Newbie on Board

[gmt]

Hi all!!

I am new here.  I like what I see and would appreciate any help that you guys might be able to provide.

My question for the board is...which debt to pay down first?  And how should we pay down our debt?  Should we continue contributing to retirement accounts and put less towards debt?  Or should we go mad crazy on the debt and pay it down as soon as possible?

Here are our debts:
Student Loan 1 - 35k @ 2.6%
Student Loan 2 - 20k @ 3.0%
Student Loan 3 - 10k @ 3.5%

We also have a 1st and 2nd mortgage @ 5.75 and 7.375% respectively.
Both my wife and I have Roth IRAs and my wife has a 403b all of which is invested at Vanguard.

We are in our late 20's and are in the 25% fed tax bracket.  We have an emergency fund, no credit card debt and no car payments.

If these were your debts, would you:
a.  pay off the student loans first (smallest to largest)
b.  pay off the loans with the highest interest rate (which I think would be the 2nd mortgage)
c.  pay off some of the student loans and max out the retirement accounts?

Thanks in advance for your thoughts.

gmt

 

[REWahoo]

Welcome to the forum gmt.

Were I in your shoes, I would fund my retirement accounts to the level of any employer match, then pay off my loans starting with the highest interest rate first. Be sure to look at the tax implications of starting with the mortgage loans, but it looks to me as if that would be the way to go.

 

[SteveR]

Hi GMT, welcome to the boards.

I agree with WAB but it all depends on the amount of your second mortgage, the amount of your first mortgage and your plans. You are still very young so you have lots of time in front of you to get these all paid off. Don't kill yourself to do it. Balance your payments to your loans and to yourself (401k and savings). Get your match if you get one from your plan, save some additional in an IRA and then pay off your highest interest or least deductible loan first.

Oh, don't forget to have some fun while you are young too. Pay yourself the gift of fun and adventure. Don't dwell too much on the loans...time and payments will take care of them. Don't waste your youth on worrying too much about 20 years from now. Life and do the wild and crazy stuff that you can get away with while your body still heals fast. When you get older it take more out of you and is harder to recover from.

 

[gmt]

REWahoo-

Thanks for your reply and the kind welcome.  
There is no employer match for our retirement accounts.  

Since there is no match would you suggest that we put retirement savings on hold and start paying off the debt with the highest interest rate?

I just keep looking at our net worth and wonder if instead of building retirement accounts we should tackle the mountain of debt.  Granted, I think this is all good debt because it has significantly increased our earning potential, but I still hate to owe anyone any money. Our ultimate goal is early retirement.

gmt

 

[gmt]

SteveR

I must have been writing my response right when you were posting yours.

Our 1st mortgage is ~$320k and the 2nd is ~ $80.  Yeah, its expensive to live in California.

You are right, we need to have fun while we are still young and  we do.  Fortunately most of our activities are pretty low cost.

Thanks for your insight.

gmt

 

[REWahoo]

Since there is no match would you suggest that we put retirement savings on hold and start paying off the debt with the highest interest rate?

The advice you got from SteveR is good (ignore the fact that he insulted WAB by confusing us ). I would find a balance, not concentrating on just paying off your loans and, as SteveR says, having some fun along the way. For the vast majority of us, getting to FIRE is a marathon, not a sprint. Gotta smell some roses along the way.

 

[HFWR]

I would maybe pay extra on the second, but giving yourself the extra time for compounding the retirement accounts would trump paying off the low-interest loans.

My advice is worth every cent you pay for it...

 

[SteveR]

My appologies to both WAB and REWahoo.........dyslexia is a terrible thing. Add to that old age, too many dead brain cells and trying to actually work while surfing several internet sites all at once...some are even work related.

GMT,
Since you don't get a match, the benefit will only be tax deferred gains on your investment. Not at all bad but free money is better. Consider a ROTH IRA if your income is low enough. It might be a better long term option for you to generate an already taxed income stream to allow you an ER.

Good luck and take it one day at a time.

 

[Nords]

Welcome to the board, GMT!

Here are our debts:
Student Loan 1 - 35k @ 2.6%
Student Loan 2 - 20k @ 3.0%
Student Loan 3 - 10k @ 3.5%

We also have a 1st and 2nd mortgage @ 5.75 and 7.375% respectively.

b.  pay off the loans with the highest interest rate (which I think would be the 2nd mortgage)

I keep looking for the trick here, but maybe this question arises out of a media overdose of "Debt bad!"

If history is any indication, you're not going to see that first mortgage rate for the next 40 years.  I don't know about student loan interest rates, but you could put your student loan money in three-year CDs and still come out ahead after taxes.

As the others have already said, sock it away to the match (if applicable) on the tax-deferred accounts.  Then pay down that second mortgage, which is probably a bit of a budget drag.

If you're looking for more living flexibility then also fund both of your Roth IRAs in whatever asset allocation you're comfortable with.  The idea behind funding the Roth is that you can withdraw the contributions penalty-free at any time.  If you have any money or limits remaining then fund the rest of your tax-deferred investments.

If that's a fixed interest rate on the student loans, then I'd pay them as slowly as is humanly possible.  Just about every investment in the world will earn more interest than you're paying!

You mentioned consulting on alternative energy.  I'm a second-generation solar geek... can you tell us more about your occupation?

 

[laurence]

My two bits, max roth IRA's for now with Vanguard, and any extra pour on that second, and just pay minimums on those low, low, rate loans. Without a match, the 401k probably isn't a great place to put your money for now. Especially if your choices of funds have high expense ratios. The two of you can combine for 8k in Roths, and start to chip away on that second. Is that a fixed second or a home equity line? I have a home equity line (not nearly as much owed, got in earlier here in San Diego) but the rate has been inching up, so we are really pounding away at it now to the tune of $2k a month.

Oh, and if you do make extra payments on the second, plus your young age, I want to chime in, make sure that Roth portfolio is at/near 100% equities!

 

[gmt]

HFWR-thanks for your comments.  

SteveR - I have only been on this board a few hours, but you have already made me feel more at ease, thanks.

Nords- Thank you for the welcome.  Yes I think the media has convinced us that all debt is bad. That and listening to stories my grandparents tell about living through the depression and their lifelong goal to live without any debt as probably influenced our views on money management.

All the interest rates are fixed and until you mentioned it in your post I never really took a step back and examined how low the rates are, that is really cheap money.  The 2nd mortgage is a bit of a bummer, so that will probably be the one we try to get rid of first.

Do you guys ever listen to Dave Ramsey on the Radio?  He is a bit preachy, but I sure do get sucked in to the thought of not owing any one any money.  And then I get on one of these boards and everyone on here is absolutely correct, that the compounding tax deferred accounts will surely out earn paying off the debt.

In regards to my occupation, I do a lot of work with all the renewable energy technologies, it really depends on what our clients are looking for.  Recently I have been working on biomass conversion technologies for combined heat and power applications, ethanol, biodiesel and syngas.  I have also been getting more and more requests to work on corn to ethanol facilities.  We do some work with solar and wind, but mainly we focus on next generation technologies that are still in the development/pre-commercialization stage.  Every once in a while I'll work on a hydro or geothermal project.  Its great work and there is something new every day.

gmt

 

[gmt]

Laurence-

Thanks for your 2 cents.

The 2nd is a fixed rate. When we went shopping for our loans everyone was shocked that we wanted fixed rate loans. In fact, a friend of mine (who has only been doing this type of work since 1999) said that I was the first person to insist on a traditional 30 year mortgage.

My wife's 403b is very low cost, as it is with Vanguard. My thought was to max out the Roth's and then max out the 403b. Thoughts?

Regarding all equities in the Roth, we both have the Target Retirement 2045 fund. I was trying to keep the management fee down as we have just recently started these accounts. I presume there have been other discussions on this board suggesting 100% equities in Roth, can you direct me to the reason or give me the Reader's Digest version?

gmt

 

[Nords]

Do you guys ever listen to Dave Ramsey on the Radio?  He is a bit preachy, but I sure do get sucked in to the thought of not owing any one any money.  And then I get on one of these boards and everyone on here is absolutely correct, that the compounding tax deferred accounts will surely out earn paying off the debt.

Eh, you're new to the board, you get a 100-day honeymoon before we start with the Ramsey jokes.

I think he was severely traumatized by his own bad behavior and is still trying to atone for it.  Admittedly he has lifetime employment helping hyperconsumers whose debt exceeds their assets, and probably at 21% interest or higher, but the guy spends so much time with people who don't do math that he seems to overlook the math himself.

You must be getting tired of all the green hype.  Remember the good ol' days when nuclear power was going to be too cheap to meter?  Decades later we're still waiting for the HPower plant to burn enough trash to generate more than 4-5% of our electricity, the Big Island's geothermal vent project is still stumbling along, and I haven't seen any of those fabled wave-machine power-generating buoys!

 

[gmt]

Thanks for the heads up on Ramsey. He always loses me a bit when he completely takes math out of the equation and relies solely on the "mental" part of the equation.

I don't mind all the green hype when it is done with respect to sound economics and science. I'm kind of a dirty hippie at heart, so I really do want these alternatives to be successful. And yes I do know about HPower, great marketing. Its really too bad that so many new technology vendors rely so heavily on marketing and then scrimp on the actual technology.

One of my good friends is an out of work nuclear engineer, he is waiting on the edge of his seat for nuclear to come back.

BTW, the wave machines just won't go away either. There are state agencies that are writing requests for this type of expertise into contracts...amazing.

gmt

 

[jdw_fire]

Welcome Newbie,

I would suggest maxing your tax deferred and Roth IRA.  The reason: in your tax bracket any money you put into a tax deferred account only costs you $.75 for every $1 you put in (an immediate 33 1/3 % return after taxes) and after taxes your mortgages are costing you 4.3125% for the first and 5.53125% for the second.  Granted when you are retired you will have to pay the tax on the income from the tax deferred account but think of all the compounding you'll get on a higher balance between now and then when compared to an after tax account.

Good luck.

 

[Gumby]

Welcome to the board.  I have found that, while you may end up agreeing or disagreeing with any particular poster, each one will make you think.

With respect to your situation, I would first max out the 403(b) to get the immediate tax deduction.  While we cannot know with certainty what our tax rate will be in retirement, I would rather have a tax deduction now and worry about paying tax on the distributions later.  Given that your wife's 403(b) is with Vanguard, you have a number of very good performance, low cost fund choices.  After the 403(b), I would max out the Roth.  You don't get the immediate tax deduction but you do get tax free growth and very liberal withdrawal requirements.

If you have money to spare, you might try making extra principal payments on the 2nd mortgage.  I view it as investing in a taxable fund returning 8.75% (if you are in the 25% bracket) with no risk.

I would let all the other loans ride.

Best wishes,

Gumby

 

[FlowGirl]

Thanks for the heads up on Ramsey.  He always loses me a bit when he completely takes math out of the equation and relies solely on the "mental" part of the equation.

I think his approach is fine for people who have psychological issues or can't control their spending. Similar to how alcoholics need to cut out drinking completely. But the rest of us can have a glass of wine once in a while... and your debt doesn't sound bad to me.

 

[jdw_fire]

I view it as investing in a taxable fund returning 8.75% (if you are in the 25% bracket) with no risk.

If the second is not tax deductible the effective taxable rate of paying it off would actually be 9.8333%.  However if the second is tax deductable and the funds you are trying to match the rate with are in a tax deferred account then the matching rate is only 5.53125%.

 

[Gumby]

jdw

Now that I have finally located my calculator, actually use the corrrect interest rate of 7.375 and do the match properly, I find that you are quite correct on the number.  My apologies gmt, but you get the point -- unless you can invest the money and receive a high enough return to offset the taxes on the earnings, it is better to pay off the loan, particularly when paying off the loan is "risk free".   As an aside, the way to calculate this is as follows:

loan interest rate/(1-marginal tax rate) = breakeven taxable rate.

7.375/(1-0.25)=9.8333%



I was assuming that gmt had run out of tax deductible places to invest the money and that the option was either taxable investment or paying the loan.  I also did not considered the ramifications of the capital gains rate versus ordinary income.  If the gains on your taxable investment were taxed at the cap gains rate of 15%, the break even return would be 8.67647%.  However, you are unlikely to find an investment that provides monthly long term capital gains, which would be the equivalent of paying off the loan, so I would use the higher number. 

Finally, if the loan interest is tax deductible, the avoided tax on the earnings is offset by the loss of the deduction.  I that case, you would invest the money if you could get more than 7.375% risk free and pay off the loan if you could not.  I am unaware of any risk free investment returning even 7.375%. 
 

 

[gmt]

Wow, thank you everyone for your help in resolving my debt/savings issue.

JDW and Gumby, thanks for the equations and equivalent rates. 

It looks like we will continue to max out the 403b and the Roth IRAs and then whatever money is leftover will go to payoff the 2nd.

Thank you again to everyone for the warm welcome and thoughtful advice.

gmt