no kids, you don't need a huge car. Plus the Prius will save on gas money.

Two steps and you are debt free. BAM!

3 - Look into programs offered for teachers buying their first home. My brother is married to a teacher and they got a loan for their first house with 3% down and a super low interest rate. Remember to buy a house that is affordable and not a McMansion.

4 - Pay the minimum on a low rate mortgage. And max out those retirement accounts.

5 - Enjoy early retirement

adgmustache

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Re: Reader Case Study - most efficient way to spend cash flow
« Reply #3 on: August 24, 2014, 03:08:32 PM »
I'd vote for option 2.  No sense paying 5-7% interest on loans while you stockpile cash for down payment at sub-1% interest.

If your credit doesn't have any dings, just lack of credit/longevity I think your score will increase substantially while you pay-off debt and amass a down payment. 

Good to know, credit was our primary concern between 1 and 2.  I think even if we pay off our loans in the next 2 years, that'll put our average account age (among the loans at least) around 6 years or so.

1 - Stop splitting the extra payment on the loans. Your student loans are 1.8% higher interest and are non-dischargable. Put all of the extra payments toward this first.

2 - Can you sell the car and get something cheaper? You can knock out this debt and replace it with a used Prius/compact hatchback for half what you owe on it. You have no kids, you don't need a huge car. Plus the Prius will save on gas money.

Two steps and you are debt free. BAM!

3 - Look into programs offered for teachers buying their first home. My brother is married to a teacher and they got a loan for their first house with 3% down and a super low interest rate. Remember to buy a house that is affordable and not a McMansion.

4 - Pay the minimum on a low rate mortgage. And max out those retirement accounts.

5 - Enjoy early retirement

Good stuff here as well.  1 is a no brainer - done and done, just rebalanced my auto-pay settings.  2 is completely on the table, though my wife is a firm "no" on a Prius.  We'll have to research our options for flipping this car into something a bit easier on the wallet (the Jeep was the OLD vehicle btw, the new car is pulling in 30mpg average).

3 is where the wrench gets thrown in as far as our plans go.  I'm picky about land, as I'm planning on starting homesteading for supplemental income/food security/low cost enjoyment, so subdivisions are out of the picture (to me this is worth the added cost).  We're looking to have a modular built versus buying an existing home.  There are a few competing modular companies in our area that do quality work, and the homes are built in a climate controlled factory instead of out in the open (they're also significantly cheaper, even compared to pre-existing homes).  Our credit union (one for state employee's actually) has a couple offerings for loans for teachers and first-time home buyers, but we'll have to see if they'll combine that with a construction loan.  Perhaps we can get a FTHB or teacher specific loan for a condo to decrease our housing outflow, which would put us in a better position to save for the 20%-30% needed on a construction loan (would also improve our debt-to-income).

4-5 I hear you, fellow mustachian!

RichMoose

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Re: Reader Case Study - most efficient way to spend cash flow
« Reply #4 on: August 24, 2014, 03:34:05 PM »
You're actually doing very well! Don't worry too much about credit score boosting techniques. As long as you don't miss payments and damage your credit score, just paying off your loans and credit card monthly will result in decent credit score by the time you're ready to purchase a house.

For an extra boost, I would do the following:

1. Take 10 - 12k from your cash pile and make a lump sum on your student loan.

2. Stop prepaying your car loan for now, get rid of the student debt first.

3. Don't dabble in blue-chip stock picking, in your 401k and taxable accounts stick to low cost index funds.

4. Consider selling the car if you can pay off your car loan (or most of it) and buy a cheap, used, fuel-sipping model

5. Don't build up a house down payment until you paid off your student loan and car loan, unless housing is cheap in your area relative to rent. (ie. you can purchase a home similar to the one you're renting for under 120k.)

6. Definitely keep contributing high amounts to your 401k and ESPP. Just be careful that your company stock doesn't make up too much of your portfolio. Keep it down to about 10% at the most.

Calvawt

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Re: Reader Case Study - most efficient way to spend cash flow
« Reply #5 on: August 24, 2014, 04:04:49 PM »
Agree with other posters.  Get rid of the highest rate student loan first while you pay the minimums on the others.  I like Option 2.

If you enjoy the car, keep it.  Otherwise go more mustachian and find an older one.  That is a personal choice.

You might want to pay your credit card twice a month just to keep the reported statement balance lower.  That will show less utilization and give you a higher credit score.  It will also not let you think you have more money in the bank than you really do.

Good job so far.  You are ahead of where I was at that age (except for the student loans).  Welcome to the world of finance/accounting!

MrsPotts

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Re: Reader Case Study - most efficient way to spend cash flow
« Reply #6 on: August 24, 2014, 05:53:34 PM »
You're actually doing very well! Don't worry too much about credit score boosting techniques. As long as you don't miss payments and damage your credit score, just paying off your loans and credit card monthly will result in decent credit score by the time you're ready to purchase a house.

For an extra boost, I would do the following:

1. Take 10 - 12k from your cash pile and make a lump sum on your student loan.

2. Stop prepaying your car loan for now, get rid of the student debt first.

3. Don't dabble in blue-chip stock picking, in your 401k and taxable accounts stick to low cost index funds.

4. Consider selling the car if you can pay off your car loan (or most of it) and buy a cheap, used, fuel-sipping model

5. Don't build up a house down payment until you paid off your student loan and car loan, unless housing is cheap in your area relative to rent. (ie. you can purchase a home similar to the one you're renting for under 120k.)

6. Definitely keep contributing high amounts to your 401k and ESPP. Just be careful that your company stock doesn't make up too much of your portfolio. Keep it down to about 10% at the most.

+1.     

Dicey

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Re: Reader Case Study - most efficient way to spend cash flow
« Reply #7 on: August 24, 2014, 05:57:54 PM »
What they said. Good advice all around.

Sdsailing

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Re: Reader Case Study - most efficient way to spend cash flow
« Reply #8 on: August 24, 2014, 07:55:08 PM »

Unlike regular houses, Modular homes depreciate, similar to mobile homes.  This will not be a good "investment" in any sense of the word.