Which debt to payoff?

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ericcohen
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Which debt to payoff?

Post by ericcohen » Mon Feb 04, 2019 8:11 pm

I'm having trouble figuring out which debt I should pay off. I could use some advice from the financial gurus here. For various reasons, I can only pay off one of these debts. My emergency fund is set, by the way.

Debt 1:
Amount owed: $24,000
Interest rate: 2.0%
Monthly payment: ~$620 /mo
Term: don't remember exactly but around 3-4 years

Debt 1 is really hurting my monthly cashflow, but the interest rate is low. And given that the money that would be used to pay off the debt is in a Prime MM earning 2.4%, i.e., more than the interest rate on the debt, it doesn't seem to make financial sense to pay it off. But it's crimping my ability to plow $$ from my after tax earnings into my investment accounts.

Debt 2:
Amount owed: $45,000
Interest rate 3.5%
Monthly payment: $300/mo
Years left: more than 15 I think or around there

Higher interest rate, but the monthly payment is comfortable and would allow me to plow money for the next group of years into my investment account. This is also my oldest account and boosts my credit a lot. The money I would use to pay it off is in a prime MM earning 2.4%. I think I could earn more than 3.5% with the $$ I plow into my investment accounts.

What should I pay off? And why?

buhlaxtus
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Re: Which debt to payoff?

Post by buhlaxtus » Mon Feb 04, 2019 8:18 pm

How much cash do you have for this? Perhaps you can pay off #1 AND half of #2 :)

Technically the best return is from paying of #2, of course, because it has the higher interest rate. But if that doesn't float your boat, the difference isn't so huge that you shouldn't just go with your feelings.

Really it's hard to give real advice without knowing the rest of the picture. I think you're leaving out a lot of information about the rest of your finances.

Topic Author
ericcohen
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Re: Which debt to payoff?

Post by ericcohen » Mon Feb 04, 2019 8:24 pm

buhlaxtus wrote:
Mon Feb 04, 2019 8:18 pm
How much cash do you have for this? Perhaps you can pay off #1 AND half of #2 :)

Technically the best return is from paying of #2, of course, because it has the higher interest rate. But if that doesn't float your boat, the difference isn't so huge that you shouldn't just go with your feelings.

Really it's hard to give real advice without knowing the rest of the picture. I think you're leaving out a lot of information about the rest of your finances.
Thanks. What other information do you want to know? I have enough to pay off either debt. If anything is left over it will go into the market.

gclancer
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Re: Which debt to payoff?

Post by gclancer » Mon Feb 04, 2019 8:28 pm

ericcohen wrote:
Mon Feb 04, 2019 8:24 pm
I have enough to pay off either debt. If anything is left over it will go into the market.
Uninformed answer due to lack of facts, but from what you’ve said, why not $24k to debt #1, $21k to debt #2 (greater interest savings due to moving down the amortization schedule) and then let debt #2 ride while you invest in taxable.

buhlaxtus
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Re: Which debt to payoff?

Post by buhlaxtus » Mon Feb 04, 2019 8:35 pm

So debt #1 is already earning you money, why pay it off at all?

Debt #2 could also earn you money, if you put the money in some stock/bond index fund and get better than 3.5% over the next 15 years. There's more risk here obviously.

Either way the amounts aren't huge. Me, I would probably pay off #2 right now because I hate having debt. #1 will be done soon enough anyway (car loan?) - and sooner if you use the extra $300 to pay it down. But plenty of people take a different perspective.

I think it comes down to your own comfort level and convenience, and whether you'd rather do something else with that $920 per month. These aren't like some credit cards where you are in an emergency and need to pay off asap. (Unless the rates could change - you didn't say.)

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RickBoglehead
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Re: Which debt to payoff?

Post by RickBoglehead » Mon Feb 04, 2019 8:36 pm

Higher interest rate first.
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rh00p
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Re: Which debt to payoff?

Post by rh00p » Mon Feb 04, 2019 9:01 pm

Pay off debt #1 since it's smaller and you'll have accomplished something. Whatever is left over use to start paying off debt #2, NOT an investment. And do whatever you have to do to pay the remaining debt.

Then you need to fix what brought about this scenario in the first place. being a slave to monthly payments is not a good place to be.
Preparing for the worst. Hoping for the best.

Morgan Dollar 1921
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Re: Which debt to payoff?

Post by Morgan Dollar 1921 » Mon Feb 04, 2019 9:09 pm

I believe you may be closer to 16 years and 4-5 months on your larger balance, the rest of the numbers point to the longer term on it. Since you say either loan can be discharged by your balance of the MM fund,... payoff Debt 1. The interest is probably not tax deductible, thus the interest difference between debt 1 and the after-tax return of 2.4 % MM fund, seems to be closer to a washout.

I place a higher value on flexibility of income, so, I pay off Dept 1, and hit Debt 2 with 21K, adding the $620 monthly payment of debt 1 now free by the payoff. You immediately increase the number of months of expenses your E fund covers, by the loss of $620 in required loan payment of debt 1. Your balance on Debt 2 will be real low if not paid off, in the same three- four years left in debt 1.

Might be the wrong answer for many here and you, but for me it works. Counting on investments to return a greater return than 3.5% is our goal, but check the return of S & P 500 or ETF ticker symbol VOO in 2018. Good luck with your decision.

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ericcohen
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Re: Which debt to payoff?

Post by ericcohen » Mon Feb 04, 2019 9:24 pm

Car loan and student loan. I only want to pay off one because the rates are so low, it seems like a waste to not put most if not all of that money in the market! But the payments are crimping my cash flow. I still have about 1200 /mo after all expenses. I have zero credit card debt, zero mortgage debt (I rent), zero other debt.

For those saying they need more information, what other info do you need?

:sharebeer

buhlaxtus
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Re: Which debt to payoff?

Post by buhlaxtus » Mon Feb 04, 2019 9:34 pm

How long will your student loan stay at 3.5%? Very important question.

What are your cash reserves beyond the ~$45k? Do you have dependents/family?

What are you doing with your other money? Spending it? Retirement savings, short term savings? Taxable, not taxable, . . .

If you are choosing between paying off the loan vs. buying luxuries, it's easy. Pay off the loans.

Vs. playing the stock market? Pay off the loans.

Vs. long term stocks/bonds index funds that may return more than 2-3.5%? That's a less clear choice. Then it's a question of what kind of risk you like to take. Me, I like the guarantee of getting rid of debt and increasing cash flow, but this is not cut and dried.

Vs. tax advantaged retirement savings? Even less a clear choice.

$1200/mo after all expenses... Is that after maximizing your contributions to retirement accounts?

mortfree
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Re: Which debt to payoff?

Post by mortfree » Mon Feb 04, 2019 9:43 pm

Debt #2.

Keeping debt around “just because” is not a good approach.

Get out of debt first. Then invest.

Morgan Dollar 1921
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Re: Which debt to payoff?

Post by Morgan Dollar 1921 » Mon Feb 04, 2019 9:45 pm

Can you deduct the interest of the student loan, and what marginal tax rate bracket are you in now?

I assumed 22% marginal rate in my first answer cutting the return of the MM fund to the range of 1.9%.

IF you can deduct student loan interest on your tax return, (not sure with the new law) as I used to, then I would let that ride out the 15 - 16 year term at 3.5%. That rate may become even more attractive prior to the end of the term of this loan, if it is fixed.
OK, I did a quick check on the new law:

""This means that you will still be allowed to claim a deduction of up to $2,500 for the interest you pay on student loans each year. If your modified adjusted gross income is less than $80,000 per year as a single filer, or less than $160,000 as a joint filer, this deduction allows you to save up to $625 per year."" (Cut and pasted off the web)

The last time I looked your student loan was dismissed in the event of an early untimely death, a morbid thought I know, but amounts to free life insurance for that loan. Knowing that Debt 2 is student loan debt,..I would now change my answer to payoff Debt 1, let debt 2 run it's term if you so desire. That said, save some for you next car purchase and pay cash, then invest the rest in ETF ticker's VTI, VOO, VYM, VTV or MGV. Take your pick, blue chip value with growth & income and a low expense ratio. Good luck and keep planning.

Topic Author
ericcohen
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Re: Which debt to payoff?

Post by ericcohen » Mon Feb 04, 2019 9:57 pm

I can't deduct any student loan interest. I am in the 24%. All the debt is fixed. My reserves are in good shape. It's not going to make or break me either way. The choice is to pay off one or the other debt and invest the rest for the long term in a sensible asset allocation. I guess I've already made the choice to not pay both off because the rates are so low it only makes sense to me to pay one or the other but not both. I mean 2% is great isn't it??? So is 3.5%.

I guess don't feel so bad being torn on this now, because I'm getting so many good but different answers.

Honestly, buh I don't max out my retirement accounts. I put in enough to get my match and that's it. I know, I know. Possibly I can put any $$ saved into increasing the money I put into those accounts.

Morgan Dollar 1921
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Re: Which debt to payoff?

Post by Morgan Dollar 1921 » Mon Feb 04, 2019 10:30 pm

" I mean 2% is great isn't it??? So is 3.5%."

Yes it is, toss a coin, or throw a dart.

Don't forget about that four letter word "Roth".

masha12
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Re: Which debt to payoff?

Post by masha12 » Mon Feb 04, 2019 10:38 pm

If it were me, I’d pay off the student loan. Just be done with it.

But, if cash flow and maximizing retirement savings is the goal and you only have $45k to use for debt payment, pay off the car loan and increase retirement contributions. Use the $300 extra per month and the remaining $21k toward the additional amount you are putting in retirement accounts.

Thecallofduty
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Re: Which debt to payoff?

Post by Thecallofduty » Mon Feb 04, 2019 10:50 pm

If it were me:

Pay off debt 2. I see no reason to keep this debt when you are able to pay it off completely.
-thecallofduty

Saving$
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Re: Which debt to payoff?

Post by Saving$ » Mon Feb 04, 2019 11:15 pm

Pay off debt #2. 3.5% is high enough that you are not guaranteed to beat that in the market.

Fund Roth to the max and use it as an emergency fund if paying off debt #2 leaves you without one.

Fund 401k to the max allowed.

Come back and post with more info if you have money left over after the above.

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FiveK
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Re: Which debt to payoff?

Post by FiveK » Tue Feb 05, 2019 12:43 am

ericcohen wrote:
Mon Feb 04, 2019 9:57 pm
...I don't max out my retirement accounts. I put in enough to get my match and that's it. I know, I know.
If "you know" then do something about it. ;)

With interest rates that low, one can make a very good case for paying neither early, but invest instead. E.g., see Investment Order.

EnjoyIt
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Re: Which debt to payoff?

Post by EnjoyIt » Tue Feb 05, 2019 7:55 am

If this was me, I would not start aggressively paying down that debt until I had a decent sized investment portfolio. The car loan will be paid off soon enough on its own relatively quickly and the school loan is at a low enough rate that I would invest. BTW, 4% is my cutoff.

But, you need to start maxing out your 401k. If you are not doing so, it’s just money you are giving up to the government which I’m sure will have a much higher tax benefit than the 3.5% interest rate.

Maybe once I had $500k or so I would consider paying down the 3.5% but not until then.

BTW, if you maxed out all pre-tax retirement accounts would your school interest be tax deductible then?

YoungBogle
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Re: Which debt to payoff?

Post by YoungBogle » Tue Feb 05, 2019 8:17 am

EnjoyIt wrote:
Tue Feb 05, 2019 7:55 am
If this was me, I would not start aggressively paying down that debt until I had a decent sized investment portfolio. The car loan will be paid off soon enough on its own relatively quickly and the school loan is at a low enough rate that I would invest. BTW, 4% is my cutoff.

But, you need to start maxing out your 401k. If you are not doing so, it’s just money you are giving up to the government which I’m sure will have a much higher tax benefit than the 3.5% interest rate.

Maybe once I had $500k or so I would consider paying down the 3.5% but not until then.

BTW, if you maxed out all pre-tax retirement accounts would your school interest be tax deductible then?
+1. This answer most aligns with my train of thought.

If someone offered you a loan in the amount of the principal at a 2-3.5% interest rate, would you take it?

Financially, the absolute WORST case scenario is that you put the money directed for the 2% & 3.5% loan into a savings account that yields 4.59% APY and make money doing nothing with zero risk or any loss of liquidity. And yes.. it’s actually less than 4.59% after taxes, but you get the jist.

https://www.doctorofcredit.com/consumer ... -checking/

Respectfully, this is where I feel I deviate from most Bogleheads. I don’t understand if their apprension towards low interest rate debt like yours, @ or below 3.5% (“low” if considering inflation and expected return if invested), comes from the principle of being in debt, or if they would rather receive the 3.5% ROI. Both reasons of which are valid, but I would imagine BH’s would want to take advantage of every arbitrage/“free lunch” opportunity possible by investing the money into higher yielding savings accounts as stated previously.
Last edited by YoungBogle on Tue Feb 05, 2019 8:54 am, edited 1 time in total.

Olemiss540
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Re: Which debt to payoff?

Post by Olemiss540 » Tue Feb 05, 2019 8:43 am

Seems like you have already answered your question.

You only want to pay off one debt and you want to do it to improve cashflow.

The only answer with your restrictions is to payoff debt #1 (the largest impact to cashflow) and invest the remaining. You are hesitating because the rates are so low, but BOTH rates are low. Your arent doing this because it is smart financially, but to improve monthly cashflow!

Then take the cashflow savings and put it into the market as well so you are investing nearly 2k/mo.
I hold index funds because I do not overestimate my ability to pick stocks OR stock pickers.

Nutmeg
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Re: Which debt to payoff?

Post by Nutmeg » Tue Feb 05, 2019 12:11 pm

It appears that you have at least $45,000 to apply somewhere, you have a 2% loan, a 3.5% loan, and a 24% tax bracket, you wish to invest more in the stock market, and you are not maxing out your 401(k).

I recommend maxing out your 401(k). You will save a guaranteed 24% in the first year, plus you will be accomplishing your goal of investing more in the stock market.

Then either save the rest of the $45,000 so you can max out your 401(k) in future years or, if you have the capacity to max it out anyway, apply the extra to the higher-rate loan.

khangaroo
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Re: Which debt to payoff?

Post by khangaroo » Tue Feb 05, 2019 12:30 pm

My view of debt aligns with Dave Ramsey, however, I still use credit cards and have a small loan ($3.1k remaining @ 4.59% interest, 60 mth).

If I were you, I would use the snowball method and pay off the $24k then pour that monthly payment into the $45k until that's paid off as well. Idk what your income or other assets are but it sounds like you would be able to pay it off in 1-2 years if you're able to pay off either one in a lump sum fashion.

You can always pay it off and if you don't like being debt-free then just take out a personal loan and go back in debt. Probably won't be able to get the same interest rates but the difference between a 7% and 3% rate on $45k is a few thousand bucks.

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