Paying off debt vs. max savings

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kmox
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Paying off debt vs. max savings

Postby kmox » Mon Jul 17, 2017 6:42 am

Hi everyone:

I'm a long-time reader and find many of the posts very inspirational, but I have hardly ever posted anything. So here goes, our situation that I'd like feedback on from the greater community...

Both me and my DW now have fairly stable jobs with a pretty high rate of income (combined +/- $150k/yr, with pay raises of abt 5%/yr), after many years of low-paying jobs, graduate school, time-off for kids, etc. At this point we can max out our 401(k)/457(b) plans with no problem. We also have some debt, which is rather manageable: $110k mortgage on a rental property (4.25% interest), $15k student loan (2.25% interest), $23k car loan (0% interest). Somehow, through all of this, we have been able to scrap together $150k in savings.

Now, it feels like we are ready for the next big step. Do we: pay down the debt? Or, max out RothIRA? We also have two small kids (5 and 2) that we would like to put money towards their 529 account (we get a state income tax break in our state), which we currently contribute nominally.

P.S. we do receive rental income, but the property is a housing bubble purchase (unbeknownst to me), which I could never shake lose of and is way underwater, and the rental only covers about three-quarters of the mortgage.

Thanks in advance for any advice.

:sharebeer

mortfree
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Re: Paying off debt vs. max savings

Postby mortfree » Mon Jul 17, 2017 7:12 am

Pay off the student loans.
Max the Roth for 2017 ($11k)
Wait for Jan 2018 and max the Roth again

That leaves you with 113k

niners9088
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Re: Paying off debt vs. max savings

Postby niners9088 » Mon Jul 17, 2017 7:36 am

I don't see any mention about your current living arrangements. Are you renting or do you own a house? My reason for asking is do you plan to buy a house in the near future in which case you would need a 20% down payment? Also how much of the money do you need for an emergency fund?

kmox
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Re: Paying off debt vs. max savings

Postby kmox » Mon Jul 17, 2017 7:44 am

We currently rent ($1210/mo) with no plans to buy. At this point in our life, we have already owned two homes (sold one), and don't see the value in owning any more (personal preference). We expect to be living overseas in about 15yrs and don't want to tie up our savings in an illiquid asset.

TravelforFun
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Re: Paying off debt vs. max savings

Postby TravelforFun » Mon Jul 17, 2017 7:53 am

- If your or your wife's employer matches your 401k/457b contribution, contribute enough to get the maximum match but no more, if they don't match, don't contribute and go to the next step.

- Put in $5,500 per year into your and your wife's Roth IRA accounts, $11k total.

- Attack all the non-mortgage debts.

- Build an emergency fund of 6 months of your expenses.

- Open 529 accounts for your kids, calculate the amounts you think they would need, and divide them by the remaining years so you know much you need to fund them per year.

- Pay off your mortgage.

- Put any left-over money into taxable accounts.

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Watty
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Re: Paying off debt vs. max savings

Postby Watty » Mon Jul 17, 2017 8:24 am

There is a wiki on this choice.

https://www.bogleheads.org/wiki/Paying_ ... _investing

kmox wrote:P.S. we do receive rental income, but the property is a housing bubble purchase (unbeknownst to me), which I could never shake lose of and is way underwater, and the rental only covers about three-quarters of the mortgage.


That would mean that you are also not building up reserves for eventual major repairs, vacancies, bad tennants, etc.

What do the numbers look like on the rental property?

It might make sense to go on and sell it even though you would need to pay to get out of the house.

In most areas the housing markets are pretty strong right now so it might not be too hard to sell. If you wait five years you could find yourself being forced to sell it in a bad housing market.

kmox
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Re: Paying off debt vs. max savings

Postby kmox » Mon Jul 17, 2017 8:52 am

Good point, and I have thought of that--selling the property. However, the house is currently valued at $80k (according to Zillow based on surrounding comps). We receive about $950 in rental income with $90/mo going to property management (it is too far from us to manage ourselves). So, if we sold it, that would mean a possible $30k haircut from current loan amount (we originally bought for $160k), of which we would not be able to cover except for borrowing more money.

kmox
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Re: Paying off debt vs. max savings

Postby kmox » Mon Jul 17, 2017 8:54 am

Thanks for the wiki link.

Also, we currently don't have six months emergency savings (for the reason specified above), but maybe only a few months at most.

CppCoder
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Re: Paying off debt vs. max savings

Postby CppCoder » Mon Jul 17, 2017 9:34 am

kmox wrote:Good point, and I have thought of that--selling the property. However, the house is currently valued at $80k (according to Zillow based on surrounding comps). We receive about $950 in rental income with $90/mo going to property management (it is too far from us to manage ourselves). So, if we sold it, that would mean a possible $30k haircut from current loan amount (we originally bought for $160k), of which we would not be able to cover except for borrowing more money.


You're losing money on the rental every month. How many months would you have to hold it until the monthly loss adds up to your current capital loss or loan payout amount? What if you lost your tenant? Don't avoid a small loss now to avoid a big loss through perpetual small bleeding. I would not want to hold a capital asset that I wasn't using with a guaranteed loss. Take your lumps, learn your lesson, and move on.

indexonlyplease
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Re: Paying off debt vs. max savings

Postby indexonlyplease » Mon Jul 17, 2017 10:03 am

I would look at the Dave Ramsey 7 step process to becoming debt free. Check online its simple process that works. You will be half way there when you pay off the debt. Then check on the Boglehead site for how to invest.

grettman
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Re: Paying off debt vs. max savings

Postby grettman » Mon Jul 17, 2017 10:16 am

After fully saturating tax advantaged accounts, I would write a check and clear out all consumer debt asap with cash reserves not associated with emergency fund. Consumer debt should be avoided at all costs (IMHO) and student loans should be put to bed quickly.

JGoneRiding
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Re: Paying off debt vs. max savings

Postby JGoneRiding » Mon Jul 17, 2017 10:36 am

Meg just posted a funding list on the retirement vscollege savings thread with ratios and int rate cut offs. you should read that and follow her suggestions.

For what it is worth Meg is a banker and worth over 1 mil at 31 and not to insane an income

chicagoan23
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Re: Paying off debt vs. max savings

Postby chicagoan23 » Mon Jul 17, 2017 11:10 am

kmox wrote: Both me and my DW now have fairly stable jobs with a pretty high rate of income (combined +/- $150k/yr, with pay raises of abt 5%/yr), after many years of low-paying jobs, graduate school, time-off for kids, etc. At this point we can max out our 401(k)/457(b) plans with no problem. We also have some debt, which is rather manageable: $110k mortgage on a rental property (4.25% interest), $15k student loan (2.25% interest), $23k car loan (0% interest). Somehow, through all of this, we have been able to scrap together $150k in savings.

Now, it feels like we are ready for the next big step. Do we: pay down the debt? Or, max out RothIRA? We also have two small kids (5 and 2) that we would like to put money towards their 529 account (we get a state income tax break in our state), which we currently contribute nominally.


My hierarchy of savings, which has worked well for me and was also recommended to me by Fidelity:

1. Contribute up to the employer match in a qualified retirement plan; and then
2. Contribute the annual max ($6,750 for family coverage) to an HSA invested in low-cost funds and do not take distributions for medical expenses; and then
3. Contribute up to the annual max ($18,000 each) for the two qualified plans; and then
4. Contribute up to the annual max ($5,500 each) to two Roth IRAs (assuming both spouses ineligible to make traditional IRA contributions but still within Roth contribution limits); and then
5. Contribute to the Section 529 account up to the maximum for the state tax deduction; and then
6. Pay off high-rate, nondeductible and secured debt (say, anything higher than the then-current Prime Rate); and then
7. Everything else goes to taxable savings.

I see no reason to pay off early a student loan at 2.25%--fixed low-rate, long-term, and unsecured. You could never walk into a bank and get a personal loan for $15k on those terms, so take advantage of it while you can. Obviously the same deal with the car loan. Roth IRAs can be used to fund education on the same basis as the 529 plans up to the amount of the cumulative contributions, making them preferable to the 529 plans, even with the state tax deduction.

Tax-advantaged space is precious, which is why it is so limited by the Internal Revenue Code. Do not let it go to waste if you can afford to contribute. And definitely don't waste it by paying more tax than you need to now in order to use after-tax money to unnecessarily wipe out low-rate, long-term debt. Especially when you are a double-income couple with stable jobs.

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FiveK
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Re: Paying off debt vs. max savings

Postby FiveK » Tue Jul 18, 2017 12:07 am

See also Investment Order for a prioritization similar to what chicagoan23 posted. It also includes some reasons behind the ordering.

bayview
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Re: Paying off debt vs. max savings

Postby bayview » Tue Jul 18, 2017 7:39 am

kmox wrote:Good point, and I have thought of that--selling the property. However, the house is currently valued at $80k (according to Zillow based on surrounding comps). We receive about $950 in rental income with $90/mo going to property management (it is too far from us to manage ourselves). So, if we sold it, that would mean a possible $30k haircut from current loan amount (we originally bought for $160k), of which we would not be able to cover except for borrowing more money.

lol @ Zillow comps :D We like to look at their estimates for our two properties and snicker. Your haircut might be a lot less drastic than $30k. On rental properties especially, I doubt if they factor in "successful rental history", because how would they know?

Even if it's an accurate figure, I agree with the other poster that it might be worth cutting your losses just to simplify and streamline, although I know that's a good-sized chunk of change.
The continuous execution of a sound strategy gives you the benefit of the strategy. That's what it's all about. --Rick Ferri

beth65
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Re: Paying off debt vs. max savings

Postby beth65 » Tue Jul 18, 2017 10:30 am

I follow these boards somewhat frequently, and I know that many people here are more fiscally conservative, but why do so many people always recommend paying off any debt first? Why is debt-free always the way to go? I have read so many books on good debt vs bad debt (Thomas Anderson's The Value of Debt is one I'm currently reading) that I would think saving in investment accounts and compound interest would be more important than paying down low-interest debt. Is it better to be debt free with $500k in the bank, or owe $300k but have $1.5 million in the bank? Obviously high-interest debt is bad, but low interest debt is not.

beth65
Posts: 18
Joined: Mon May 08, 2017 1:51 pm

Re: Paying off debt vs. max savings

Postby beth65 » Tue Jul 18, 2017 10:34 am

chicagoan23 wrote:
kmox wrote: Both me and my DW now have fairly stable jobs with a pretty high rate of income (combined +/- $150k/yr, with pay raises of abt 5%/yr), after many years of low-paying jobs, graduate school, time-off for kids, etc. At this point we can max out our 401(k)/457(b) plans with no problem. We also have some debt, which is rather manageable: $110k mortgage on a rental property (4.25% interest), $15k student loan (2.25% interest), $23k car loan (0% interest). Somehow, through all of this, we have been able to scrap together $150k in savings.

Now, it feels like we are ready for the next big step. Do we: pay down the debt? Or, max out RothIRA? We also have two small kids (5 and 2) that we would like to put money towards their 529 account (we get a state income tax break in our state), which we currently contribute nominally.


My hierarchy of savings, which has worked well for me and was also recommended to me by Fidelity:

1. Contribute up to the employer match in a qualified retirement plan; and then
2. Contribute the annual max ($6,750 for family coverage) to an HSA invested in low-cost funds and do not take distributions for medical expenses; and then
3. Contribute up to the annual max ($18,000 each) for the two qualified plans; and then
4. Contribute up to the annual max ($5,500 each) to two Roth IRAs (assuming both spouses ineligible to make traditional IRA contributions but still within Roth contribution limits); and then
5. Contribute to the Section 529 account up to the maximum for the state tax deduction; and then
6. Pay off high-rate, nondeductible and secured debt (say, anything higher than the then-current Prime Rate); and then
7. Everything else goes to taxable savings.

I see no reason to pay off early a student loan at 2.25%--fixed low-rate, long-term, and unsecured. You could never walk into a bank and get a personal loan for $15k on those terms, so take advantage of it while you can. Obviously the same deal with the car loan. Roth IRAs can be used to fund education on the same basis as the 529 plans up to the amount of the cumulative contributions, making them preferable to the 529 plans, even with the state tax deduction.

Tax-advantaged space is precious, which is why it is so limited by the Internal Revenue Code. Do not let it go to waste if you can afford to contribute. And definitely don't waste it by paying more tax than you need to now in order to use after-tax money to unnecessarily wipe out low-rate, long-term debt. Especially when you are a double-income couple with stable jobs.


I agree - 2.25% rate is so low it's not worth paying off early. Once you pay that money, it's gone, you don't win an award for paying it off early, you have no equity and no liquidity. If the markets do have a downturn/recession, I would rather have more liquidity if needed.

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willthrill81
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Re: Paying off debt vs. max savings

Postby willthrill81 » Tue Jul 18, 2017 10:39 am

beth65 wrote:I follow these boards somewhat frequently, and I know that many people here are more fiscally conservative, but why do so many people always recommend paying off any debt first? Why is debt-free always the way to go?


Because many of us, along with millions of Americans, have been burned badly with debt in the past.

Debt can certainly be a useful tool, but it can also be a very deadly one. FAR more people have been hurt by debt than helped by it, and even the best laid plans for using it properly can go awry.

"The rich rules over the poor, And the borrower becomes the lender's slave."
- Proverbs 22:7
“It's a dangerous business, Frodo, going out your door. You step onto the road, and if you don't keep your feet, there's no knowing where you might be swept off to.” J.R.R. Tolkien,The Lord of the Rings

beth65
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Re: Paying off debt vs. max savings

Postby beth65 » Tue Jul 18, 2017 10:45 am

willthrill81 wrote:
beth65 wrote:I follow these boards somewhat frequently, and I know that many people here are more fiscally conservative, but why do so many people always recommend paying off any debt first? Why is debt-free always the way to go?


Because many of us, along with millions of Americans, have been burned badly with debt in the past.

Debt can certainly be a useful tool, but it can also be a very deadly one. FAR more people have been hurt by debt than helped by it, and even the best laid plans for using it properly can go awry.

"The rich rules over the poor, And the borrower becomes the lender's slave."
- Proverbs 22:7


But if you are earning 6% returns in the market, and you have a student loan debt of 2.5%, assuming that's fixed, why pay that off sooner? How do you get burned on a student loan debt with a low fixed rate? If you have 2x the amount of the loan in liquidity, even a job loss should not prevent you from making payments. I think good debt is one that you CAN easily pay off, but you make more money elsewhere. Meaning you can't actually get burned by it. I don't like to put all of my liquidity in risky investments, either, because then it's not really liquid. Like I mentioned above, if you pay of debt too soon, that money is gone, and if the market crashes, you can't get it back without taking more loans at a higher interest rate.

mortfree
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Re: Paying off debt vs. max savings

Postby mortfree » Tue Jul 18, 2017 10:50 am

beth65 wrote:But if you are earning 6% returns in the market, and you have a student loan debt of 2.5%, assuming that's fixed, why pay that off sooner? How do you get burned on a student loan debt with a low fixed rate? If you have 2x the amount of the loan in liquidity, even a job loss should not prevent you from making payments. I think good debt is one that you CAN easily pay off, but you make more money elsewhere. Meaning you can't actually get burned by it. I don't like to put all of my liquidity in risky investments, either, because then it's not really liquid. Like I mentioned above, if you pay of debt too soon, that money is gone, and if the market crashes, you can't get it back without taking more loans at a higher interest rate.



sorry for jumping in, you're getting hung up on percents and riding the good times for the market and the economy...

OP has 150k cash losing money sitting his bank account.

15k in student loans is pennies, might as well just get rid of it.

underwater house. (financially :D )

what would you do with the 150k cash?

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willthrill81
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Re: Paying off debt vs. max savings

Postby willthrill81 » Tue Jul 18, 2017 11:01 am

beth65 wrote:
willthrill81 wrote:
beth65 wrote:I follow these boards somewhat frequently, and I know that many people here are more fiscally conservative, but why do so many people always recommend paying off any debt first? Why is debt-free always the way to go?


Because many of us, along with millions of Americans, have been burned badly with debt in the past.

Debt can certainly be a useful tool, but it can also be a very deadly one. FAR more people have been hurt by debt than helped by it, and even the best laid plans for using it properly can go awry.

"The rich rules over the poor, And the borrower becomes the lender's slave."
- Proverbs 22:7


But if you are earning 6% returns in the market, and you have a student loan debt of 2.5%, assuming that's fixed, why pay that off sooner? How do you get burned on a student loan debt with a low fixed rate? If you have 2x the amount of the loan in liquidity, even a job loss should not prevent you from making payments. I think good debt is one that you CAN easily pay off, but you make more money elsewhere. Meaning you can't actually get burned by it. I don't like to put all of my liquidity in risky investments, either, because then it's not really liquid. Like I mentioned above, if you pay of debt too soon, that money is gone, and if the market crashes, you can't get it back without taking more loans at a higher interest rate.


If the market crashes, how will you earn that 6% return in the market?

The twist to using leverage to increase your returns is that you usually need to be really leveraged in order for it to make a significant difference in your situation. The OP's case is no different. It isn't going to move the needle much regardless as to what he does, so why not remove obligations on future money when it can be done painlessly now?
“It's a dangerous business, Frodo, going out your door. You step onto the road, and if you don't keep your feet, there's no knowing where you might be swept off to.” J.R.R. Tolkien,The Lord of the Rings

niners9088
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Re: Paying off debt vs. max savings

Postby niners9088 » Tue Jul 18, 2017 11:32 am

Here is what I would do.

I'd keep about 6 months cash in an emergency fund in a high yield savings account. (~40k)
I'd payoff the student loans. While it might not be the best bang for your buck it will simplify things and it is a small amount. (15k)
For the car I'd either pay it off or add the remaining onto my emergency fund and bank the 1% risk free rate. (23k)
I'd max my 401ks (36k)

This should be about ~114k so 36k remaining.
I'd figure out what I want to do with the rental. I'd either sell it or do something to get it to cash flow positive. If you have a good history of rental income at $950 I would think you can easily get $110-130k for it. Don't trust Zillow it is often way off.

Then I'd fund the 529


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