Author Topic: The Student Loan Dilemma  (Read 4444 times)

isbjshaffer

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The Student Loan Dilemma
« on: August 24, 2014, 06:56:52 AM »
Hi Everyone! I'm hoping you all can provide some advice in a current financial crossroads that my husband and I are facing. Ever since we started reading MMM about a year ago we have been making changes to our lives to become FI. A major hurdle for us has been our student loans. We went to an expensive school and up until recently, neither of us have actually been using our degree. We have $40,000 in student loans.

Fortunately, we purchased a foreclosure in December 2012 for $97,000. Zillow currently has the home priced at $152,000 and we now owe $94,000 on it. So not even two years later we have nearly $60,000 in equity in the home. Our payment on the home does include PMI, which we hate of course, but the mortgage company will not consider letting us out early even due to the amount of equity in the home until it's been 5 years or 78%.

Our crossroads is this - Should we refinance the house to try to pay off some of the student loans and rid ourselves of the PMI? Or should we just refinance to get out of the PMI and not take cash out for the student loans? Or not refinance at all? Or could we be better off selling the house?

My husband's half of the loans are the easiest to deal with. His interest rates are from 1-2%. My half ranges anywhere from 4-7%

We are having an appraiser come out to the house this week to give us a better idea of what the house is worth. From there, we may have a better idea of what direction to take either with refinancing, doing nothing but making larger payments or selling, but I wanted to ask you all if you think there is some glaring issue that we are missing with any of this.

Our current interest rate on a 30 year loan is 3.25% however, if you include the $100 of PMI per month as interest (since it's not going toward principal), our "effective interest rate" is much closer to 5%. The refinance we're considering, assuming the house comes in for at least $140,000, would put us at a 4.99% interest rate. The way the guy at Quicken explained it was that since we are not planning on living here more than 3-5 years, there's no sense in paying the higher closing costs for a lower interest rate. Our payment would still be the same and we could "pay off" as much as $12,000 of the student loans with the $2,000-$3,000 in closing costs being added to the loan.

BTW, this is our only "debt emergency" but we feel it's crucial before we can continue on our Mustachian journey. Please let me know if I've forgotten any info and I look forward to hearing from you!

 

« Last Edit: August 24, 2014, 07:22:25 AM by isbjshaffer »

nereo

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Re: The Student Loan Dilemma
« Reply #1 on: August 24, 2014, 08:40:40 AM »
Hello and welcome first poster

reading over your post I hear little alarm bells ringing all over the place.  Thankfully not the huge clanging ones that signal 'the end' but rather the small ones that tinker in the background.
Let's start with the $60k of 'equity' as estimated from Zillow.  Equity is only realized once you finalize the sale with a buyer willing to pay that price.  Zillow's useful for giving you a ball-park estimate, but it does not mean that your house will sell for that amount at a future date.  Appraisals are typically inflated.

The second alarm bell is when you state that you are "not planning on living here more than 3-5 years" and yet you want to use some of the equity in your home to pay of student loans.  The problem with this approach is that you are transfering all the risk onto your home while depleting its equity.  If the real-estate market takes a dive in 3-5 years you could find yourselves underwater and unable to move, which is a horrible situation to be in.  If you have a financial emergency (read: bankruptcy) then creditors cannot take your degrees from you, even if you still have student loans.  In contrast, home equity is one of the very few assets that are protected in bankruptcy.  Also, there's a whole host of options for student loans repayment if/when you have economic hardships that don't exist for your mortgage.  In sum, when the S*&t hits the fan, you're better off having lots of equity in your house and still owing student loans.

Regarding your husbands SLs - at 1-2% I see no reason to pay those off any faster than necessary.  Just let inflation keep chipping away at them.  Yours are a bit more pressing, especially the ones closer to 7%. 

I've never had a PMI but I'm surprised that the amount of equity in the home needs to be 78% (!)  From what I've seen most lenders are closer to 20%. Regardless, your stated effective interest rate is close to 5%.  I do not see the advantage for you to refinance at 4.99%, given my concerns over using the difference to pay off loans. If I understand correctly, in effect you are locking in a 4.99% rate for your loans over 30 years and loosing equity in the process.  It's a lose-lose situation for you.

Here's a different question for you:  Given your current income and expenses, how much extra money could you contribute each month towards your SLs?  Also, can you give a breakdown of your SLs? 

Hope this helps. 

Zaga

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Re: The Student Loan Dilemma
« Reply #2 on: August 24, 2014, 08:50:04 AM »
Student loans have protections that mortgages don't, in particular they are forgiven on the death or total disability of their owner.  So no, I would never take out home equity to pay off student loans, even if it would lower my interest rate.

And I have made this choice myself, we have close to $60K in student loans at 5% interest (down from $100K) and a paid off house.  We could take out a home equity loan for a lower interest rate and pay them off if we chose to.

Finally, there isn't any benefit of you refinancing at a 5% interest rate when your effective interest rate is already at 5%.  You'll move in a few years and get your equity out then and use it for another down payment or whatever other goal you have. 

In the meantime paying extra each month towards your higher interest loans, you'll get them paid off if you keep at it.

isbjshaffer

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Re: The Student Loan Dilemma
« Reply #3 on: August 24, 2014, 09:06:20 AM »
Forgive me I must have said that incorrectly, in order to have the PMI removed we must have paid down 22% of the loan leaving 78% remaining to pay off before the PMI falls off. Making the required payments, that will not happen for another 7 years which would be $8,400 going toward PMI, also known as "nothingness."

Our area was not hit quite as hard as others during the housing crash, and I can only see the economy getting better at this current rate. Of course, if the appraisal comes in at less than $140,000 our decision will likely be much easier. Refinances also only let you refinance up to 85% of your home's value, so there is a bit of safety there. Worst case scenario that plays out in my head is that we have to stay in the house a little longer than we planned. Or if for any reason we have to declare bankruptcy (highly unlikely but just to entertain the thought...) and the student loans were in the house, we would actually be rid of them! Perhaps I'm being too optimistic about the economy, however I view any equity that we have in the home as a bonus since we've not lived there very long. I wouldn't view it as equity lost but more like "not as much gained" if that makes sense.

The reason for considering this is that as I said earlier, our payment would remain the same and no PMI, thus freeing up more cash flow each month for principal payments on the house or remaining student loans.

Here's the breakdown of the loans:

Interest Rate   6.800%
Principal Balance   $2,196.10

Interest Rate   6.000%
Principal Balance   $3,593.71

Interest Rate   6.000%
Principal Balance   $2,310.24

Interest Rate   5.600%
Principal Balance   $4,612.45

Interest Rate   5.600%
Principal Balance   $5,280.75

Interest Rate   4.500%
Principal Balance   $2,805.22

We could certainly contribute a lot more to the student loans. Right now we're trying to figure out what the best option is to pay them off more quickly. If we can put more toward the loans by lowering the interest rate on them as well that frees up even more cash flow to pay them off more quickly. Like I said, we're exploring our options before we dive in headfirst to anything this big.



nereo

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Re: The Student Loan Dilemma
« Reply #4 on: August 24, 2014, 09:34:41 AM »
ok - thanks for the clarification.  22% seems more normal to be rid of the PMI.

Let's start by just looking at the refinance option (sans SL payments).  If that works out in your favor, go ahead and do it.

However, for the reasons Zaga and I listed, using your home equity to pay off student loans is almost always a bad idea, and I worry that you are falling into the trap of thinking that with some accounting wizardry you can be rid of them.
Let's be clear. If you use your home equity to pay off your student loans, you are not "rid of them".  What you have done is hidden them - effectively morphed them from (presumably) 10 year loans at 4.5-6.8% to a 4.99% loan at 30 years.  The loans are still there - they are just part of your house now.  And if bad times come, you loose all that equity, and all the protection you'd have had if you had kept them as SLs.
Worse, you're not even gaining very much.  Currently, your average rate on your SLs are 5.692%  If I understand you correctly you are considering rolling them over into a 30 year mortgage at 4.99%. Not a lot of savings there (especially when you consider how much more in interest you will pay over the life of the loan).
Not to mention that you'll loose the ability to target the highest interest rates.   In all likelihood you'd be much better off using your available resources to pay off the highest-interest loans as quickly as possible instead of holding on to them at a slightly reduced rate for decades.

It does sound like you are being optimistic with what will happen.  If your area wasn't hit as hard during the housing crash it stands to reason that it also doesn't have as much to rebound.  And I promise you no one can tell you with any certainty what the housing market will look like for any area in 3-5 years.  Personal injury, lawsuit, health problems, job termination, natural disaster etc can all quickly change the equation.  I'm not trying to be a doomsayer, but equity is what allows people to leave if/when conditions get bad.  No equity, no mobility.

Sblak

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Re: The Student Loan Dilemma
« Reply #5 on: August 24, 2014, 09:45:59 AM »
I agree and would not refinance to use equity to pay off loans.  You never indicated how much you and your husband make together and what your expenses are.  If you provide the details we can give real advice, making wild guesses here, but I think that you could pay the loans off another way.

With dual incomes and a cheap mortgage you should just pay off the high interest loans. Stop spending money. Cancel phones, cable, vacations, going out, and everything else.  Then pay off the loans in a year or two with the money you save.

That way you keep equity, have no loans and can keep saving for retirement.
« Last Edit: August 24, 2014, 11:43:57 AM by Sblak »

Joel

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Re: The Student Loan Dilemma
« Reply #6 on: August 24, 2014, 10:06:41 AM »
I would not refinance at all. I would aggressively pay down the loans above 5% interest and then pay extra on the mortgage to get rid of pmi.

rubybeth

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Re: The Student Loan Dilemma
« Reply #7 on: August 24, 2014, 11:01:57 AM »
I would tackle your student loans exactly how DH and I tackled ours: highest interest rate paid off first, then snowball that amount into the next highest interest rate, and so on. It's the snowball method. Once you pay off one, paying off the next gets easier, and so on down the line. We paid off nearly $54k in less than four years doing this.

isbjshaffer

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Re: The Student Loan Dilemma
« Reply #8 on: August 26, 2014, 05:22:48 AM »
Thanks for the responses everyone! I really appreciate it!

Thegoblinchief

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Re: The Student Loan Dilemma
« Reply #9 on: August 26, 2014, 06:09:54 AM »
Alternatively, shop the loan around. You should be able to do much better than 4.99.

But I agree with the others. This way, you can target the highest interest debt first (6.8%) and move down. Once you hit 4.5ish% rates, however, don't bother prepaying. You're much better off maxing out all tax advantaged accounts and even taxable investments than prepaying debt at rates below that.

Zillow's estimates are utter horseshit, for the record.