Author Topic: Seeking Advice: Loan-payoff to retirement-savings ratio  (Read 6305 times)

moonpalace

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Seeking Advice: Loan-payoff to retirement-savings ratio
« on: February 05, 2017, 08:49:05 AM »
First post! Hello!

I'm 41, my wife is 39. Two kids, 7 & 11.

We just had a serious oh-my-god-we're-blowing-it moment about our finances and I'd love some advice about how to move on in a better direction.

We gross about $170k combined. Currently putting away 14% of my pay in a 401(a) (I put in 3%, employer puts in 11%, which is the max match). Balance in the 401(a) is $74,000.

We are in the midst of a couple of months of putting every extra penny towards emergency fund, paying off a credit card, and a large tax bill. We've also finally started setting aside money for future expenses (home repairs, summer camps, new-used car in a couple years, etc.).

But starting in March/April we'll have about $3k per month to put towards either paying down debts or retirement.

Outstanding debts are as follows:
$47,000     3.5%
$16,700     3.8%
$5,750       3.75%
$8,600       1.99%
$282,000   2.75% (mortgage)

Since my wife is self-employed we could open an individual 401(k) and put in up to $54,000 per year, pre-tax.

My question is, should every extra cent go to that 401(k) with all the tax benefits that go with it? To paying off the loans, despite the low rates? Some combination of both?

Thanks for any thoughts!

gavinshmavin

frugaliknowit

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Re: Seeking Advice: Loan-payoff to retirement-savings ratio
« Reply #1 on: February 05, 2017, 09:27:31 AM »
Step #1:   Figure out why you have about 45% of your income's worth of consumer debt (not counting mortgage) and how to stop the bleeding.

Step #2:  Stop all unmatched investing until the non-mortgage debt is gone.  Others here will say your investments will yield higher, blah, blah, but I'm more of the Dave Ramsey camp (kill the non-mortgage debt/baby steps, etc....).

The great news is you have "a big shovel" (big income) to dig out of the sheet!
« Last Edit: February 05, 2017, 09:29:14 AM by frugaliknowit »

moonpalace

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Re: Seeking Advice: Loan-payoff to retirement-savings ratio
« Reply #2 on: February 05, 2017, 09:39:16 AM »
Step #1:   Figure out why you have about 45% of your income's worth of consumer debt (not counting mortgage) and how to stop the bleeding.

Step #2:  Stop all unmatched investing until the non-mortgage debt is gone.  Others here will say your investments will yield higher, blah, blah, but I'm more of the Dave Ramsey camp (kill the non-mortgage debt/baby steps, etc....).

The great news is you have "a big shovel" (big income) to dig out of the sheet!

Thanks for the response!

I should've been clearer, it's all student loans from law school. The bleeding has been stopped!

bugbaby

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Re: Seeking Advice: Loan-payoff to retirement-savings ratio
« Reply #3 on: February 05, 2017, 06:51:29 PM »
With your high income and low interests on the loans, I think you're best off maxing your retirement accounts as close as possible to IRS limits.

Then do an analysis of your spending (Mint is a quick aid). Post your monthly expenses here, and I'm certain the Mustachian crew can make a lot of suggestions to optimize it.

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NoStacheOhio

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Re: Seeking Advice: Loan-payoff to retirement-savings ratio
« Reply #4 on: February 06, 2017, 06:10:16 AM »
Step #1:   Figure out why you have about 45% of your income's worth of consumer debt (not counting mortgage) and how to stop the bleeding.

Step #2:  Stop all unmatched investing until the non-mortgage debt is gone.  Others here will say your investments will yield higher, blah, blah, but I'm more of the Dave Ramsey camp (kill the non-mortgage debt/baby steps, etc....).

The great news is you have "a big shovel" (big income) to dig out of the sheet!

Thanks for the response!

I should've been clearer, it's all student loans from law school. The bleeding has been stopped!

What does your spending look like? How much is left over? What's your target amount for the emergency fund?

moonpalace

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Re: Seeking Advice: Loan-payoff to retirement-savings ratio
« Reply #5 on: February 06, 2017, 06:55:15 AM »
What does your spending look like? How much is left over? What's your target amount for the emergency fund?

Take-home: ~ $11,456 (some variability on the home daycare income)

Taxes (for quarterly payments): $1,665
Student-loan payments:         $1,242
Mortgage, taxes, insurance:   $2,644

Phones (3): $43.95
Trash: $35.00
Daycare ins.: $66.37
Heating Oil: $82.00
Kid music rental: $21.00
Electric: $120.50
Water: $95.00
Car ins.: $85.50
Internet: $43.50
Groceries: $675
Gas, oil changes, etc.: $150
Allowances: $80
Medical/Dental co-pays: $60
Climbing gym (winter only): $70
My "whatever" money: $50
Wife's "whatever" money: $50

Emerg. Fund:  $100
Summer Camp: $166
Gifts: $44
Christmas: $70
Firewood: $100
House fund (repairs, etc.): $500
Phone replacements: $25
Computer replacement: $25
Car replacement: $263

That totals $8571. So just about $2850 left over, before the face-punching starts. And every dollar we put into the solo 401k will reduce the quarterly tax set-aside by 35 or 40 cents.

Thanks again, everyone!
« Last Edit: February 07, 2017, 07:00:39 AM by gavinshmavin »

NoStacheOhio

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Re: Seeking Advice: Loan-payoff to retirement-savings ratio
« Reply #6 on: February 06, 2017, 07:13:58 AM »
The spending side doesn't look crazy. I think you just need to decide what to prioritize.

For me, personally, I'd probably split the surplus down the middle, and do $1500 each in savings and additional debt payments.

Those interest rates aren't crazy. I'd probably start with that 3.75% loan, just because it's smaller, and easier to knock out quickly, then just go down the line from highest interest to lowest. All of the extra payments should be going to the highest interest rate.

I like this Excel template for helping with planning: https://www.vertex42.com/Calculators/debt-reduction-calculator.html

moonpalace

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Re: Seeking Advice: Loan-payoff to retirement-savings ratio
« Reply #7 on: February 06, 2017, 07:36:24 AM »
Thanks, NoStacheOhio! Glad to hear the spending doesn't seem too crazy (now, at least). It was *far* worse until recently.

What are your thoughts about including the mortgage in the debt snowball? While it's appealing to pay it off in six years, with two kids headed toward college, I'm not sure I should be in a huge rush to build home equity. Might make more sense to just really max out the solo 401(k) after the other loans are gone (~2.5 years according to the calculator).

NoStacheOhio

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Re: Seeking Advice: Loan-payoff to retirement-savings ratio
« Reply #8 on: February 06, 2017, 07:48:13 AM »
Thanks, NoStacheOhio! Glad to hear the spending doesn't seem too crazy (now, at least). It was *far* worse until recently.

What are your thoughts about including the mortgage in the debt snowball? While it's appealing to pay it off in six years, with two kids headed toward college, I'm not sure I should be in a huge rush to build home equity. Might make more sense to just really max out the solo 401(k) after the other loans are gone (~2.5 years according to the calculator).

I'd ride the mortgage out as long as possible, and try to shelter as much income as possible from FAFSA. How long until they start college?

moonpalace

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Re: Seeking Advice: Loan-payoff to retirement-savings ratio
« Reply #9 on: February 06, 2017, 07:53:45 AM »
We've got a sixth grader and a second grader, so college start dates (assuming they go that route) are 2023 and 2027.

Working Plan
Increase retirement contributions by $2k/month starting in April.

Increase loan payments by $1,500/month starting in April.

Debt-free except for mortgage by 2019, then throw all available $ at the 401(k) up to limit of $54k/year.

FIRE by ??????

Ebrat

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Re: Seeking Advice: Loan-payoff to retirement-savings ratio
« Reply #10 on: February 06, 2017, 08:42:56 AM »
This is kind of where we're at right now, trying to decide how much to stick into 401ks vs student loan paydown, etc. It looks like your marginal tax rate is pretty high? Between that fact and the low rate on the student loans, I'd put the emphasis on the 401k. Though I can empathize with getting the satisfaction of paying off the loans.

Giro

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Re: Seeking Advice: Loan-payoff to retirement-savings ratio
« Reply #11 on: February 06, 2017, 09:11:11 AM »
If only your wife is self-employed and your combined income is only 170k, I think your calculation is incorrect regarding the max solo 401k amount.  I don't believe she would qualify for the 54k max amount. 

What is her income from the business?


moonpalace

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Re: Seeking Advice: Loan-payoff to retirement-savings ratio
« Reply #12 on: February 06, 2017, 10:30:55 AM »
What is her income from the business?

Her income is about $90k but it goes up a bit each year.

You're probably right about the 54k. I hadn't anticipated actually running into the limit, and hadn't done the math yet. Wrote hastily earlier.

Marginal tax rate is 25% (federal) and our state taxes are fairly high too. Plus she pays "self-employment tax" of ~15%. So the tax benefits are really big.

But boy, oh boy is it (emotionally) tempting to pay down the loans.

Giro

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Re: Seeking Advice: Loan-payoff to retirement-savings ratio
« Reply #13 on: February 06, 2017, 11:37:03 AM »
What is her income from the business?

Her income is about $90k but it goes up a bit each year.

You're probably right about the 54k. I hadn't anticipated actually running into the limit, and hadn't done the math yet. Wrote hastily earlier.

Marginal tax rate is 25% (federal) and our state taxes are fairly high too. Plus she pays "self-employment tax" of ~15%. So the tax benefits are really big.

But boy, oh boy is it (emotionally) tempting to pay down the loans.

I am self employed as well.  It is absolutely a no-brainer for me to max out my solo 401k for the tax breaks and I would guess it is for you both as well.  The calculation is below.

EXAMPLE
Income from business - 100,000
Business Expenses - 10,000
Deduct 1/2 self employ taxes - 6885

Income eligible for addtl 20% 401k = 83115

20% additional = 16,623
401k limit = 18,000

Total eligible to contribute to solo 401k = 34623


So, either pay down small interest debt with that 34k or save 25% federal tax on it + state and local taxes.   Clearly, it makes more sense to invest it.  If you choose to pay down debt, that is an emotional choice.





moonpalace

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Re: Seeking Advice: Loan-payoff to retirement-savings ratio
« Reply #14 on: February 06, 2017, 11:47:08 AM »
Giro, when you put numbers on it it is a pretty stark choice!

Basically 3.5% vs ~40%.

I've got to figure out our max contribution to the 401k. I suspect it'll be somewhat lower than the max that we have available, so maybe I'll be able to satisfy my emotional desire to snowball the loans with whatever's left over.

Thanks!

Giro

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Re: Seeking Advice: Loan-payoff to retirement-savings ratio
« Reply #15 on: February 06, 2017, 12:35:50 PM »
The only thing is that you need to check to see if you can deduct those contributions on your state and local taxes.  Each state is different. 

I mean, the federal savings is plenty, but you don't want to be surprised at tax time.

moonpalace

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Re: Seeking Advice: Loan-payoff to retirement-savings ratio
« Reply #16 on: February 06, 2017, 06:26:38 PM »
Thanks again, Giro. I'll check with an accountant friend on the state-taxes question too.

*amended to add that these contributions would be state-deductible as well, to the tune of 4.8%*
« Last Edit: February 07, 2017, 11:23:09 AM by gavinshmavin »

FrugalFan

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Re: Seeking Advice: Loan-payoff to retirement-savings ratio
« Reply #17 on: February 06, 2017, 06:35:47 PM »
I'd be in no hurry to pay off the loans either given the tax advantages of investing instead. However, it looks like maybe there are a few things missing from your budget? Hair cuts, clothes, birthday gifts, eating out, entertainment, travel. Those categories may not exist or be lower for you, but the only way to really know for sure is to track your expenses closely for several months. Websites like Mint or Personal Capital make that really easy to do - just link your accounts and it does all the tracking by category.

moonpalace

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Re: Seeking Advice: Loan-payoff to retirement-savings ratio
« Reply #18 on: February 06, 2017, 06:41:24 PM »
Travelling Biologist, thanks for the thoughts! And yes there are some missing things in the budget right now. I've only been tracking everything for one month, and that month was the first month of crisis-driven belt-tightening. So you're absolutely right that there will be *something* in those categories, but there just wasn't last month. Although the categories you named are pretty low for us generally. Probably a total of $100-200 for the family across all the ones you named per month.

I'm using YNAB to track expenses and so far I really like it a lot.

Retire-Canada

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Re: Seeking Advice: Loan-payoff to retirement-savings ratio
« Reply #19 on: February 06, 2017, 07:05:52 PM »
Given the low interest rates on your debt I would pay the minimum payments on everything and invest the rest.

moonpalace

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Re: Seeking Advice: Loan-payoff to retirement-savings ratio
« Reply #20 on: February 07, 2017, 07:03:02 AM »
Thanks, Retire-Canada! The more I really run the numbers and try to put my emotions aside, the more I see the wisdom of your advice.

That said, if I run into the limits on tax-deductible contributions, I think I will do a little bit of loan-payment acceleration.

*Just edited my monthly budget post to reflect some of the stuff Travelling Biologist mentioned as well*

Retire-Canada

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Re: Seeking Advice: Loan-payoff to retirement-savings ratio
« Reply #21 on: February 07, 2017, 07:36:39 AM »
That said, if I run into the limits on tax-deductible contributions, I think I will do a little bit of loan-payment acceleration.

You could put the extra $$ in a taxable investment accounts that way you can get the return, but should you want/need to use that money to pay off the debts you have easy access to it. That's how I look at my mortgage. I don't pay it down fast, but I put those potential additional payments into accounts I can get the money from without major hassles. Best of both worlds in my mind.

moonpalace

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Re: Seeking Advice: Loan-payoff to retirement-savings ratio
« Reply #22 on: February 07, 2017, 07:45:04 AM »
You could put the extra $$ in a taxable investment accounts that way you can get the return, but should you want/need to use that money to pay off the debts you have easy access to it. That's how I look at my mortgage. I don't pay it down fast, but I put those potential additional payments into accounts I can get the money from without major hassles. Best of both worlds in my mind.

Hmm. Something to think about there. Where do you have those accounts? Vanguard?

Retire-Canada

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Re: Seeking Advice: Loan-payoff to retirement-savings ratio
« Reply #23 on: February 07, 2017, 07:47:41 AM »
Hmm. Something to think about there. Where do you have those accounts? Vanguard?

I'm in Canada so I can't invest directly with Vanguard. I have accounts at a brokerage called Questrade and I hold Vanguard ETFs there. If I need some $$ I can sell those ETFs and transfer them to my bank. That's pretty unlikely that I would need to do that, but it gives me flexibility.

nobody123

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Re: Seeking Advice: Loan-payoff to retirement-savings ratio
« Reply #24 on: February 07, 2017, 07:49:36 AM »
Since you've mentioned the emotional aspect, why not use the first 4 months of the $3K to pay off the two lowest student loan balances?  Then use the payments for those two loans to pay extra on the remaining two loans, which should satisfy your need to see those balances going down at an accelerated rate.

See if you can stick to the realities of your new budget over the next 4 months, see what "hidden" expenses crop up, and then revise your budget to reflect your actual expenses.  Then take whatever leftover you have and maximize your tax advantaged savings.

When your oldest is entering high school, that's when you need to visit the FAFSA form and figure out if there is anything you can do to minimize the EFC.  However, at 170K gross, it will be difficult to do anything of consequence.

moonpalace

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Re: Seeking Advice: Loan-payoff to retirement-savings ratio
« Reply #25 on: February 07, 2017, 08:16:28 AM »
Thanks, nobody123!

Since you've mentioned the emotional aspect, why not use the first 4 months of the $3K to pay off the two lowest student loan balances?  Then use the payments for those two loans to pay extra on the remaining two loans, which should satisfy your need to see those balances going down at an accelerated rate.

That's a thought, for sure. That would yield a snowball payment of $352 after the first four months, with just two student loans remaining. They'd be paid off a few years early that way and it sure would be nice to have the small ones gone this year! I also wonder, though, if my current desire to accelerate loan payments will disappear once we're really killing it on the retirement side.

See if you can stick to the realities of your new budget over the next 4 months, see what "hidden" expenses crop up, and then revise your budget to reflect your actual expenses.  Then take whatever leftover you have and maximize your tax advantaged savings.

Definitely wise about taking a few months to really settle on realistic expenses. Even in month 2 of using YNAB, I'm already in love with how it reports average spending by category. So amazing. And so unfortunate that we never started tracking stuff until last month!

When your oldest is entering high school, that's when you need to visit the FAFSA form and figure out if there is anything you can do to minimize the EFC.  However, at 170K gross, it will be difficult to do anything of consequence.

*gulp!* What about quitting my job for a few years and being my wife's home-daycare assistant? :-)

nobody123

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Re: Seeking Advice: Loan-payoff to retirement-savings ratio
« Reply #26 on: February 07, 2017, 12:00:53 PM »
Thanks, nobody123!

Since you've mentioned the emotional aspect, why not use the first 4 months of the $3K to pay off the two lowest student loan balances?  Then use the payments for those two loans to pay extra on the remaining two loans, which should satisfy your need to see those balances going down at an accelerated rate.

That's a thought, for sure. That would yield a snowball payment of $352 after the first four months, with just two student loans remaining. They'd be paid off a few years early that way and it sure would be nice to have the small ones gone this year! I also wonder, though, if my current desire to accelerate loan payments will disappear once we're really killing it on the retirement side.

That's the beauty of it.  If you are killing it with retirement savings and change your mind about the loan repayments, you can always go back to the minimum payments and divert the $352 to your investments.  It's not a forever decision, and neither choice is "bad" per se.  Maybe you'll get a big retirement nest egg and be more motivated to kill off those pesky loans, who knows?  Some will say it's a simple math problem and there is a singular optimal answer, but you need to do what keeps you motivated.  It's only natural that what motivates you will change over time.
« Last Edit: February 07, 2017, 12:05:16 PM by nobody123 »

moonpalace

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Re: Seeking Advice: Loan-payoff to retirement-savings ratio
« Reply #27 on: February 07, 2017, 01:00:25 PM »
That's the beauty of it.  If you are killing it with retirement savings and change your mind about the loan repayments, you can always go back to the minimum payments and divert the $352 to your investments.  It's not a forever decision, and neither choice is "bad" per se.  Maybe you'll get a big retirement nest egg and be more motivated to kill off those pesky loans, who knows?  Some will say it's a simple math problem and there is a singular optimal answer, but you need to do what keeps you motivated.  It's only natural that what motivates you will change over time.

Yes, definitely a good perspective! Thanks for that.

And I think this will have to be open to adjustment all along to make sure we're not over-contributing to the 401(k) beyond deductible limits.


moonpalace

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Re: Seeking Advice: Loan-payoff to retirement-savings ratio
« Reply #28 on: February 17, 2017, 09:12:57 AM »
Just thought I'd post a follow-up here, now that I've had 10 more days to stew on this, and have talked it over with a CPA.

First off, I really can't thank you all enough for the advice. This is going to be completely life-changing.

1) Our max solo 401(k) contribution for 2017 is something like $33.5k
2) Every dollar we put in there saves us more than 37% in taxes. The "more than" is because we might lower our taxable income enough that other credits and deductions increase (e.g. the child tax credit). A virtuous cycle!
3) We're going to start out doing $2,000 in automatic contributions per month, and whatever extra we have will go into a savings account until we know for sure what the 2017 max contribution is, at which point we'll try to max it out.
4) Might throw a little extra at the student loans (e.g. during months when I get an extra paycheck), but it's not going to be a monthly priority right now.

Hooray!

GregO

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Re: Seeking Advice: Loan-payoff to retirement-savings ratio
« Reply #29 on: February 17, 2017, 01:40:47 PM »
I think you've pretty much already made this decision here, but I just wanted to point out that this doesn't have to be an either/or question.  If you are saving 37% on your taxes for every dollar that you put into your retirement accounts, then why can't your tax savings go to paying down your loans?  If you contribute $33.5k into the 401k, then you will have over $12k in tax savings.  That should also be surplus cash flow that you could then throw at your debt.  So the answer can simply be both.  For every $ that you contribute, you'll have 37 cents that you can put toward your debt!  Seems like a financial and emotional win to me right there.

moonpalace

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Re: Seeking Advice: Loan-payoff to retirement-savings ratio
« Reply #30 on: February 18, 2017, 06:38:07 AM »
I think you've pretty much already made this decision here, but I just wanted to point out that this doesn't have to be an either/or question.  If you are saving 37% on your taxes for every dollar that you put into your retirement accounts, then why can't your tax savings go to paying down your loans?  If you contribute $33.5k into the 401k, then you will have over $12k in tax savings.  That should also be surplus cash flow that you could then throw at your debt.  So the answer can simply be both.  For every $ that you contribute, you'll have 37 cents that you can put toward your debt!  Seems like a financial and emotional win to me right there.

GregO, thanks for this perspective! There is very likely to be some extra paid toward the debt, and we were just discussing this morning that if we actually succeed in maxing out the 401k, we'll get >$5k in a tax refund (because our quarterly payments are based on contributing $18k), which we'd put towards our highest-interest loan. Big wins all around!

Viking Thor

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Re: Seeking Advice: Loan-payoff to retirement-savings ratio
« Reply #31 on: February 18, 2017, 07:55:52 AM »
Sounds like you are already going this direction but I'll throw my two cents in to encourage you- don't pass up the instant 37% ROI from the 401k in tax savings. Plus given your current retirement savings balance you need to build wealth, I would argue given the numbers you can't "afford" to pay off 3% debt at expense of the instant tax savings and building your retirement nest egg.

Of course if you can throw some extra at the debt after maxing 401k that's good too.

The good news is with your renewed focus on shoring up finances your plan should have you making great progress and in much better shape in a few years.

Dicey

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Re: Seeking Advice: Loan-payoff to retirement-savings ratio
« Reply #32 on: February 18, 2017, 08:04:32 AM »
Thanks, NoStacheOhio! Glad to hear the spending doesn't seem too crazy (now, at least). It was *far* worse until recently.

What are your thoughts about including the mortgage in the debt snowball? While it's appealing to pay it off in six years, with two kids headed toward college, I'm not sure I should be in a huge rush to build home equity. Might make more sense to just really max out the solo 401(k) after the other loans are gone (~2.5 years according to the calculator).
I'd ride the mortgage out as long as possible, and try to shelter as much income as possible from FAFSA. How long until they start college?
^This^+ 282,000.

Great advice, NSO. The fact that you understand this means that you won't be NSO for long.

moonpalace

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Re: Seeking Advice: Loan-payoff to retirement-savings ratio
« Reply #33 on: February 18, 2017, 12:56:57 PM »
Thanks, Diane C and Viking Thor! And everyone else.

I'm feeling really really good about this plan to max out the 401k (or come as close as possible). And so glad to have found this community.

I suppose one other question is whether it even makes sense to pay down those 3% debts after maxing out the 401k.