Where would you put this extra money?

June 30, 2010 3:30 PM

SpecificFinancialFilter: What payments would you make with an extra $550 dollars a month?

Just trying to get opinions\ideas about how to best pay down debt and save at the same time.

I am getting ready to make an extra $550 a month. Given the following variables and information, how would you distribute the money? (Please assume that these amounts listed will remain. I am only looking to "add" or "not add" to these amounts).

I am 32.
I currently put back $100 in a normal savings account per month.
I currently put $125 into a Roth IRA per month.
I pay the minimum mortgage payment (5.0% interest rate, 30-year fixed).
I pay the minimum car payment (7.25 % interest).
My school loans are currently set at a 10-year repayment plan (interest rates are 6.8% for the loans).

In summary, where would you suggest I put the extra money.

I appreciate your thoughtful responses. I have some ideas but want to see what fellow MeFites think make best financial and long-term sense.

Thanks!

posted by bengalsfan1 to Work & Money (23 answers total)

If you can make extra payments on your car loan without penalty then do that. The interest you're paying on that is higher than any savings account will currently earn.

(disclaimer: I'm from the UK and don't understand what a Roth ira is, so if its the equilivent of a UK ISA or comparable then you may want to max that out)

(on iPhone so 'cant' just google it)
posted by Simon_ at 3:35 PM on June 30, 2010

Do you have an emergency fund already saved up that could pay all of your expenses for six months?
posted by kylej at 3:35 PM on June 30, 2010

Car loan.
posted by yoyoceramic at 3:37 PM on June 30, 2010

I would work on putting the money toward an emergency fund like kylej suggests first, then pay off the house. The others may have higher interest rates, and the conventional wisdom is to pay those off first, but I try to think of things in terms of emergency. A paid-off car would be great, but if you lost your job or became handicapped in some way, a stash of cash and a roof over your head would take care of a majority of worries.
posted by cottonswab at 3:41 PM on June 30, 2010

Some Additional Information:

Yes, I have an emergency fund in case anything really bad happened.
posted by bengalsfan1 at 3:42 PM on June 30, 2010

Your car loan interest rate sounds extremely high. I'd either refinance that or pay it down. The remainder should go into the Roth -- the maximum contribution right now is $5K. You should be trying to hit that limit every year.
posted by AmitinLA at 3:42 PM on June 30, 2010

1. Emergency Fund of 3-6 months income
2. Max Roth IRA for the year
3. Pay off Car
4. Pay off Student Loan
5. Pay extra on the house
posted by msbutah at 3:43 PM on June 30, 2010

Oh, and I forgot to mention that paying off the house is probably a terrible idea, though that depends partly on your overall investment strategy and where your house is located.
posted by AmitinLA at 3:44 PM on June 30, 2010

Mortgage. Making thirteen (or 26 if you are bi) payments shaves years. Your payments are likely so low that you can do easily do this and choose another option from column B.
posted by fixedgear at 3:47 PM on June 30, 2010

Don't choose the mortgage. Considering mortgage interest is tax-deductible in the US your effective rate of return for paying off the mortgage is lower than 5% - it's 5% times your marginal tax rate. A mortgage is the cheapest way to get a loan and you should pay it off last. In some cases, never pay it off. If you're getting above 4% in your IRA then put it all there if possible after paying off car & school loans.

Save liquid cash. Then save for retirement. Then pay off car loan and school loan.
posted by GuyZero at 4:12 PM on June 30, 2010

It sounds like you have quite a bit of financial discipline, for which you are to be congratulated. Why not reward yourself by taking, say, $50 of that extra $550/month to treat yourself? Then I would absolutely put $500/month to the car loan, which should get it paid off pretty quickly. Once it's paid off, you can bump up some of your other payments, perhaps working toward getting rid of the student loan, but it would also be a good idea to start a fund so that your next car can be purchased for cash.
posted by DrGail at 4:24 PM on June 30, 2010

Nthing the car loan. Not only is paying that off a guaranteed 7.25% return, when it's paid off, you will no longer have a car payment, which means you will have, what, $750 or $900 extra a month instead of $550 (depending on the size of your car payment; mine has been between $200 and $350 for various cars, so those are the numbers I used).
posted by kindall at 4:58 PM on June 30, 2010

A thought on the loans:

There are two schools of thought on paying off debt. One is the popular "pay off the highest interest loan first" school of thought, and this is the one espoused by most financial planners, etc.

There's also the "debt snowball" approach, which I heard about through Get Rich Slowly, but I believe was originated by Dave Ramsey? Anyway, the idea is that you make minimum payments on all your loans, and direct any surplus towards your smallest loan. Once that is done, you take the money you were paying towards your smallest loan, and put it towards your next-smallest. And so on. I'm doing this approach right now and it works best for me, mainly because of the excellent psychological boost that comes from paying down a loan completely.

Also, I love the snowball effect - once I'm done with my credit card debt (3 more months!), I will start making bigger payments on my car loan.

However, this approach seems more designed towards people who have trouble managing their finances and debt responsibly, hence the importance of the positive feedback loop. It sounds like you're pretty good with money, so you may wish to stick with the "pay off the highest interest loan first" approach.

Also, nthing what other folks said about your mortgage. I'm in a similar situation - no mortgage, but I have significant federal student loans. It doesn't make a ton of sense for me to pay those off early because 1. the interest is deductible and 2. I work in the public sector and will be eligible for forgiveness of my federal loans in 8 years.
posted by lunasol at 5:33 PM on June 30, 2010

Go debt snowball. I think that ends up being the car payment. Pay that off, and on to the next! The idea is that psychologically moving from lowest to highest debt gives you momentum! So say your car payment is $200/month, once you finish that, you now have $750/month to work on the next one. Momentum is the key.

And also, nice work on the financial discipline!
posted by artlung at 5:33 PM on June 30, 2010

I'd max out my Roth IRA (which would only take 7 months to do) and then kill that car loan. An extra ~$2800 a year would really make a difference there.

About how much of your car loan is left?
posted by punchtothehead at 5:52 PM on June 30, 2010

Also, once your car loan is paid off, you won't necessarily need comprehensive car insurance (the insurance that would replace your own car in the event that it was damaged in an accident you caused). You may want it, but in my own situation, I estimated that it would add up to more expense than replacing the car itself.
posted by salvia at 6:00 PM on June 30, 2010

I have $7000 on my car loan left. My car payment is $275.00 per month.

Everybody: Thanks for all of your responses thus far! Very informative.
posted by bengalsfan1 at 6:17 PM on June 30, 2010

Make sure you have 6 months (of every expense, including your latte or Netflix subscription or whatever) in your emergency fund - more if you're in any risk (at all) of losing your job. My stepfather is a database guy, and we once got down to actually using the powdered milk and whole wheat we stored because we're Mormon (I think he was unemployed 13 months, though I was young and self-absorbed, so it may have been longer.) My personal "liquid savings" goal is going to take years to reach, thanks to that experience. 5-year CDs renewing on a staggered basis every six months, yep. Powdered milk is nasty.

Make sure your insurance needs are taken care of, especially if you have kids or are in some high risk category.

Then, and only then, max out the IRA, then pay down the car, then the student loan (unless you qualify for any special repayment plan, which I don't think you do since you're saying you've got 10 years.) I'd start a regular (non-IRA) investment account with whatever's left over rather than bother with the mortgage, due to the tax implications noted above. But IRAs and 401(k)s are better than cars and houses anyway, since they're sheltered in bankruptcy. You might have another retirement account (besides the Roth) that you can contribute to, incidentally. Public employees often have deferred compensation (457(b)) plans, for instance, and there's SEP IRAs for (amongst other things) the self-employed.

Oh, and buy something nice. You're getting a raise (from whatever source;) it's psychologically beneficial to enjoy it.
posted by SMPA at 6:25 PM on June 30, 2010

I would do a split snowball. Plan to pay off the car loan in one year. (Your rate is high, and your term long.)

At the end of one year, you will have $825 a month extra. Max out your Roth each month and put the rest into house payments. (I love a nice tax write-off, but I cannot emphasis enough the enormous freedom of not having house payments. It is a glory to which I very actively aspire.)
posted by DarlingBri at 10:03 PM on June 30, 2010

Each month I would put an extra $150 towards the car payment, $100 towards the student loans $200 to the IRA, and eat better food with the other $100.
posted by WeekendJen at 1:30 PM on July 1, 2010

If you already have a diet of mostly fresh foods, then take that $100, and put anouthe r$50 towards the IRA and use the other $50 as your monthly dick around cash because you were awesome enough to get a raise.
posted by WeekendJen at 1:32 PM on July 1, 2010

Pay down the car loan. It's crazy high. For example, my car is financed by the dealer at 2.90 percent and you can find new car loans for like 6-ish percent. It might make sense to refinance, if your credit is good and fees don't overwhelm it. But if you can't, paying it down is a pretty risk free way to save yourself 7 percent a year for a while. Better than your Roth, which may earn more over the long term in stocks, but carries significant risks. Everyone's focused on the annual max just a bit too much there. Your goal is to have the most cash at a certain retirement date, not deprive the federal govt of the most money possible; to the extent these are the same, fine, but don't assume they do.

Put down the extra money in order of return. That basically means car loan first, then student loans then mortgage or maybe IRA. The mortgage interest is deductible, so can discount the intersest rate by your top tax bracket. Don't do Ramsey's debt snowball, for the most part it's a gimmick to justify the price of his books. Unless it matches my plan by accident. Your financial life is pretty simple, to where paying off small loans quickly doesn't really reduce your headaches or mail volume much.

I know you didn't want to tweak the minimum payments, but consider how much you need in savings accounts. If you've got enough for a few month's of emergency spending and bulk purchases (my car insurance and web hosting both offer up front payment discounts), you might leave what you have sit and earn interest for a while and aim the extra cash flow at your car payments. Or if you really like the FDIC, maybe start moving into higher return Certificates of Deposits. Some places offer breakable CDs should an emergency arise; I recall a local bank offered one where there was a break penalty that prorated over time to where you still earned interest after a three or four weeks. Just a suggestion to mull over.

To recap, throw all your extra money at:

1. Car loan (until it's paid off)
2. Student loans (until it's paid off)
3. Roth (up to the 5k limit)
4. Mortgage (until it's paid off)
posted by pwnguin at 3:05 PM on July 1, 2010

There are a few way you can do a "snowball" depending on your goals. The basic idea, of course, is that you put all your extra cash toward one specific debt. Once that's paid off, you use the monthly payment you'd been using for that debt, and combine it with your extra cash, and use that money toward paying the next debt. As you pay off each debt, in other words, you pay the next one off faster, with larger payments -- your payments "snowball." The question is, how do you choose the next debt to attack? This is where the variations come in.

1. Pay off the smallest balance first, then the next smallest, etc. This gives you success in paying off one debt as quickly as possible, which many people find encouraging.

2. Pay off the account with the highest interest rate first, then the next highest, etc. This minimizes the total amount of interest you will pay.

3. Pay off the account with the highest monthly payment first, then the next highest, etc. This maximizes the amount of free cash you have each month, which can be very useful if your income varies from month to month or if you just want a little extra security some months.
posted by kindall at 4:19 PM on July 1, 2010