Millenial student loan debt, amirite?
June 28, 2015 11:54 AM   Subscribe

Best strategy for paying down student loan debt for my *snowflake* situation. I don't want to bankrupt my future, but I also am not looking for taking risks like getting my hopes set on loan forgiveness. Specific details inside.

I am immensely grateful that I have a job with benefits and am not in as much debt as others. My debt is $60k, not 100k, but that is a huge number to me as a first generation college grad. I can't change the amount I borrowed but I want to be fiscally more responsible now that I have this panic about my debt and want to make sure I'm paying down in a smart, strategic way. Regarding future concerns, I don't want kids and I am ok with the fact I might not be able to own a home within the next 10-15 years while I get this debt under control. My main aspirations are living a modest, comfortable life and maybe get married (nothing lavish) sometime in the distant future.

Details: I'm 27 and have a humanities degree from a state school and will be paying back under the Income-Based Repayment plan. My current job wouldn't qualify for Public Service forgiveness, but I know under the IBR I can get the remainder forgiven after 25 years if I stick with the minimum payments. Is that the smartest thing to do in the long run? My balance would be astronomical by then and I would have to pay taxes as I believe the balance forgiven would be considered income for that tax year.

How dire is my situation? My income is ~ $30k/year and my debt is: $22k unsub at 4.6%, $22k sub at 3.8% and $11k unsub at 6.8% and they are Direct and Stafford loans. I also have a $10k auto loan at 7% and just started contributing to my Roth 401k with employer match up to 6%. The vesting schedule is 3 years and I have been employed 1 year, should I contribute the max or wait until I'm fully vested? I don't have much of savings but ~ 4k available revolving credit.

My options seem to be: pay the minimums and have money saved for the tax hit during forgiveness at 25 years. Option B to pay down aggressively by any means necessary but gambling on future savings and retirement. Or Option C, which I'm leaning more towards, contributing towards a Roth 401k and IRA while making more than minimum payments on student loans.

My payment is ~ $150/mo. and I'm planning on paying another $50 -150 extra each month. Should I put that money to better use as contributions to IRA? I know the interest on student loans is tax deductible and if I contribute to my IRA and 401k it lowers my AGI which is a plus right? I think my main focus should be on getting rid of the 6.8% balance first and then pay off the car, meanwhile max out my IRA and 401k contributions and then slowly pay down the other lower interest loans. My only solace is knowing how much money I'll save in the long run by living modestly and not having kids, but I know that the earlier I save for retirement, the better off I'll be. I have the sense that this is when I should be saving aggressively for retirement (because who knows if I'll get Social Security) and instead I'm paying back loans from getting my education. Mefites, can I get a reality check please and help me gain some financial perspective?
posted by Zeratul to Work & Money (10 answers total) 7 users marked this as a favorite
About the vesting: check with your employer but being vested usually means that the money that your employer has already contributed gets to stay yours instead of being taken back when you leave (as it would be if you left the job before vesting). Most employers go ahead and contribute their portion even before you are vested (sometimes there is a waiting period - say, one year - before they start contributing). So if that's the case with your employer, yes, I'd say go ahead and contribute enough to your retirement to get the full match.
posted by aka burlap at 12:31 PM on June 28, 2015

To be blunt, are you open to finding a job that pays more? It will be a pretty tight squeeze to pay a whole lot more on either your auto or student loans out of that salary. You are earning well below the median for a college graduate; I wouldn't put up with that for long (if you can help it ) unless it is a "training" type job that is near-certain to position you for something better quite soon. I don't mean to dismiss the difficulty of job searches these days, particularly for new grads, but you should at least consider that after you're established for a year or two.

You have the right idea with paying off the highest interest loan first, and given that it also has the smallest balance, that is a double benefit - often it's easier to stick with an accelerated repayment plan if you can see some tangible benefit like a whole loan dropping off. However, I would prioritize the auto loan first; it has a yet higher interest rate, a smaller balance, and I suspect a shorter term as well, which makes the monthly payment higher. I bet you're paying almost $200 a month on the car, right? If you could clear that payment from your monthly obligation you could put it towards the loans, where as you are not clearing your student loan payment from the decks any time soon. Also you could shift down to cheaper insurance once there is no loan against the car (I bet you're paying for comprehensive and collision right now which is... not a bad idea but it's quite expensive for someone in your position).

I know the interest on student loans is tax deductible

That's true but to be clear you can't increase the amount of interest you pay in a given year by making supplemental payments - they will all come out of principal. So yes, you should deduct your student loan interest for sure, but it will be a fixed amount each year, you can't increase it by paying your loans faster.

Good luck.
posted by Joey Buttafoucault at 12:44 PM on June 28, 2015 [2 favorites]

I know this isn't exactly what you asked about, but in general your vehicle value probably shouldn't exceed 25% of your annual income (unless you received it as a gift), and better still if you shoot for 10% of your income. Cars are tricky, because they are a very easy way to bleed money from your budget (insurance, maintenance, etc) and because there is such a huge variance in costs entirely driven by nice-to-have features (vs need-to-have features)... A $5k car is often just as safe as a $20k car. If you sold your car right now and bought a pre-2007 Honda Civic, I'm guessing you could bank a few thousand in your emergency fund, pay off the $10k loan, and reduce your insurance costs.

In terms of paying off your loans, the 7% car loan is absolutely the riskiest in the bunch (one bad accident and you'll owe the $10k and need to get a new car!) and should be what you focus on first.
posted by samthemander at 12:52 PM on June 28, 2015 [1 favorite]

to paraphrase aka burlap's point: if you put money into your 401k, and leave before you vest, you will not lose the money you put in, only the money the employer matched with. If you stay the 3 years, you get to keep that match money. So the sooner you start contributing to your 401k, the the more extra money the employer will put in. It's definitely worth doing if you see yourself staying for the 3 years.

It sounds like you are doing well and have a good handle on your budget & finances, especially for someone just starting out on a career. However, you do not yet have much of a safety net to absorb unexpected expenses, and these can easily wreak havoc with your finances. In particular, using your credit card lines to cover emergency expenses is to be avoided if at all possible - the high interest rates can easily put you into a spiral that keeps you in debt. If I were in your shoes, my priorities would be:
- avoid putting a balance on any of my credit cards (use them but pay them off every month)
- keep current on all my debts, so I'm not in default & don't ding my credit rating - this means minimum payments
- save for a rainy day fund - start with, say, saving a month's living expenses over the first year, and keep it up until you have 6 months' living expenses in a liquid account.
- contribute enough to the 401k to get the max employer match, assuming you have a pretty good expectation that you'll stay the 3 years
- pay down your loans, starting with the highest interest rates first

Good luck!

(On preview - yes, you should also be thinking about how to make more money. Will that come from changing careers and/or employers, or can you see your current job as a foot in the door that could leave to advancement?)
posted by mr vino at 12:53 PM on June 28, 2015

Response by poster: Thanks for the responses so far, especially the clarification about the 401k and vesting.

mr vino: I'm hoping this current job is a foot in the door that does lead to advancement. Once I've paid my dues the first few years, I'm planning on leveraging that to a better paying position in a different department.

Samthemander: I have GAP insurance on my '12 Honda and full coverage, would it be terrible if I just kept it and paid it off? Car payment & insurance is ~ $350.
posted by Zeratul at 1:26 PM on June 28, 2015

I mean, anything you choose to do is ok, as long as you're not hurting anyone. The beauty/terror of being an adult! Lots of people do choose to spend more on cars, even knowing that it's a luxury expense. The question is, does that fit wth your goals and values?

Doing the math, it looks like you're putting 20% of your after-tax salary toward the car each month, and that a decent chunk of that is going to interest.

I'm a few years ahead of you and make about 2x your income. I drive a 2003 Mazda worth about $3k, because I've prioritized "save a $100k house down payment" as my goal (screw you, CA housing market). For me that means de-prioritizing the nicer car, so I can put that $280/month (more than $3k/year!) where it really matters to me.
posted by samthemander at 1:41 PM on June 28, 2015 [2 favorites]

Oh yeah! The other way to think about the car thing is to just plan on keeping the car foreverrrr so that you squeeze every dollar out of it. However, that still means you're paying more for a luxury item now and will have a less luxurious car in the future- you just need to decide if that is something you're cool with.
posted by samthemander at 1:45 PM on June 28, 2015 [1 favorite]

$60k isn't such an astronomical amount of debt that I would advise planning on going the forgiveness route. Especially if you expect your income to grow. By dragging out the payments for 25 years you will be paying so much more in interest than you would if you paid off your loans in 10 or 15 years, that you'd probably end up spending more.

My advice would to address things in roughly this order:

1. Contribute the 6% to the 401k for the match. That's a 100% return on your money so it's a no-brainer. I seem to be alone on this view but at your age with your income and your debt, I wouldn't priotize retirement at all after that. 6% is good enough for you right now.
2. Build up a small emergency fund of 3 months living expenses.
3. Then work on the debt, probably starting with the car and then the higher interest student loans.
4. After getting the debt down to what you consider a manageable level, build up your emergency more and/or increase your retirement contributions.
posted by Asparagus at 5:09 PM on June 28, 2015

Do you need the car to get to work? If yes, save enough money to fix the car when it breaks (if no, get rid of the car). Then agressively pay off the car. Then worry about the other things. Unless you're living in a very low cost of living area, or still living with your parents rent free, I can't see you having a whole lot of extra cash left after paying for your loans.
posted by kjs4 at 5:34 PM on June 28, 2015

So here's a quick summary of priorities:

life, minimum payments, etc @ INF%
401k match @ 108%
IRA @ 9 %
401k remainder @ 8%
$10k auto @ 7%
$11k student @ 6.8%
$22k student @ 4.6%
$22k student @ 3.8%

Detailed explanation

Obviously you make minimum payments, because penalties are severe. And you pay rent, eat food, and such.

Once you've allocated the bare necessities, use the above guide to direct your payments, maxing out each line before allocating to the one below it. I've sorted it by expected return. for debts, this is simply the interest owed in the next year. For investments, this is the expected return over the next year. I estimate an portfolio return of 10 percent. The 401k match gets a 100% boost, and a rough estimate of 2 percent expense ratio. Your traditional IRA should be more competitive, but conservatively estimate 1 percent expense ratio.

You're absolutely right that contributions can lead to reduced IBR minimum payments. However, Roth contributions are post-tax, and therefore would not affect your AGI. If possible, you should make non-Roth contributions first. The more you contribute to your 401k, the less you pay in taxes and payments. Which frees you up for more contributions, which saves a bit more taxes and loan payments, until the series converges. Unless you're already maxing out your 401k, I wouldn't put too much faith in the standard Roth vs Traditional arguments. Plus refundable tax credits! So aim to max out the 401k / IRA above all else.

I doubt you can afford to max out the 401k / retirement options, but if you do manage it:

Your auto loan is high interest and not a tax deduction. Read the fine print of your loan, and if you can make extra payments to reduce principle, do so. Many auto loans have weird repayment structures that reduce the benefit of making extra payments, so be careful. Gap insurance is tricky --this is for when you owe more on the car than it's worth. It might be worth breaking out the 10k car loan into two parts: the bit you need to pay off to eliminate GAP, and the bit that won't be affected. But you'll need to know how much the premium is to get a sense of whether you should prioritize it above retirement contributions.

After that, student loans. Sub / unsub doesn't really matter unless you're in school, so it's just sorted by interest rate. Technically these have a tax adjustment that reduces expected costs, but your tax bracket should be 10-15 percent. Feel free to figure out which one you're in an adjust the table accordingly.

Finally, don't worry too much about Social Security. Much is made about their solvency, but once the trust fund runs out, it's estimated that they'd be able to pay 75 percent of promised benefits. Given demographics are slow changing, we have plenty of time to arrive at a solution, and it will probably involve some reducing benefit rates for the top bracket.
posted by pwnguin at 8:36 PM on June 28, 2015 [4 favorites]

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