Priority of payoffs

Non-investing personal finance issues including insurance, credit, real estate, taxes, employment and legal issues such as trusts and wills
Post Reply
jplatzer
Posts: 9
Joined: Fri Mar 02, 2018 10:24 am

Priority of payoffs

Post by jplatzer » Mon Mar 19, 2018 6:15 am

Good morning,

After reading through the Bogleheads Investment Philosophy, The Bogleheads Guide to Investments, and the various starter kits I decided to take a hard look at our financial situation.

I realized that we have too many expenses that by paying off some debts, I can free up more money to save and invest.

Right now, we have 2 car lease payments, a 401K loan (used this to pay off a credit card with an interest rate over 20%. The interest rate on the loan is only 5%), and a 2nd mortgage that I'd like to pay off. My initial plan was to pay off one of the car lease payments which would free up $300 per month. I would then put that toward the principal of the 401K loan along with additional one time payments in September of this year and next year. This would pay the 401K loan off by next September. I could then take the $600 freed up from that and add it to the principal every month of the 2nd mortgage (I've been adding $200 per month to principal for a few years already so this would be $882 additional on the principal. I'd also add a few thousand each September to pay it down.

This plan would pay off the 401K loan by next September and the 2nd mortgage by the following September 2020.

I'm wrestling with it because I'd like to actually pay off one of these 4 items this September. Alternatives could include paying off the entire 401K loan all at once (would be about $13,500 in September) or alternatively to pay off both car leases (about $15,000) in total. Paying off both car leases would free up $600 per month which could then go to the 401k loan or mortgage.

I'm rambling a bit but the goal is to pay all 4 of these off as quickly and prudently as possible so I can start saving. This will help us to spend way less than we earn and get us into a healthier financial lifestyle. Thank you in advance.

User avatar
djpeteski
Posts: 689
Joined: Fri Mar 31, 2017 9:07 am

Re: Priority of payoffs

Post by djpeteski » Mon Mar 19, 2018 6:39 am

If it was me, I would live like "my house is on fire", financially speaking, and do everything to get that 401k loan paid off. No eating out, no investing, no vacations, etc... I would also consider working an extra job or three. What troubles me from your short description is that you saw the 401K loan as wise, exchanging a 5% loan for a 20% loan. However some things need to be pointed out:
You had a 20% loan.
You leased a car with that 20% loan.
You leased a second car with a leased car and a 20% loan.
You then decided to take out a loan that could turn into a 40-50% loan.

To me that indicates a spending problem.

A good rule of thumb for the cars is to pay them off in a year, or sell. So those would be next in my opinion.

Then tackle the HEL.

My advice would be not to invest until you have the cars and the 401K loans complete. Then contribute only to your match while you take care of the HEL.

Dude, you really need to get on a budget. For people like you: daveramsey.com. I say that as an former over spender myself. Good luck to you.

JoeRetire
Posts: 1684
Joined: Tue Jan 16, 2018 2:44 pm

Re: Priority of payoffs

Post by JoeRetire » Mon Mar 19, 2018 7:01 am

Pay off the highest interest rate loan first, then the next highest, etc.

Meanwhile, look hard at the reasons why you incurred those debts in the first place. If you don't already have an emergency fund which could prevent getting in debt, fund that.

NextMil
Posts: 517
Joined: Wed Dec 13, 2017 12:33 pm

Re: Priority of payoffs

Post by NextMil » Mon Mar 19, 2018 7:13 am

If I were you, and I know I am going to get flogged for this, but I would ignore interest rates, and just list smallest to largest and attack the smallest one a la Dave Ramsey's snowball method - that system works great especially for someone starting out. As djpeteski said, you need to treat this like your house is on fire, and get on a written budget.

hightower
Posts: 512
Joined: Mon Dec 12, 2016 2:28 am

Re: Priority of payoffs

Post by hightower » Mon Mar 19, 2018 7:22 am

I would spend some time watching or listening to Dave Ramsey to help you get a grip on your spending problem (which is why you have a debt problem). You have some serious behavioral issues to address before you'll actually be able to get out of debt. It's good you're here asking questions though, that's an important first step in the right direction.

I agree with paying off smallest balances first to help gain a sense of accomplishment. Also, never lease a car again. What do you mean you're going to pay off the lease? Do you mean pay off the loan balances? From now on, buy used cars and pay cash until you're out of debt;) Also, throw away your credit cards. Save a small emergency fund first before starting the loan pay off process so you can avoid needing to use debt in the future.

Grt2bOutdoors
Posts: 19481
Joined: Thu Apr 05, 2007 8:20 pm
Location: New York

Re: Priority of payoffs

Post by Grt2bOutdoors » Mon Mar 19, 2018 7:24 am

NextMil wrote:
Mon Mar 19, 2018 7:13 am
If I were you, and I know I am going to get flogged for this, but I would ignore interest rates, and just list smallest to largest and attack the smallest one a la Dave Ramsey's snowball method - that system works great especially for someone starting out. As djpeteski said, you need to treat this like your house is on fire, and get on a written budget.
+1 - Agreed. Do exactly as above, smallest to largest. I'd pay the second mortgage off last. OP you need to live below your means. What caused you to incur credit card debt? Do you have a budget? Look up Dave Ramsey - Total Money Makeover. Once you get off the debt cycle, you can then begin to invest more heavily.
"One should invest based on their need, ability and willingness to take risk - Larry Swedroe" Asking Portfolio Questions

User avatar
Watty
Posts: 14574
Joined: Wed Oct 10, 2007 3:55 pm

Re: Priority of payoffs

Post by Watty » Mon Mar 19, 2018 7:35 am

I didn't follow the way you were talking about "pay off one of the car lease payments" since that sort of sounds like you were talking about a car loan. Is that some sort of option you have to buy the leased cars at any time?

If so then would it would it make sense to buy the cars with conventional auto loans if you could get lower interest rates and payments?

Part of your problem is that no matter how you divvy up the money you are still dealing with the same loan amounts and your ability to pay so which you pay first will make a limited difference. You should probably consider;

1) Turning in the cars at the end of the lease and getting much less expensive cars.

2) Figuring out some way to bring in more income with a part time work in the evenings and weekends. In some jobs working more overtime is also an option.

The 401k loan would really bother me since if you get leave that job then it would usually have to be paid back real quick. This could be a problem if you are laid off or if you find a higher paying job with another company.

Other people have mentioned checking out Dave Ramsey to help figure how to to get out of debt. He has a good reputation for helping with that but one thing to watch out for is that his ideas about how to invest money once you are out of debt are widely regarded as being pretty bad so you should not follow his investing advice.

Grt2bOutdoors
Posts: 19481
Joined: Thu Apr 05, 2007 8:20 pm
Location: New York

Re: Priority of payoffs

Post by Grt2bOutdoors » Mon Mar 19, 2018 7:38 am

Watty wrote:
Mon Mar 19, 2018 7:35 am


Other people have mentioned checking out Dave Ramsey to help figure how to to get out of debt. He has a good reputation for helping with that but one thing to watch out for is that his ideas about how to invest money once you are out of debt are widely regarded as being pretty bad so you should not follow his investing advice.
What you don't agree with purchasing 4 good growth mutual funds? 25% in a growth fund like the S&P 500, 25% in an international growth fund, 25% in a growth and income fund and 25% in a "shoot the lights out" aggressive growth fund. What could go wrong? :wink: Works great in a bull market.
"One should invest based on their need, ability and willingness to take risk - Larry Swedroe" Asking Portfolio Questions

ChinchillaWhiplash
Posts: 570
Joined: Sat Jan 20, 2018 5:40 pm
Location: Colorado

Re: Priority of payoffs

Post by ChinchillaWhiplash » Mon Mar 19, 2018 8:02 am

Pay off the highest interest rate 1st. Then the next. The 401k loan is paying interest to yourself, so I wouldn't worry about that as much. There is usually a 5 year time frame on those loans. One issue is that if the 401k is employer provided and you quit or get fired, you have to pay the loan back at that time. Otherwise I would just figure out how much you need to pay per month to pay it off for the 5 years. Use the extra money to pay off other debt.

emoore
Posts: 478
Joined: Mon Mar 04, 2013 8:16 pm

Re: Priority of payoffs

Post by emoore » Mon Mar 19, 2018 8:17 am

I agree with what most people said. Pay off the 2nd mortgage and the cars. Don't worry about the 401k loan too much. The recent tax law has changed the grace period for paying off a 401k loan after you leave your job. It was 60 days and now it's the following years tax date (April or October if you file an extension.

User avatar
Epsilon Delta
Posts: 7430
Joined: Thu Apr 28, 2011 7:00 pm

Re: Priority of payoffs

Post by Epsilon Delta » Mon Mar 19, 2018 10:58 am

jplatzer wrote:
Mon Mar 19, 2018 6:15 am
I realized that we have too many expenses that by paying off some debts, I can free up more money to save and invest.
This is not true and you should keep looking at your situation until you understand why.

The way to free up money to save and invest is by not spending it. Debt is money you have already spent, you can't do anything about that, but you can control future spending. Paying off debt does not increase your net worth any more than putting the same money into savings.

Rearranging the debt may reduce your interest payments which is a good thing, but it does not increase savings.

Luke Duke
Posts: 787
Joined: Tue Jun 18, 2013 11:44 am
Location: Texas

Re: Priority of payoffs

Post by Luke Duke » Mon Mar 19, 2018 11:15 am

You may not be allowed per company policy to make extra payments on the 401k loan. At my old company you either paid it out per the original terms or you paid the balance off in full. You couldn't just throw extra cash at it every once in a while.

delamer
Posts: 6387
Joined: Tue Feb 08, 2011 6:13 pm

Re: Priority of payoffs

Post by delamer » Mon Mar 19, 2018 5:08 pm

Watty wrote:
Mon Mar 19, 2018 7:35 am
I didn't follow the way you were talking about "pay off one of the car lease payments" since that sort of sounds like you were talking about a car loan. Is that some sort of option you have to buy the leased cars at any time?

If so then would it would it make sense to buy the cars with conventional auto loans if you could get lower interest rates and payments?

Part of your problem is that no matter how you divvy up the money you are still dealing with the same loan amounts and your ability to pay so which you pay first will make a limited difference. You should probably consider;

1) Turning in the cars at the end of the lease and getting much less expensive cars.

2) Figuring out some way to bring in more income with a part time work in the evenings and weekends. In some jobs working more overtime is also an option.

The 401k loan would really bother me since if you get leave that job then it would usually have to be paid back real quick. This could be a problem if you are laid off or if you find a higher paying job with another company.

Other people have mentioned checking out Dave Ramsey to help figure how to to get out of debt. He has a good reputation for helping with that but one thing to watch out for is that his ideas about how to invest money once you are out of debt are widely regarded as being pretty bad so you should not follow his investing advice.
I was also confused about paying off the leases. Would you get a reduction in the remaining cost of the leases if you paid them in a lump sum? Then it might make sense to pay them off. But if not, the what is the advantage?

And where is the money coming from to pay off any of your debt? If you have savings to pay off the debt, you could invest that money now. Let’s say you have $15,000 in savings. You can either pay off debt or invest it. Which is the better option depends in interest rates, tax implications, preferred asset allocation, and probably other factors.

Post Reply