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 Post subject: Help Me Prioritize - High Income, High Debt
PostPosted: Mon Nov 26, 2012 3:57 pm 

Joined: Mon Nov 26, 2012 3:00 pm
Posts: 8
Hi everyone:

Hoping to get your collective wisdom on how best to allocate my cash. I know that invest v. save v. debt has been done a million times, but I would appreciate your tailored advice nonetheless.

Demographics: Married, 30 years old, two young kids, single income. High cost of living area.

Income: Approximately $200k. Stable company, good performance reviews, but demanding job and "employee attrition" is part of the business model. In the event of job loss, reasonable chance of securing new job at same salary, very good chance of securing new job at 60-80% of salary. Would almost surely get 3 months notice/severance.

Assets:
House - $525k
Two Roth IRAs - $60k total
Pre-tax 401k - $6k
Cash - $10k

Liabilities:
Mortgage - $417k @ 3.625% fixed
HELOC - $50k @ 4.5% variable
Student loans - $115k @ 2.8%-7.65%
($23k @ 7.65%, $20k @ 6.5%, $6k @ 6%, $21k @ 5.5%, $21k @ 4.5%, $19k @ 4%, $5k @ 2.8%)
Family loan - $19k @ prime
Car loan - $15k @ 0%

I have, up to now, been laser focused on getting rid of some limited-time 0% credit card debt that we racked up last year. (We spent in anticipation of a bonus that ended up smaller than expected. Lesson learned: Never spend bonus money in advance! Just ask http://www.imdb.com/title/tt0097958/)

Now I'm trying to figure out what to work on next:

- Emergency fund. I have enough saved cash and free cash flow to cover life's little surprises without going into debt. I do not have enough cash to survive long without income, but I can expect to get 3 months notice/severance if laid off. My family has cash to make an emergency gift/loan if there were a long period of unemployment. I have $50k in unused credit card limits that I could access, likely at a 12-month 0% teaser rate. And I can withdraw Roth IRA contributions penalty-free. None of this is as reliable as money in a savings account, but is the extra security worth settling for 0.5% interest?

- Debt repayment. See above for interest rates, etc. My income is too high to deduct student loan interest, and the rates won't go down in a consolidation. Currently on a 25-year repayment plan in order to maximize free cash flow. On the HELOC: Unlike the other loans, I could pull money back out if I got in a pinch.

- Retirement savings. No company 401k match. Until Congress closes the door, we can still contribute to Roth IRAs via Roth conversion.

- Car savings. The current family car (no associated loan) is 10 years old and starting to feel small for the growing brood. Anticipating a replacement will be needed within about 2 years.

- Kids college savings. I funded my own education (and am still paying for it), so this is not a huge priority for me, but I'd like to get started eventually.

Help! So many competing priorities! Do I focus on maximizing liquidity for security? Do I get money into retirement savings to take advantage of compounding interest? Do I focus on the guaranteed return of repaying the higher-interest student loans? Do I repay the HELOC first, letting it double as an emergency fund? Do I save for anticipated future expenses, to reduce the need for future debt?

Please tell me in what order you would focus on things. Or, if you would split between a few different goals, in what percentages?


[edited to fix an error in the mortgage interest rate]


Last edited by Cicero on Tue Nov 27, 2012 5:42 am, edited 2 times in total.

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 Post subject: Re: Help Me Prioritize - High Income, High Debt
PostPosted: Mon Nov 26, 2012 6:52 pm 

Joined: Mon Nov 01, 2010 5:15 pm
Posts: 1230
Quote:
I have, up to now, been laser focused on getting rid of some limited-time 0% credit card debt that we racked up last year.

Hi, welcome to the forum.

Is this credit card debt gone or is there still a balance? If it's still hanging around then I would knock it out first because when the 0% expires, they're coming out the corner swinging with high interest rates.

Next I would tackle the highest interest rate student loans since some are pretty high & you don't get a tax deduction.

Then the HELOC and/or car replacement fund. The rest can simmer for a while until some of these high interest debts are gone.

How urgent is the repayment on this "family loan"?

With 2 kids, single paycheck, & a company with high employee attrition...you're walking on a tightwire in my view with your debt load.

Sidenote question...you didn't mention it but does your employer give you health insurance?


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 Post subject: Re: Help Me Prioritize - High Income, High Debt
PostPosted: Mon Nov 26, 2012 7:04 pm 

Joined: Mon Nov 26, 2012 3:00 pm
Posts: 8
Tightwad wrote:
Is this credit card debt gone or is there still a balance? If it's still hanging around then I would knock it out first because when the 0% expires, they're coming out the corner swinging with high interest rates.


Gone as of this month. The eventual expiration of the 0% rate kept us extremely motivated to pay off quickly.

Tightwad wrote:
How urgent is the repayment on this "family loan"?


Not urgent.

Tightwad wrote:
With 2 kids, single paycheck, & a company with high employee attrition...you're walking on a tightwire in my view with your debt load.


In complete agreement. The question is how best to navigate the situation, given that I'm already on the tightwire and can't turn around.

Tightwad wrote:
Sidenote question...you didn't mention it but does your employer give you health insurance?


Yes. And dental and disability and modest term life. I also have a large private term life policy.


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 Post subject: Re: Help Me Prioritize - High Income, High Debt
PostPosted: Mon Nov 26, 2012 7:12 pm 

Joined: Mon Nov 01, 2010 5:15 pm
Posts: 1230
Quote:
Yes. And dental and disability and modest term life. I also have a large private term life policy.


Okay, good. The reason I asked was that I had a friend who made a high income like you but was a 'contractor' not an employee so all he got was a fat paycheck. No 401K, no insurance, no benefits of any kind. With 2 kiddos you can't pass insurance up.


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 Post subject: Re: Help Me Prioritize - High Income, High Debt
PostPosted: Mon Nov 26, 2012 9:53 pm 

Joined: Fri Jun 25, 2010 3:06 pm
Posts: 81
Have you considered selling the house and getting a cheaper one? You're spending 17.5k per year in interest alone by living in that house. That's enough to buy a brand new car for cash every year to put it in perspective.

I would also consider prioritizing the 401k rather than the Roth given your level of income. You may want to run the numbers first but generally speaking if you have high income a pre-tax contribution works out better than a post-tax contribution.

While you're at it read The Millionaire Next Door. The book is very good at showing how one can have a high income and be broke at the same time due to lifestyle choices. Which leads me to you should cut down your expenses. Just because you make 200k a year doesn't mean you have to spend like it. I don't even own an HDTV yet even though I could easily afford one. Nor do I have cable or a high priced phone plan. There is no reason to "keep up with the Joneses" if you value your financial life.


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 Post subject: Re: Help Me Prioritize - High Income, High Debt
PostPosted: Mon Nov 26, 2012 11:03 pm 

Joined: Sun May 29, 2011 4:50 am
Posts: 183
Your financial picture is not just your assets, liabilities and income, but a key factor is your expenses.

417000 3.675 15324.75
50000 4.5 2250
23000 7.65 1759.5
20000 6.5 1300
6000 6 360
21000 5.5 1155
21000 4.5 945
19000 4 760
5000 2.8 140
19000 1 190
15000 0 0
24184.25

If your gross income is $200k before taxes and your interest payments are $24k a year, 12% of your gross income is going toward interest alone! Once you start figuring in taxes and your typical household expenses, it doesn't leave much for paying down the principal, not to mention putting money away for your savings goals.


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 Post subject: Re: Help Me Prioritize - High Income, High Debt
PostPosted: Tue Nov 27, 2012 4:23 am 

Joined: Mon Nov 26, 2012 3:00 pm
Posts: 8
nelson wrote:
Have you considered selling the house and getting a cheaper one? You're spending 17.5k per year in interest alone by living in that house. That's enough to buy a brand new car for cash every year to put it in perspective.


That's one way to look at it, but if I stopped paying my mortgage interest, my family would have to live in that brand new car.

We have considered downsizing the home, but in this part of the country we would not be able to reduce our housing costs tremendously, especially when you factor in transaction costs such as broker fees. If I could do it over again, perhaps I would have waited a little longer to buy, but our previous rent was much more than our current housing interest payments. For context, the four of us live in a 1900 sq. ft. 3 bedroom house in a nice but not elite suburb. Like I originally said, high cost of living area.

We are working hard to keep our expenses under control. I have only been out of professional school and earning this income for a short time, so we're not talking about years of spendthrift history. Because of our efforts to reduce spending, we have several thousand dollars a month to be putting toward financial goals -- which is why I'm asking for advice about how to prioritize.


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 Post subject: Re: Help Me Prioritize - High Income, High Debt
PostPosted: Tue Nov 27, 2012 7:26 am 

Joined: Fri Jun 25, 2010 3:06 pm
Posts: 81
Here's your answer, focus on debt repayment.

You definitely don't need to put money in your retirement account (yet)* except to get the company match, which you said they don't offer. Same thing with savings for the kids college. You can easily pay for their college if you didn't have debt. The interest rate for the debts easily will beat the interest rate for savings (and investments can go either way, but you're here to provide for your family, not gamble).

And yes you do need some cash savings for emergencies and a car. I would have a savings account for both the emergency fund and the car fund (it can be the same account). Grow it fast enough to have enough to pay cash for a new car, and still have 3 months savings, by the time 2 years is up. If you do come into an emergency sooner, the extra cash will help and you can forgo the car until you can get things back together. If everything is peachy king for the 2 years, go ahead and pay cash for the new car.

Back to debt repayment, I would concentrate on the highest interest first. In your situation the student loan. Also it's already divided up into chunks so you can feel like you're making progress (i.e. pay off the 23k loan @7.65, then the $20k loan @6.5). Once you get down to the 4% loan you have to decide if you want to just finish it off or start paying the HELOC. Either choice is fine. The numbers favor the HELOC but you might feel better getting one loan completely cleared off the books. The important thing is to become debt free and keep your concentration on that goal.

*Once all your debts are repaid, max out retirement savings and start saving for the kids college.


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 Post subject: Re: Help Me Prioritize - High Income, High Debt
PostPosted: Tue Nov 27, 2012 11:25 am 

Joined: Sat Oct 20, 2012 7:20 pm
Posts: 23
Well, you have the potential to be in good shape just 5 years out.

If I were in your shoes, I would:

1) Pay off the two highest interest SLs first, since your CCd is now done.

2) Make sure you're maxing out your 401(k), since it lowers your tax burden significantly. I'd hold off on the Roth contributions for now - getting the monthly obligations paid off is more important, IMO.

3) Make sure your tax withholding is accurate, so you get the most money each month as income.

4) Make a prioritized budget for everything else - I am sure that you could be paying more than $2K per month on debt if you have a written budget. Areas to scrutinize: cell phones; cable package; utilities (can you do level billing?); eating out, clothes for the kids; food planning and groceries; untracked cash.

5) I would also be setting aside $500 per month for expenses you KNOW are imminent - car and house repairs. I would not be replacing your current car until the first two student loans are paid off. If you're diligent about this "expense savings fund", you could have $12K to pay cash for a new car in a couple of years. Then you won't have a car loan, AND the cash flow due to paid off student loans will absolutely give you some real breathing room.

Best of luck!


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 Post subject: Re: Help Me Prioritize - High Income, High Debt
PostPosted: Tue Nov 27, 2012 6:27 pm 

Joined: Mon Nov 26, 2012 3:00 pm
Posts: 8
So it sounds like there is consensus that the interest savings from paying off the higher-interest student loans outweighs the flexibility (i.e., ability to pull money back out in emergency) of paying off the HELOC.

Is there also consensus that I should focus on the higher-interest student loans ahead of retirement contributions?


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 Post subject: Re: Help Me Prioritize - High Income, High Debt
PostPosted: Tue Nov 27, 2012 6:44 pm 

Joined: Tue Jun 30, 2009 9:44 pm
Posts: 326
Location: Atlanta, Georgia
Cicero wrote:
So it sounds like there is consensus that the interest savings from paying off the higher-interest student loans outweighs the flexibility (i.e., ability to pull money back out in emergency) of paying off the HELOC.

Yes, I would agree.

Cicero wrote:
Is there also consensus that I should focus on the higher-interest student loans ahead of retirement contributions?

No, I disagree here. Personally, I consider retirement contributions to be a given, something that comes out of my paycheck before I even see the money, as the power of compounding interest is very real. If you think maxing your 401k is too much of a strain on your resources, then I would at least partially fund it while simultaneously paying down the highest rate student loan.


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 Post subject: Re: Help Me Prioritize - High Income, High Debt
PostPosted: Tue Nov 27, 2012 7:46 pm 
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Cicero wrote:
I have, up to now, been laser focused on getting rid of some limited-time 0% credit card debt that we racked up last year.


Just a pet-peeve alert - a laser produces collimated light. That is as close to the OPPOSITE of being focused as one can get. I know people use that term, but it's profoundly ignorant in my opinion. But I do understand your point.


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 Post subject: Re: Help Me Prioritize - High Income, High Debt
PostPosted: Tue Nov 27, 2012 7:50 pm 
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Joined: Wed Sep 23, 2009 9:01 am
Posts: 5402
With that off my chest...

I think I'd go after the highest interest rate student loans first.

I'd also continue to pay on the family loan at an aggressive rate even though it is not urgent. That's because those things can come back to bite you. Everything could be totally cool then if you go on a vacation a few years from now it could raise hackles. Maybe not a problem in your family but something to think about.

Otherwise, it sounds like you are in good shape and any of the choices are good ones.


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 Post subject: Re: Help Me Prioritize - High Income, High Debt
PostPosted: Wed Nov 28, 2012 2:35 pm 

Joined: Fri Feb 10, 2012 6:14 am
Posts: 64
If you can get a car loan for ~2% (which you certainly can now, and probably can in a couple years) I think it would be silly to pay cash for a car. Wait until you need it, of course, but why pay, say $15k in cash when you could borrow $15k at 2% and pay off $15k in higher-interest debt?

My husband and I are in a very similar situation, mortgage, student loans, a family loan, a car loan, needing a new(er) truck badly, and paying down 0% cards used to finance a home renovation when the construction loan fell through. My husband is in the process of buying a truck and we fully intend to borrow for the truck at 2% and use our cash to pay down higher interest debt.

And for my pet peeve... 1900 square feet is huge, especially in a high cost of living area! Not saying you should move, but don't act like it's a small house.


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 Post subject: Re: Help Me Prioritize - High Income, High Debt
PostPosted: Wed Nov 28, 2012 3:32 pm 

Joined: Mon Nov 26, 2012 3:00 pm
Posts: 8
Humble apologies for my lack of understanding of lasers.

And apologies for raising your hackles about square footage, ssarah. I didn't mean to imply that I think my house is small, but it's no mansion, either. My point was that, while we could save some money by downsizing the house, we would not be able to go too much smaller without it having a material affect on our standard of living. We lived in a much smaller rental a couple of years ago, and being cooped up with the kids in a small space drove my wife up the wall. But many people live very well in much less space, so, yes, everything is relative.

You raise a really interesting point about car financing. While I'm not aware of any banks or credit unions offering car loans for much less than 3.5%, the car companies are being pretty free with their 0% or 0.9% financing deals lately, including on late model used cars. It's precisely this sort situation that poses a financial dilemma for me -- it seems wasteful and counter-productive to defer paying a relatively high interest loan in order to avoid taking out a relatively low interest loan. But emotionally I don't like the idea of planning to take out more debt in the future. (Also, I'm probably susceptible to the way that so many personal finance talking heads demonize car loans.)


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