Reader Case Study - Need help with student loan repayment and saving ratio

[SalMonella]

Hello all!  I am 26, have recently graduated law school, and am fortunate to have a job.  Despite scholarships, I graduated with a large amount of student debt.  I also lived above my means in a very expensive city while a graduate student.  I now wish to repent and live responsibly, but need this forum's help formulating a plan. 

I'm doing some things right, but I'm doing many things very wrong.  I would love to be able to knock my debt out as quickly as possible, but I am worried that:
   1. I need to save money for a house/retirement/children/etc. and I will lose out on time and compounding interest if I delay putting money in a savings account/401(k)/Roth IRA while I am eligible;
   2. If I save/invest my money, and I lose my job, then it is there to withdraw, even if at a penalty.  If I pay my loans off instead, I will have nothing to show for my hard work (the student loans can always be forgiven after 25 years in the absolute worst case scenario that I lose my job and can't get a similar salary elsewhere and am forced to go on income based repayment);

Income: I net around $4700 a month.  I started working only two months ago.  There are lock-step raises every year, and a potential for an annual bonus if I bust my ass.

Assets: 
   • Around $2,200 in a checking account, already spoken for in my monthly budget for November.
   • $1,000 in a savings account which I have designated my Emergency Fund. 
   • Old Japanese sedan that I bought used for $2500, likely worth around that. 
   • A motorcycle worth $11,200 according to KBB, but I doubt I could get more than $9,000 on the private market for it.  I am trying to sell it.

Liabilities: 
   • $4,476.25 - 0% - old Credit Card Debt that is at 0% for 11 more months.
   • $8,315.85 - 6.99% - Motorcycle Loan
   • $16,641.19 - 7.875% - Private Student Loan
   • $118,571.43 -  3/4 of it is 6.8%, 1/4 is at 7.9% (enrolled in auto debit so I get a .25% reduction) - Federal Student Loans
   
Current monthly expenses:  
   • $1395.74 - Federal Student Loans (designed to be 10 year repayment, could be reduced with IBR/Consolidation, etc.)
   • $0.00 - Private Student Loan - I am not sure what the payment will be, but it will start in a few months
   • $174.21 - Motorcycle Loan
   • $111 - Credit Card Minimum payment.
   • $57 - Health Insurance
   • $107.50 - Crossfit Gym
   • $9.99 - Spotify music service
   • $27.50 - Motorcycle insurance
   • $37.50 - Car insurance
   • $4.99 - Rouxbe membership fee (online cooking school)
   • $60 - fuel
   • $22 - haircut
   • $200 - work clothing (I work at a conservative law firm, I am required to wear a suit every single day. I put away $200 a month to save up for suits to build a wardrobe.  I currently own only three and they are old and look like shit.  Looking the part is important in this career and so this is an important part of my budget).
   • $25 - dry cleaning
   • $400 - groceries
   • $200 - dining out
   • $20 - misc. recreation and leisure with the gf (movie, etc.)
   • $20 - donations
   • $50 - I put away $50 dollars a month towards inevitable car repairs/service
   • $250 - I put away $250 a month towards travel because I have never been back to my birth country since leaving as a refugee in 1994 and I am committed to visit it in 2014.  However, my debt is making me rethink this.
   
I don't pay rent anywhere because I am living in my parent's basement.  My employer pays for my cell phone. 

I know the obvious next moves: sell the bike, get rid of the bike loan and insurance, stop dining out, forget about a trip to my birth country, get rid of the crossfit gym, and pay off my debt.

However, as I stated in the beginning, I don't know anything about saving for retirement or a house and whether I should be doing that at the same time as paying off my debt so as not to lose out on Roth IRA benefits while I am eligible.  Once I am eligible, I plan on maxing out my employer's matching to 401(k).  Other than that, any input would be appreciated.  Do I focus on debt first and foremost?  Do I max out annual Roth IRA limits, and then focus on debt?

Thank you all!

[Mazzinator]

Hello and welcome! Here's my 2 cents for your student loans.

First, i'd put your federal loans on IBR for the interest savings* but you'll have to use the ibr calculator and see if your payments will be less than the monthly interest amount. This "buys" you the next 3 years to focus on paying off the private loans first. Then you can invest more, to lower your AGI, which lowers your IBR payments. You can then save up cash for an EF or to make a lump sum payment to the IBR loans at the end of the 3 yrs.

Again, you'll have to crunch the numbers and make sure your fed loans on IBR are way less than the interest per month.

http://studentaid.ed.gov/repay-loans/understand/plans/income-based/calculator

http://www.aie.org/managing-your-money/finance-tools/daily-interest-calculator.cfm

*Interest payment benefit—If your monthly IBR payment amount doesn’t cover the interest that accrues (accumulates) on your loans each month, the government will pay your unpaid accrued interest on your Direct Subsidized Loans or Subsidized Federal Stafford Loans (and on the subsidized portion of your Direct or FFEL Consolidation Loans) for up to three consecutive years from the date you began repaying your loan under IBR.

[goodlife]

Well, you have already pointed out many good things yourself. Definitely reduce your expenses. I would cut all of the following to zero: Gym, Spotify, Rouxbe, Haircut (do you reall get your hair cut every month?), donations (sorry, I like to donate too but I don't think you can afford this for a while), motorcycle insurance (just deregister it right now even before you sell it), dining out.

Next, if I were you, I would focus equally on building an emergency fund and paying down your debt. Definitely sell the motorcycle asap. +1 on living out of your parents' basement btw, I would keep doing that until your debt is gone, saving money on rent and other stuff will really help you so much in getting rid of that debt.

I know you might feel overwhelmed, so for the next 3 years or so I would just focus on the debt. Forget about a house downpayment and saving for non-existent children for now. And once your debt is gone, it's not like you "have nothing to show for it", it will be a really big accomplishment!

And think about it like this, your income is really good, if you can keep your personal expenses to 700 every month, then you have 4000 to throw at that debt! You will likely get some year-end bonus...now think about how quickly your debt can be gone! Your motorcycle debt can be gone as soon as you sell that thing. Your credit card debt can be gone in 2 months time! And while you have a lot of student loans, if you keep this up for 3-4 years, you can get rid of all of it! That is not a very long time. So yes, my advice would be to first build an emergency fund and then focus 100% on your debt. Yes, do your 401k contribution assuming your employer matches it. But other than that, I would forget about everything else and just pay down that debt.

Regarding your suits problem, I am also required to wear suits, but do check out online retailers and thrift stores as well, you don't have to spend that much on a suit. If you have 4 suits, you are fine, you can always mix and match.

Now, to your trip to wherever it is (maybe Europe...), I am a sucker for these things. Plan ahead, see how cheap you can make it, there are very cheap ways to travel. There are things in life that are important and I have a feeling this might be important to you. If you can do it for 1k or less, then do it. Otherwise, don't. You could also try to get some side income (tutoring on the weekends etc.) in order to save up for that. Maybe others will disagree with me on this one, but assuming you reduce all your other expenses and make good progress on your debt, I would not write it off completely.

EDIT: Your grocery bill is really really high for one person btw. Given that you live with your parents, can you talk to them about just contributing maybe 100 a month for groceries or even zero and do something else for them instead, like cleaning the house or whatever else they might need?

[SalMonella]

Mazzinator - Only $17,000 of the $118k+ are subsidized.  And my IBR payment would be around $950 (a co-worker in the same boat as me with the same salary just got on IBR).  Not sure what my interest is a month, but I suspect it is less than $950, and closer to $600/700.

[SalMonella]

goodlife - re: the groceries, my living arrangement is a bit more complicated.  While all of my belongings are in my parents' basement, I stay with my gf during the week because she lives 1.5 miles from my office and my parents live in the suburbs 20-50 minutes away depending on traffic.  Thus, the groceries are for 2 people (1.5 really, she buys some groceries and eats out on occasion).  I don't ask her to contribute more because she doesn't ask me to pay half the rent despite me sleeping there most nights of the week and taking up closet space with my suits.  I will admit, we try to buy only organic, whole foods and this makes food more expensive than it otherwise could be.  However, the extra price is justified to me because we are what we eat.

[Mazzinator]

Ok, just trying to help and like i said, you'd have to crunch your own numbers.

I just thought because you're a recent grad and new job that maybe your 2012 AGI would be low. And possibly your 2013 since you just started working. And afterwards you deduct the $2500 (interest deduction) $17.5 (401k) and $5500 (tIRA) it could put your AGI low enough to benefit. This way it becomes a win win.

Ok, i'll shut up about it now :)
Good luck.

[Catbert]

Yep, hit the debt before you save for a house or retirement (other than maybe 401k if there's a match).  You should only count on 7% yearly return on your portfolio.  Much of your debt is around that %.  All the cool things you heard about the magic of compounding returns by starting retirement saving early are actually working against you with your debt.  Kill it before you start serious savings.

I would attack your debt by 1st looking at your credit card and pay enough each month so it is entirely paid off a month before your 0% interest expires.  0% is great but it will likely jump way up when the teaser period expires.

I don't understand all the ins and outs of SLs so I may be missing something unique to SLs. I would pick one (probably the private loan with the highest interest rate) and work on it.  Then move on to the next one.  I wouldn't consolidate the other SLs.  Rather I would try to kill them off one by one so that over time my collective minimum payments are less in case you lose your job. 

[SalMonella]

Mazzinator - those are all very good points.  I may be able to game the system by showing a low AGI for 2012 and 2013.  However, then my concern is that I have interest accumulating that is not eligible for the interest payment benefit because the overwhelming majority of the SL debt is unsubsidized.  Assuming this debt isn't getting forgiven, wouldn't paying less per month than the amount of monthly unsubsidized interest just be delaying the inevitable and paying more in the long run?

[seattlecyclone]

You're right that interest will still accrue at the same rate on your non-subsidized loans if you go on IBR. I still recommend it for a few reasons:
* It will make your required payment on those loans smaller in the short term. That will allow you to put more cash toward knocking out your private student loan and your credit card before the 0% rate expires. Once those loans are gone, you can put all your extra cash toward the federal loans and pay them down aggressively.
* If the worst happens and you are unemployed for a long period of time, remember that you need to have been on IBR for 25 years to get the balance forgiven. Might as well start the plan now to get that clock ticking, just as a small extra insurance policy.

I'm curious whether the $950/month IBR amount you estimated is actually accurate for you. According to the Department of Education's online calculator, a single person would need to have an AGI of $93,250 to have IBR payments of $150. You say you net $4,700/month, or $56,400/year.

What's your gross salary? I'll assume for the sake of argument that you have about 30% taken out of your paycheck for taxes, making your gross salary be about $80k. If you contribute the maximum $17.5k to your 401(k) plan (which I recommend) and take the maximum $2,500 student loan interest deduction, your AGI will be in the neighborhood of $60k.

The calculator says the IBR payment for a single person with a $60k AGI is only $535/month. So if you go on IBR, your minimum payment for your federal loans will go down by about $800. This will allow you to pay off your other loans that much quicker.

The good news is that your current spending is low enough that you already have $1,500/month to allocate toward a combination of additional debt payments and retirement savings. Cut back on some of your spending as you've already stated you plan to do, and you'll have the debt gone and the start of a good tax-deferred retirement stash in just a few years. Good luck!

[SalMonella]

seattlecyclone - My gross salary is $95,000 a year.  I am netting approximately $4700 a month because:

1) $416.66 comes out every month for a year to repay an interest free $5k salary advance my employer gave me while I was studying for the bar and not working - this paid for my living expenses at the time;
2) $100 comes out every month pre-tax for parking, which is the cheapest parking I've managed to find.  Before I was an attorney, I used to bike 14 miles each way to get to work just for the exercise, but it is not feasible at my current office because I have to change into a suit and there are no showers.
3) don't remember exact figures, but dental and health insurance premiums also getting taken out.

[SalMonella]

Mazzinator - As I understand it, if your IBR payment is less than the interest that accrues on your loans each month, the government will only pay your unpaid accrued interest on your subsidized loans.  Only $17k out of $118k is subsidized.  Therefore, if my IBR payment is less than the interest that accrues, the government will only pay around 14% of my accrued interest.  Thus, the rest of the interest will be growing on top of my principal. 

[Mazzinator]

Oops, meant to edit not remove my last post. And obviously i can't shut up :)

Anyways, can they be consolidated to meet the requirements?

Doesn't it still work out in your favor, because that $17k is essentially interest free? And you can attack the private loans first? Like seattlycyclone pointed out.

[SalMonella]

Mazzinator - to address your first question, the only thing that will happen if I consolidate the loans is that my interest rate will become a single weighted average, around 7.15%.  I found the following language helpful:

"Even though after consolidation you will have one loan, if you are consolidating subsidized and unsubsidized loans, they will be tracked separately. If you decide to return to school or enter into another deferment period, the subsidized portion of your consolidation loan retains the benefit of having the interest paid for you during that time. The only exception to this rule is a Federal Perkins Loans. If you consolidate Perkins Loans, they are included in the unsubsidized portion of the Consolidation Loan and do not retain their interest benefits."  from mappingyourfuture.org

I suppose it is true that the $17k would remain interest free, though.  The approach you and seattlecyclone suggested is not one I considered, and I am starting to see the merits of it.  Very thankful for your inputs.

[CHOPAG]

You may want to look into the extended graduated repayment plan on your federal loans. You'd be able to minimize your required monthly payment in the beginning, and use the money you free up to target your private loan and your higher-interest federal loans.

[seattlecyclone]

Your gross salary is higher than I figured. Parking, health insurance, and 401(k) contributions should lower your AGI by perhaps as much as $20k if you max out your 401(k). An AGI of $75k still qualifies you for an IBR payment of $722. This is about half of what you'll have to pay on the normal repayment plan. You can still use this extra cash to pay off your other debt, which is good. However, I calculate that you're only being charged about $700/month of interest, so you're not likely to see much (if any) of your interest on the subsidized portion of your loan paid by the government during IBR.

One thing to look into is what year's income you have to report. For example, if you can get on IBR based on the income you reported on your last tax return (when you were still in school), you might even qualify for a zero payment until you have to send in this year's numbers.

[jflo]

You wouldn't be the first attorney to ride to work and change into a suit w/o a shower. I'm in that category and often ride to presentations without even being able to change and no one seems to notice till I decline the parking validation or don't walk to the parking lot. Check some of the cycling threads. The idea that "my job requires me to look fancy" just keeps you locked into a certain salary or lifestyle whether you want it or not. Not saying you should slum it, just that wearing a nice suit does not equal must drive.

[TrulyStashin]

I'm a BigLaw transactional attorney.  We don't have showers.  I live 17 miles away from work and I do a hybrid bike/ drive commute.   Every morning I put my bike on my car and drive to within about 2 miles of my office where there is abundant and free street parking.  I take bike off car, plop my bag into the basket  and cycle the rest of the way.   I've been doing it every single day since May (in Virginia humidity and heat; rain and cold).  It's a short distance so I don't get very sweaty or very wet when it rains.  I keep a washcloth at work and clean up, cool off, and get dressed.

At work, I keep suits in a garment bag on the back of my office door.  Shoes live under my desk.  Deodorant, slips, a fresh bra, and a little makeup live in a desk drawer.

Doing this reduced my costs by:  $130/ mo parking; $12/ mo tolls; $80/ mo gym; and about $10/mo gas.   Roughly $250 a month or so.

I am 45 years old (law school from age 40 - 43) and have $156k in student loan debt at 6.8 and 7.9% and consumer loan debt  that I am committed to annihilate ASAP.  I contribute the minimum needed to get my employer's match to my 401k and put a small amount into a HSA.   Like you, I worry that I'm losing time to compound interest, but in my case (given my age) it is a much greater issue than it is for you.   That's why I'm determined to pay off the debt as soon as humanly possible.  My hair is on fire.  So is yours.

Strategize which debts to pay off first by prioritizing high interest over lower interest.  Scrub your budget for every spare dime and send it all toward debts in order of priority.   My two cents..........

Edited:  Once or twice, I've needed to use public transit instead of biking (e.g. networking event in the evening).  In that case, I still park where it is free and ride the bus to and from my office.  There are ways to avoid the parking fee if you look for them.

[Mazzinator]

Ok, so i would see if you can just put the $17k on IBR, asap, at least for now. I'd leave the other sl as is. Or, if you have to put all the fed loans on ibr, i think i would pay the interest on those (unsubsidized) each month before it capitalizes. I would not do graduated extended.

Also, before the 6 month grace period is up, you should pay off the accrued interest before it capitalizes. If you're within that timeframe still.

Also, i agree with trulystachin, and contribute to your 401k up to the match as your only investing right now, and send all other money to debt.

I also, and you have to do a guy check first, but i even moved some of my high interest SL to a 0% apr 0 fee credit card. Then i paid/am paying them the minimum payment until the last 2or3 months, which i will then pay it off. I just treat the CC as a loan and never use it. I try to optimize every area and figure if i'm willing to cut cable to save $100 then i'm willing to "risk" transfer the SL to a CC to save $100 in interest.

Anyways, good luck and it sounds like you're going to do great.

Fwiw, we also have tons of SL and my husband is a lawyer too.

[TrulyStashin]

I also, and you have to do a guy check first, but i even moved some of my high interest SL to a 0% apr 0 fee credit card.

I like this idea and I've been planning to do this once my consumer debt is paid.  I have great credit (fortunately) and could easily move $20k off of student loans onto a CC with a 0% promotional rate (3 or 4% one-time flat fee cheaper than SL interest) with a 12 or 18 mo. term on the promotional rate.  I plan to divide the amount due by the term and pay that amount each month, in addition to my SL payment, so that it is certain to be PIF by the time the term ends.

So, $20k moved over to a CC +$800 (4% fee) with a 12 month term gives me a monthly payment of $1733.00.   Goal is to pay this IN ADDITION to making my standard monthly SL payment of $1905.00.  Ambitious, but that's how I intend to crush these loans.

Once I'm ready to execute this plan, I'll refine my math to be sure exactly how much SL debt to move to a CC, but this describes my basic strategy.