Which Debt to Payoff First?!

Non-investing personal finance issues including insurance, credit, real estate, taxes, employment and legal issues such as trusts and wills
Post Reply
AndyFromPennsylvania
Posts: 40
Joined: Sun Jul 16, 2017 6:15 pm

Which Debt to Payoff First?!

Post by AndyFromPennsylvania » Sun Nov 05, 2017 5:43 pm

Hey Bogleheads, need some advice.

My wife and I are receiving $30k (after tax) from an estate of a deceased family member. Would appreciate some advice on how to use it best. I am 31 and my wife is in her late 20s. We recently became parents (4 month old) and home owners. I work full time and my wife works part time to spend more time at home with the little one. Here is our financial status:
- $130,000 mortgage at fixed 4.125% at 30 years. We're 6 months in.
- $9,500 car loan at 2.5%
- My wife has $30,000 in student loans, but they are interest free. No joke.
- I am contributing 3% to my 401k so I get the maximum company contribution.
- My wife and I are also maxing out our Roth IRAs.
- We have a $25,000 emergency fund in a money market. Good for 6 months.

We have not yet started a 529 plan for college. I came to this forum previously and got some great advice. Instead of first starting a 529 for our little one, we decided to max out our Roth IRAs first. I've read a few discussions on here and came across an idea of considering purchasing bonds instead of paying down a mortgage. But I have not figured out the logic yet of how to calculate what is more beneficial (regarding bonds). How does one go about even purchasing bonds? So I am asking what approach would you recommend with the $30k. Thanks in advance!

Olemiss540
Posts: 567
Joined: Fri Aug 18, 2017 8:46 pm

Re: Which Debt to Payoff First?!

Post by Olemiss540 » Sun Nov 05, 2017 6:05 pm

I would try using the 30k in order to MAX 401k contributions for this year and next year while also paying the vehicle loan off.

Once vehicle was paid off and IRA/401k maxed, I would work on paying off the student loans in order to improve cash flow to best allow you to continue doing so for the foreseeable future.

Do you have access to an HSA through work contributions?

You need to secure your retirement before worrying about college costs. It's much easier to cash flow college than it is to cash flow retirement.....
I hold index funds because I do not overestimate my ability to pick stocks OR stock pickers.

PFInterest
Posts: 2252
Joined: Sun Jan 08, 2017 12:25 pm

Re: Which Debt to Payoff First?!

Post by PFInterest » Sun Nov 05, 2017 6:41 pm

Max 401 then pay off car.

User avatar
FiveK
Posts: 5598
Joined: Sun Mar 16, 2014 2:43 pm

Re: Which Debt to Payoff First?!

Post by FiveK » Sun Nov 05, 2017 6:44 pm


Stormbringer
Posts: 583
Joined: Sun Jun 14, 2015 7:07 am

Re: Which Debt to Payoff First?!

Post by Stormbringer » Sun Nov 05, 2017 8:32 pm

I'll go against the grain here and recommend that you first pay off the car, and then apply what is left towards the student loans with a goal of paying those off ASAP.

You could throw it all at your 401(k), but that is a one-time event and you wouldn't be dollar cost averaging. Rather, you would be putting it all at once into a richly valued market. Paying off debt is a risk-free way of increasing your cash flow in a sustainable way that will allow you to invest on a regular schedule for the long-term. Take the money you save each month by having fewer payments and permanently increase your 401(k) contributions accordingly.
"Compound interest is the most powerful force in the universe." - Albert Einstein

momvesting
Posts: 78
Joined: Tue Apr 12, 2016 9:18 pm

Re: Which Debt to Payoff First?!

Post by momvesting » Sun Nov 05, 2017 8:37 pm

Pay off the car. Increase the 401k by at least an amount equal to what the car payment was plus some for tax savings. Increase the emergency fund with the rest.

User avatar
FiveK
Posts: 5598
Joined: Sun Mar 16, 2014 2:43 pm

Re: Which Debt to Payoff First?!

Post by FiveK » Sun Nov 05, 2017 8:44 pm

Stormbringer wrote:
Sun Nov 05, 2017 8:32 pm
You could throw it all at your 401(k), but that is a one-time event
Indeed - and this year's 401k window closes as of the year's final paycheck.

Also, consider the case of the world's worst market timer.

User avatar
Watty
Posts: 14128
Joined: Wed Oct 10, 2007 3:55 pm

Re: Which Debt to Payoff First?!

Post by Watty » Sun Nov 05, 2017 9:59 pm

One option is to use part of the money to pay down your mortgage if your lender will agree to "recast your mortgage" (Google this). They are not required to but they usually will and only charge a couple of hundred dollar processing fee. The way that it works is that if you pay down your mortgage by 20%, or whatever makes sense, then your required monthly payment will also be reduced by the same percentage. The length of the loan and the interest rate will stay the same. This could be important if yo are laid off or interest rates go way up and you want to keep the loan for a long time.

I don't see a compelling "right" choice but if I was in your situation I would put it all towards recasting your mortgage then putting the freed up cash flow each month into your retirement accounts. That could reduce your mortgage payment by over 20%

One thing to look into is how long your wife's loans will be interest free. At some point interest may start being charged.

One other option would be to put all the money towards your kids college savings. By the time the kid goes to college that could be about enough to pay for a stat university.

mega317
Posts: 2554
Joined: Tue Apr 19, 2016 10:55 am

Re: Which Debt to Payoff First?!

Post by mega317 » Mon Nov 06, 2017 12:39 am

Without more info I would favor getting it all into the 401k over 2 years. You only have limited tax-advantaged space every year. I disagree with Stormbringer. No one knows what's going to happen in the future but the general trend of the market has been up, so in theory the earlier you invest the better.

But I have a larger concern. I think for most people 3% plus Roths will be a stretch for retirement. And you haven't started saving for college yet. And the child will become more expensive over time. If you're comfortable doing so you might benefit from giving us more detailed numbers.

EnjoyIt
Posts: 1583
Joined: Sun Dec 29, 2013 8:06 pm

Re: Which Debt to Payoff First?!

Post by EnjoyIt » Mon Nov 06, 2017 1:47 am

Andy,
With limited information we can only give limited advice.
Considering your debts, I can assume cashflow is a very important to you two right now. So let me break down your options for you.

1) Invest the money in a retirement account or a taxable account. This will over long term more than likely provide you the best benefit financially. Long term being the next 20-30 years. But, it provides no increase in cashflow and you won't reap the benefits for decades.

2) Put money in your highest interest rate loan which is the mortgage. Mathematically this is your second best option. But, it provides no visible benefit today. Your mortgage payments won't decrease, and you will not see any change in how much cash you have on hand every month.

3) Pay money in the second lowest loan which is the 2.5% car loan. This may seam like a silly idea because of the rate being so low, But paying off the car provides an instant increase in cashflow for your family.

4) Pay off the school loan which gives you the same answer as #3.

Personally if I was in your shows and had a newborn I would value cashflow over long term wealth which is why I would pay off the car and invest the rest. I would invest the $20500 by placing everything into a high yield savings account and then investing 1/12 of it every month till it is gone. Again mathematically this is not the most ideal answer, but based on your situation it will likely provide you with reasonable results with the security of having some cash on hand with a newborn. I would also take your increased cashflow from not having to pay your car note anymore and invest that as well.

hightower
Posts: 510
Joined: Mon Dec 12, 2016 2:28 am

Re: Which Debt to Payoff First?!

Post by hightower » Mon Nov 06, 2017 7:10 am

AndyFromPennsylvania wrote:
Sun Nov 05, 2017 5:43 pm
Hey Bogleheads, need some advice.

My wife and I are receiving $30k (after tax) from an estate of a deceased family member. Would appreciate some advice on how to use it best. I am 31 and my wife is in her late 20s. We recently became parents (4 month old) and home owners. I work full time and my wife works part time to spend more time at home with the little one. Here is our financial status:
- $130,000 mortgage at fixed 4.125% at 30 years. We're 6 months in.
- $9,500 car loan at 2.5%
- My wife has $30,000 in student loans, but they are interest free. No joke.
- I am contributing 3% to my 401k so I get the maximum company contribution.
- My wife and I are also maxing out our Roth IRAs.
- We have a $25,000 emergency fund in a money market. Good for 6 months.

We have not yet started a 529 plan for college. I came to this forum previously and got some great advice. Instead of first starting a 529 for our little one, we decided to max out our Roth IRAs first. I've read a few discussions on here and came across an idea of considering purchasing bonds instead of paying down a mortgage. But I have not figured out the logic yet of how to calculate what is more beneficial (regarding bonds). How does one go about even purchasing bonds? So I am asking what approach would you recommend with the $30k. Thanks in advance!
There are lot's of good options here. None of which would be better than the other IMO. I think everyone would agree to go ahead and get rid of the car loan first (and don't buy cars on credit ever again). Next I would either consider putting the rest in a 529, which would give you a very big head start on college savings. That's probably the best use for the money IMO since it's money coming from a relative, it would be nice to see that money go towards advancing your family's future. It wouldn't be wrong to pay down the mortgage either. It also wouldn't be wrong to pay off the student loans. It's all debt and eventually it has to be paid. Do you really need 25k in emergency funds? What are your annual expenses? What kind of income do you bring in each year? These numbers can also help decide the best course of action. I don't really think maxing the 401k would be all that beneficial, especially if you're already in a fairly low tax bracket.

Jack FFR1846
Posts: 7799
Joined: Tue Dec 31, 2013 7:05 am

Re: Which Debt to Payoff First?!

Post by Jack FFR1846 » Mon Nov 06, 2017 7:32 am

If you use standard deduction, pay it towards the mortgage.

If not, pay off the car, and increase your 401k contributions for the rest of the year and into next year.

When you get right down to it, this isn't a lot of money, so it doesn't make a huge difference what you do. I would absolutely agree not to start a 529. You need to get rid of your debts first, in my opinion. Fill up retirement tax advantaged accounts. When you get to the point where you have no debts at all (this means mortgage paid off) and have extra money, look at 529s. I didn't say to start one. iBonds might be better for you. A taxable account would be more flexible. Whether you get state tax breaks for 529 contributions figures into that decision.
Bogle: Smart Beta is stupid

student
Posts: 2533
Joined: Fri Apr 03, 2015 6:58 am

Re: Which Debt to Payoff First?!

Post by student » Mon Nov 06, 2017 8:18 am

I agree with others who said pay off the car loan. Depending on your job security, I would put the rest in the emergency fund, increasing it to cover just under 1 year.

soccerrules
Posts: 803
Joined: Mon Nov 14, 2016 4:01 pm

Re: Which Debt to Payoff First?!

Post by soccerrules » Mon Nov 06, 2017 11:31 am

Good solid opinions here.

I would do the thing(s) that help you sleep at night.

For me right now it would be paying off debt. I would sleep better at night knowing that I owed nothing. I think people under estimate the emotional and physical toll that debt has on you/family.
Don't let your outflow exceed your income or your upkeep will be your downfall.

User avatar
JupiterJones
Posts: 2693
Joined: Tue Aug 24, 2010 3:25 pm
Location: Nashville, TN

Re: Which Debt to Payoff First?!

Post by JupiterJones » Mon Nov 06, 2017 4:46 pm

I'd lean toward the car too. Be nice to not be on the hook for that payment every month, wouldn't it?

But if you're paying PMI, I'd consider paying down the mortgage to get rid of it.
Stay on target...

mortfree
Posts: 1276
Joined: Mon Sep 12, 2016 7:06 pm

Re: Which Debt to Payoff First?!

Post by mortfree » Mon Nov 06, 2017 6:45 pm

I would choose between the Mortgage if you are paying PMI or student loan just because of the loan amount.

This car will not be his last car and I would guess the next car would not be bought with cash either.

I would really try to go higher than 3% for 401k.

Details are lacking

AndyFromPennsylvania
Posts: 40
Joined: Sun Jul 16, 2017 6:15 pm

Re: Which Debt to Payoff First?!

Post by AndyFromPennsylvania » Sun Nov 12, 2017 7:10 pm

All - Thank you for the input. Reading your responses has been great, and much appreciated. I apologize for the delay, hectic last few weeks. My wife and really like the idea of paying off the car first. I am going to follow up with a few individuals responses. This forum is great, learning a few news things already. :happy

AndyFromPennsylvania
Posts: 40
Joined: Sun Jul 16, 2017 6:15 pm

Re: Which Debt to Payoff First?!

Post by AndyFromPennsylvania » Sun Nov 12, 2017 7:13 pm

Jack FFR1846 wrote:
Mon Nov 06, 2017 7:32 am
If you use standard deduction, pay it towards the mortgage.

If not, pay off the car, and increase your 401k contributions for the rest of the year and into next year.

When you get right down to it, this isn't a lot of money, so it doesn't make a huge difference what you do. I would absolutely agree not to start a 529. You need to get rid of your debts first, in my opinion. Fill up retirement tax advantaged accounts. When you get to the point where you have no debts at all (this means mortgage paid off) and have extra money, look at 529s. I didn't say to start one. iBonds might be better for you. A taxable account would be more flexible. Whether you get state tax breaks for 529 contributions figures into that decision.
Thank you for the input. How do you go about investing in iBonds? I just looked up what they are. I need to learn more about bonds, any recommendations on where to start to get my feet wet?

AndyFromPennsylvania
Posts: 40
Joined: Sun Jul 16, 2017 6:15 pm

Re: Which Debt to Payoff First?!

Post by AndyFromPennsylvania » Sun Nov 12, 2017 7:15 pm

EnjoyIt wrote:
Mon Nov 06, 2017 1:47 am
Andy,
With limited information we can only give limited advice.
Considering your debts, I can assume cashflow is a very important to you two right now. So let me break down your options for you.

1) Invest the money in a retirement account or a taxable account. This will over long term more than likely provide you the best benefit financially. Long term being the next 20-30 years. But, it provides no increase in cashflow and you won't reap the benefits for decades.

2) Put money in your highest interest rate loan which is the mortgage. Mathematically this is your second best option. But, it provides no visible benefit today. Your mortgage payments won't decrease, and you will not see any change in how much cash you have on hand every month.

3) Pay money in the second lowest loan which is the 2.5% car loan. This may seam like a silly idea because of the rate being so low, But paying off the car provides an instant increase in cashflow for your family.

4) Pay off the school loan which gives you the same answer as #3.

Personally if I was in your shows and had a newborn I would value cashflow over long term wealth which is why I would pay off the car and invest the rest. I would invest the $20500 by placing everything into a high yield savings account and then investing 1/12 of it every month till it is gone. Again mathematically this is not the most ideal answer, but based on your situation it will likely provide you with reasonable results with the security of having some cash on hand with a newborn. I would also take your increased cashflow from not having to pay your car note anymore and invest that as well.
Thank you for your input, really enjoyed it! Very good point about having cash on hand because of the newborn.

AndyFromPennsylvania
Posts: 40
Joined: Sun Jul 16, 2017 6:15 pm

Re: Which Debt to Payoff First?!

Post by AndyFromPennsylvania » Sun Nov 12, 2017 7:22 pm

Stormbringer wrote:
Sun Nov 05, 2017 8:32 pm
I'll go against the grain here and recommend that you first pay off the car, and then apply what is left towards the student loans with a goal of paying those off ASAP.

You could throw it all at your 401(k), but that is a one-time event and you wouldn't be dollar cost averaging. Rather, you would be putting it all at once into a richly valued market. Paying off debt is a risk-free way of increasing your cash flow in a sustainable way that will allow you to invest on a regular schedule for the long-term. Take the money you save each month by having fewer payments and permanently increase your 401(k) contributions accordingly.
I looked up what dollar cost averaging is. Another person on here shared an interested article. I've been taking advantage of reading the books recommended on here. Any recommendation on how you learned how to implement dollar cost averaging with your accounts?

AndyFromPennsylvania
Posts: 40
Joined: Sun Jul 16, 2017 6:15 pm

Re: Which Debt to Payoff First?!

Post by AndyFromPennsylvania » Sun Nov 12, 2017 7:29 pm

mega317 wrote:
Mon Nov 06, 2017 12:39 am
Without more info I would favor getting it all into the 401k over 2 years. You only have limited tax-advantaged space every year. I disagree with Stormbringer. No one knows what's going to happen in the future but the general trend of the market has been up, so in theory the earlier you invest the better.

But I have a larger concern. I think for most people 3% plus Roths will be a stretch for retirement. And you haven't started saving for college yet. And the child will become more expensive over time. If you're comfortable doing so you might benefit from giving us more detailed numbers.
What kind of other information would be helpful? I did forget to mention that my wife and I put down 20% when we purchased the home, so no PMI. Our annual pretax combined income is approx $110,000 (so 25% tax bracket). This year we switched into a high deductible medial plan for 2018, so opened an HSA (ran across some posts recommending this, and it did make sense for us). I need to look into if it's a good idea to max out an HSA. I wonder if there is benefit in using to supplement a retirement account.

User avatar
FiveK
Posts: 5598
Joined: Sun Mar 16, 2014 2:43 pm

Re: Which Debt to Payoff First?!

Post by FiveK » Sun Nov 12, 2017 7:30 pm

AndyFromPennsylvania wrote:
Sun Nov 12, 2017 7:22 pm
Stormbringer wrote:
Sun Nov 05, 2017 8:32 pm
I'll go against the grain here and recommend that you first pay off the car, and then apply what is left towards the student loans with a goal of paying those off ASAP.

You could throw it all at your 401(k), but that is a one-time event and you wouldn't be dollar cost averaging. Rather, you would be putting it all at once into a richly valued market. Paying off debt is a risk-free way of increasing your cash flow in a sustainable way that will allow you to invest on a regular schedule for the long-term. Take the money you save each month by having fewer payments and permanently increase your 401(k) contributions accordingly.
I looked up what dollar cost averaging is. Another person on here shared an interested article. I've been taking advantage of reading the books recommended on here. Any recommendation on how you learned how to implement dollar cost averaging with your accounts?
The more one learns, the more one realizes there is no "sure thing."

See http://www.schwab.com/public/schwab/nn/ ... iming-Work and
http://awealthofcommonsense.com/2014/02 ... ket-timer/ for counterpoints to DCA. ;)
Well, the second article isn't exactly a "don't DCA" message, but it is a "don't be afraid that the market is high" perspective.

Stormbringer
Posts: 583
Joined: Sun Jun 14, 2015 7:07 am

Re: Which Debt to Payoff First?!

Post by Stormbringer » Sun Nov 12, 2017 7:38 pm

AndyFromPennsylvania wrote:
Sun Nov 12, 2017 7:22 pm
I looked up what dollar cost averaging is. Another person on here shared an interested article. I've been taking advantage of reading the books recommended on here. Any recommendation on how you learned how to implement dollar cost averaging with your accounts?
It's really as simple as investing a similar amount at regular intervals. For example, investing $500 every month instead of $6,000 once per year. It is just another form of diversification -- over time.

Here is what Warren Buffett had to say about it:
Warren Buffet wrote: The main danger is that the timid or beginning investor will enter the market at a time of extreme exuberance and then become disillusioned when paper losses occur. (Remember the late Barton Biggs’s observation: “A bull market is like sex. It feels best just before it ends.”) The antidote to that kind of mistiming is for an investor to accumulate shares over a long period and never sell when the news is bad and stocks are well off their highs. Following those rules, the “know-nothing” investor who both diversifies and keeps his costs minimal is virtually certain to get satisfactory results. Indeed, the unsophisticated investor who is realistic about his shortcomings is likely to obtain better long-term results than the knowledgeable professional who is blind to even a single weakness.
Edit: As others have pointed out, there is an argument to be made that dollar-cost averaging is not optimal mathematically. However, you are a younger, new investor and you may well find that your greatest adversary is yourself and your reaction to the gyrations in the market. As Mr. Buffett's comments indicate, DCA is a defense against what you might do if the market drops a bunch right after you buy. There are plenty of people around here with steely nerves that focus purely on the math, but in reality most people are susceptible to counter-productive behavioral issues that adversely affect their performance.
"Compound interest is the most powerful force in the universe." - Albert Einstein

AndyFromPennsylvania
Posts: 40
Joined: Sun Jul 16, 2017 6:15 pm

Re: Which Debt to Payoff First?!

Post by AndyFromPennsylvania » Sun Nov 12, 2017 9:27 pm

Stormbringer wrote:
Sun Nov 12, 2017 7:38 pm
AndyFromPennsylvania wrote:
Sun Nov 12, 2017 7:22 pm
I looked up what dollar cost averaging is. Another person on here shared an interested article. I've been taking advantage of reading the books recommended on here. Any recommendation on how you learned how to implement dollar cost averaging with your accounts?
It's really as simple as investing a similar amount at regular intervals. For example, investing $500 every month instead of $6,000 once per year. It is just another form of diversification -- over time.

Here is what Warren Buffett had to say about it:
Warren Buffet wrote: The main danger is that the timid or beginning investor will enter the market at a time of extreme exuberance and then become disillusioned when paper losses occur. (Remember the late Barton Biggs’s observation: “A bull market is like sex. It feels best just before it ends.”) The antidote to that kind of mistiming is for an investor to accumulate shares over a long period and never sell when the news is bad and stocks are well off their highs. Following those rules, the “know-nothing” investor who both diversifies and keeps his costs minimal is virtually certain to get satisfactory results. Indeed, the unsophisticated investor who is realistic about his shortcomings is likely to obtain better long-term results than the knowledgeable professional who is blind to even a single weakness.
Edit: As others have pointed out, there is an argument to be made that dollar-cost averaging is not optimal mathematically. However, you are a younger, new investor and you may well find that your greatest adversary is yourself and your reaction to the gyrations in the market. As Mr. Buffett's comments indicate, DCA is a defense against what you might do if the market drops a bunch right after you buy. There are plenty of people around here with steely nerves that focus purely on the math, but in reality most people are susceptible to counter-productive behavioral issues that adversely affect their performance.
Really enjoyed the article; thank you for sharing! :happy

Post Reply