How much debt can one reasonably repay per year?

Discuss various money matters here. Loans (federal and private), scholarships, lottery winnings, or other school finance related information and queries.
User avatar
swc65
Posts: 1003
Joined: Wed Jul 22, 2009 11:27 am

Re: How much debt can one reasonably repay per year?

Postby swc65 » Tue Aug 02, 2011 4:33 pm

IAFG wrote:If you lose your six figure job, you'd be better off having the cash than less debt. IBR/LRAP ain't gonna pay your mortgage/rent or car payment.


THIS. Having liquidity to cover your out of pocket costs in the event of joblessness>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>> having a lower SL balance. If you lose your job you can defer your loans. But if you have already spent a ton of your would-be savings paying down the debt, how are you going to eat? The old rule used to be that you needed 6 mos of your monthly expenses in the bank (or similarly risk free/liquid asset. Given the rise of long-term unemployed and that law firms seem more eager to hire a noob than someone who is sans job, it might be better to ahve 1-2 years of monthly expenses saved up.

User avatar
vanwinkle
Posts: 9740
Joined: Sun Dec 21, 2008 3:02 am

Re: How much debt can one reasonably repay per year?

Postby vanwinkle » Tue Aug 02, 2011 4:34 pm

rayiner wrote:
IAFG wrote:If you lose your six figure job, you'd be better off having the cash than less debt. IBR/LRAP ain't gonna pay your mortgage/rent or car paymentfood.

Seriously, though, this is credited. If you do get Lathamed having a big cushion is going to let you keep looking for a good job (rather than just some job) a lot longer.

Actually... I agree with this. And a 7-8% interest rate is probably worth the peace of mind of having that cushion. With a significant stash you'd know you could survive for months without a job if your employer craters.

User avatar
swc65
Posts: 1003
Joined: Wed Jul 22, 2009 11:27 am

Re: How much debt can one reasonably repay per year?

Postby swc65 » Tue Aug 02, 2011 4:35 pm

DaveBear07 wrote:This is probably the best thread on budgeting/loan repayment on TLS. Good work people.

As a soon to be married 1L, my fiancee and I are looking at potentially 150k total in student loans (maybe a little more since next year we won't have the government paying any interest for us.) Anyways--- she is currently in Physican Assistant school and our plan upon graduating is to immediately pay off our debt. We're hoping for 70k-80k starting for her and BigLaw for me (yes, I know). And with the budgets I've been running, (approx. 30k living expenses), we're going to try to pay it off in 3 years.

But I'm in the camp that isn't intending to try to do any investing (except maybe outside of the 401k matching) until the debt is paid off at the for-sure-interest-rate.



I don't understand this mentality. What happens at the end of three years if you both lose your jobs? Great that you have no debt, but then you will have much less savings than you otherwise would have. I get that some people just hate debt, but govt. SL debt is the most manageable debt there is with all of the repayment options and deferral/forbearance.

User avatar
IAFG
Posts: 6665
Joined: Mon Jun 15, 2009 1:26 pm

Re: How much debt can one reasonably repay per year?

Postby IAFG » Tue Aug 02, 2011 4:36 pm

vanwinkle wrote:
rayiner wrote:
IAFG wrote:If you lose your six figure job, you'd be better off having the cash than less debt. IBR/LRAP ain't gonna pay your mortgage/rent or car paymentfood.

Seriously, though, this is credited. If you do get Lathamed having a big cushion is going to let you keep looking for a good job (rather than just some job) a lot longer.

Actually... I agree with this. And a 7-8% interest rate is probably worth the peace of mind of having that cushion. With a significant stash you'd know you could survive for months without a job if your employer craters.

It's not even really 7-8%. It's just the difference btw the 7-8% and the return you're getting on your savings.

User avatar
swc65
Posts: 1003
Joined: Wed Jul 22, 2009 11:27 am

Re: How much debt can one reasonably repay per year?

Postby swc65 » Tue Aug 02, 2011 4:37 pm

IAFG wrote:
vanwinkle wrote:
rayiner wrote:
IAFG wrote:If you lose your six figure job, you'd be better off having the cash than less debt. IBR/LRAP ain't gonna pay your mortgage/rent or car paymentfood.

Seriously, though, this is credited. If you do get Lathamed having a big cushion is going to let you keep looking for a good job (rather than just some job) a lot longer.

Actually... I agree with this. And a 7-8% interest rate is probably worth the peace of mind of having that cushion. With a significant stash you'd know you could survive for months without a job if your employer craters.

It's not even really 7-8%. It's just the difference btw the 7-8% and the return you're getting on your savings.


That's still just nominal interest. if inflation is running at 2-5% the real interest rate is even less!!! If we have 70s/early 80s style inflation the real interest rate (as some people are predicting) could even be negative or close to zero.

User avatar
DaveBear07
Posts: 188
Joined: Fri Jan 23, 2009 4:21 pm

Re: How much debt can one reasonably repay per year?

Postby DaveBear07 » Tue Aug 02, 2011 4:39 pm

swc65 wrote:
DaveBear07 wrote:This is probably the best thread on budgeting/loan repayment on TLS. Good work people.

As a soon to be married 1L, my fiancee and I are looking at potentially 150k total in student loans (maybe a little more since next year we won't have the government paying any interest for us.) Anyways--- she is currently in Physican Assistant school and our plan upon graduating is to immediately pay off our debt. We're hoping for 70k-80k starting for her and BigLaw for me (yes, I know). And with the budgets I've been running, (approx. 30k living expenses), we're going to try to pay it off in 3 years.

But I'm in the camp that isn't intending to try to do any investing (except maybe outside of the 401k matching) until the debt is paid off at the for-sure-interest-rate.



I don't understand this mentality. What happens at the end of three years if you both lose your jobs? Great that you have no debt, but then you will have much less savings than you otherwise would have. I get that some people just hate debt, but govt. SL debt is the most manageable debt there is with all of the repayment options and deferral/forbearance.


I understand your objection, but you are assuming that we haven't saved in case we lose our jobs. The typical advice is 6-8 months of income in savings; anyone think that is too little?

But the mentality is that if we want to accumulate wealth over our lifetime, then we have to get out from under the debt---- after having budgeted for emergencies, job loss, insurance, etc. etc. Thoughts?

User avatar
vanwinkle
Posts: 9740
Joined: Sun Dec 21, 2008 3:02 am

Re: How much debt can one reasonably repay per year?

Postby vanwinkle » Tue Aug 02, 2011 4:40 pm

swc65 wrote:I get that some people just hate debt, but govt. SL debt is the most manageable debt there is with all of the repayment options and deferral/forbearance.

This is the thing I think most people don't realize. If you suddenly find yourself jobless, this is the one form of debt you can have where the government will help you if you can't afford it. They don't do that shit with mortgages, home equity loans, or credit cards.

But then, I think we've reached a "OMG debt is bad" mentality where everyone is afraid of it. I was just thinking about this yesterday, when I heard an ad on the radio for a "converting debt into wealth system" scam that promised to help you eliminate your mortgage and live debt-free within a couple years. I bet there are tons of stupid people out there who go "O RLY?" and buy a copy of his "solution" because they're scared shitless of debt right now and they want out.

User avatar
vanwinkle
Posts: 9740
Joined: Sun Dec 21, 2008 3:02 am

Re: How much debt can one reasonably repay per year?

Postby vanwinkle » Tue Aug 02, 2011 4:40 pm

swc65 wrote:That's still just nominal interest. if inflation is running at 2-5% the real interest rate is even less!!! If we have 70s/early 80s style inflation the real interest rate (as some people are predicting) could even be negative or close to zero.

NY TO 190

User avatar
IAFG
Posts: 6665
Joined: Mon Jun 15, 2009 1:26 pm

Re: How much debt can one reasonably repay per year?

Postby IAFG » Tue Aug 02, 2011 4:41 pm

DaveBear07 wrote:
swc65 wrote:
DaveBear07 wrote:This is probably the best thread on budgeting/loan repayment on TLS. Good work people.

As a soon to be married 1L, my fiancee and I are looking at potentially 150k total in student loans (maybe a little more since next year we won't have the government paying any interest for us.) Anyways--- she is currently in Physican Assistant school and our plan upon graduating is to immediately pay off our debt. We're hoping for 70k-80k starting for her and BigLaw for me (yes, I know). And with the budgets I've been running, (approx. 30k living expenses), we're going to try to pay it off in 3 years.

But I'm in the camp that isn't intending to try to do any investing (except maybe outside of the 401k matching) until the debt is paid off at the for-sure-interest-rate.



I don't understand this mentality. What happens at the end of three years if you both lose your jobs? Great that you have no debt, but then you will have much less savings than you otherwise would have. I get that some people just hate debt, but govt. SL debt is the most manageable debt there is with all of the repayment options and deferral/forbearance.


I understand your objection, but you are assuming that we haven't saved in case we lose our jobs. The typical advice is 6-8 months of income in savings; anyone think that is too little?

But the mentality is that if we want to accumulate wealth over our lifetime, then we have to get out from under the debt---- after having budgeted for emergencies, job loss, insurance, etc. etc. Thoughts?

half a year's savings + living expenses + significantly paying down your loans? doesn't sound possible in most cities. add on top of that trying to save for a house downpayment to get yourself out of a rental, which is also costing you money... really, the differences btw these schemes are pretty small.

User avatar
DaveBear07
Posts: 188
Joined: Fri Jan 23, 2009 4:21 pm

Re: How much debt can one reasonably repay per year?

Postby DaveBear07 » Tue Aug 02, 2011 4:50 pm

I'm open to other plans because money is money--- but everything I've read and heard points towards:

1) Budget (rent, utilities, food, insurance, emergency, 6-8 months of income, etc.)
2) Debt at approx. 8% interest.
3) Down Payment on House and Matching 401k.
4) Investing for currently-decades-away-matters such as kids' college and retirement.

Thoughts?

User avatar
rayiner
Posts: 6184
Joined: Thu Dec 11, 2008 11:43 am

Re: How much debt can one reasonably repay per year?

Postby rayiner » Tue Aug 02, 2011 5:02 pm

DaveBear07 wrote:I'm open to other plans because money is money--- but everything I've read and heard points towards:

1) Budget (rent, utilities, food, insurance, emergency, 6-8 months of income, etc.)
2) Debt at approx. 8% interest.
3) Down Payment on House and Matching 401k.
4) Investing for currently-decades-away-matters such as kids' college and retirement.

Thoughts?


Re: (3), I think you have to balance two things. On one hand, housing prices haven't necessarily bottomed out yet. That said, they may be near the bottom and stay stagnant for a few years. So you don't have to worry about housing prices shooting up anytime soon and can put off saving for a down payment. On the other hand, mortgage interest rates are ridiculously low right now. These 4% mortages (barely over inflation) are not going to last forever and indeed may not last very long. So having the scratch to pull the trigger on a house before mortgage rates shoot up could be worth quite a lot of money.

ToTransferOrNot
Posts: 1928
Joined: Thu Jan 22, 2009 12:45 am

Re: How much debt can one reasonably repay per year?

Postby ToTransferOrNot » Tue Aug 02, 2011 5:09 pm

IAFG wrote:
DaveBear07 wrote:
swc65 wrote:
DaveBear07 wrote:This is probably the best thread on budgeting/loan repayment on TLS. Good work people.

As a soon to be married 1L, my fiancee and I are looking at potentially 150k total in student loans (maybe a little more since next year we won't have the government paying any interest for us.) Anyways--- she is currently in Physican Assistant school and our plan upon graduating is to immediately pay off our debt. We're hoping for 70k-80k starting for her and BigLaw for me (yes, I know). And with the budgets I've been running, (approx. 30k living expenses), we're going to try to pay it off in 3 years.

But I'm in the camp that isn't intending to try to do any investing (except maybe outside of the 401k matching) until the debt is paid off at the for-sure-interest-rate.



I don't understand this mentality. What happens at the end of three years if you both lose your jobs? Great that you have no debt, but then you will have much less savings than you otherwise would have. I get that some people just hate debt, but govt. SL debt is the most manageable debt there is with all of the repayment options and deferral/forbearance.


I understand your objection, but you are assuming that we haven't saved in case we lose our jobs. The typical advice is 6-8 months of income in savings; anyone think that is too little?

But the mentality is that if we want to accumulate wealth over our lifetime, then we have to get out from under the debt---- after having budgeted for emergencies, job loss, insurance, etc. etc. Thoughts?

half a year's savings + living expenses + significantly paying down your loans? doesn't sound possible in most cities. add on top of that trying to save for a house downpayment to get yourself out of a rental, which is also costing you money... really, the differences btw these schemes are pretty small.


Rental only costs you money over ownership (assuming real estate is actually going up in value which is, of course, not an accurate assumption right now and may not be in the foreseeable future) if you're going to live in the place for 5ish years, at least in Chicago. ETA: You're also significantly exposing yourself to the onslaught of the municipal debt crisis, which is going to manifest in much higher property taxes + more... generous... assessments of value for prop tax purposes.

I am not "afraid" of debt; I am troubled by paying well over $50 of interest a day on said debt with the only return being some ambiguous sense of "comfort" or protection against being Lathamed. With $163k of debt, being Lathamed = screwed regardless of savings you might have to cover short-term expenses. I would rather be in a situation where I have the freedom in 4 years to do whatever I want - including waiting tables, if I decide the professional world isn't for me - rather than saving up a large cushion to temporarily stave off the catastrophic effects of being laid off.

That said, Ray does have a really good point re: the current 4% rate on mortgages. But frankly, none of us in this thread are going to have the resources assembled within the "4% timeframe" to pull the trigger on a house.

User avatar
birdlaw117
Posts: 2167
Joined: Thu Sep 16, 2010 12:19 am

Re: How much debt can one reasonably repay per year?

Postby birdlaw117 » Tue Aug 02, 2011 5:14 pm

It's going to take you a long time to build up 6-8 months worth of income. I've generally heard that you want to make sure you can cover expenses for 3 months. During tough economic times such as these, it would probably be smart to have a little more. Anyways, it really doesn't make sense to build your budgeted emergency savings off of income. You should budget it off of projected expenses. 6-8 months worth of income, when you factor in that you are saving and "contributing" to this fund and take that away from your expenses, would likely be able to maintain your current lifestyle for a year. I think that's being unnecessarily conservative.

But yeah, definitely have an emergency fund, I just don't think it needs to be that big.

User avatar
IAFG
Posts: 6665
Joined: Mon Jun 15, 2009 1:26 pm

Re: How much debt can one reasonably repay per year?

Postby IAFG » Tue Aug 02, 2011 5:29 pm

ToTransferOrNot wrote:
Rental only costs you money over ownership (assuming real estate is actually going up in value which is, of course, not an accurate assumption right now and may not be in the foreseeable future) if you're going to live in the place for 5ish years, at least in Chicago.


you don't have to come out ahead for this to make sense, just break even + closing costs. if i stay in a condo for 5 years and sell it in 5 years for what i paid, i've lived there for 5 years for closing costs.
ETA: You're also significantly exposing yourself to the onslaught of the municipal debt crisis, which is going to manifest in much higher property taxes + more... generous... assessments of value for prop tax purposes.


fine but that's going to be built into rental prices too

I am not "afraid" of debt; I am troubled by paying well over $50 of interest a day on said debt with the only return being some ambiguous sense of "comfort" or protection against being Lathamed. With $163k of debt, being Lathamed = screwed regardless of savings you might have to cover short-term expenses. I would rather be in a situation where I have the freedom in 4 years to do whatever I want - including waiting tables, if I decide the professional world isn't for me - rather than saving up a large cushion to temporarily stave off the catastrophic effects of being laid off.

again, you're assuming you'll definitely have to pay it eventually. not necessarily true.

That said, Ray does have a really good point re: the current 4% rate on mortgages. But frankly, none of us in this thread are going to have the resources assembled within the "4% timeframe" to pull the trigger on a house.

well that's not necessarily true either. some people might be significantly on the way there through savings, family help, etc. and how long that will be available is an unknown, as is how quickly it will change.
Last edited by IAFG on Tue Aug 02, 2011 5:31 pm, edited 1 time in total.

User avatar
albusdumbledore
Posts: 1132
Joined: Thu Nov 05, 2009 4:38 pm

Re: How much debt can one reasonably repay per year?

Postby albusdumbledore » Tue Aug 02, 2011 5:31 pm

DaveBear07 wrote:I'm open to other plans because money is money--- but everything I've read and heard points towards:

1) Budget (rent, utilities, food, insurance, emergency, 6-8 months of income, etc.)
2) Debt at approx. 8% interest.
3) Down Payment on House and Matching 401k.
4) Investing for currently-decades-away-matters such as kids' college and retirement.

Thoughts?

I have an issue with #3 too. I constantly see people on here rationalize paying off their debts before doing something like maxing out their 401k contribution because "there's no way you're gonna beat the guaranteed 7% interest rate on the loans". Well, sure, for a single year. The issue is that if you wait to contribute to your 401k and instead you hammer those loans a little bit faster, the amount you're giving up isn't a single 7% return. The amount you're giving up is the amount you would have paid in for that year, compounded at 7%(or whatever return you end up making in the markets) for every year until you retire. Which is a whole hell of a lot more than a 7% return.

ToTransferOrNot
Posts: 1928
Joined: Thu Jan 22, 2009 12:45 am

Re: How much debt can one reasonably repay per year?

Postby ToTransferOrNot » Tue Aug 02, 2011 5:39 pm

These are directed at IAFG's post:

True re savings/family help: the thread seemed to have a baseline assumption of "significant debt and no current assets," and that's what I was going on.

Re: higher prop taxes being factored into rentals - yes, that is true, but if higher prop taxes make the place you're renting go up in rent too much, you can pretty easily move. The same isn't true for owning.

Re: Your first point - if you stay in a condo for 5 years, and sell it for what you paid, you've still paid property taxes, interest on the mortgage, condo association fees, etc. There are "rental vs. ownership" calculators out there (http://www.nytimes.com/interactive/busi ... lator.html). I've done a lot of playing around with that one, and 5 years seems to be the point where the total cost of living in a place starts to tip in favor of ownership.

For what it's worth, I really am interested to know if I'm "missing" something in this calculus. Basically, due to Chicago's IBR, my student loans are "free" for this coming year, and then I have a clerkship bonus coming to me when I start in 2012. I've done a lot of research into the "should I save all I can during my clerkship year, and use that + bonus for a house in 2012 (I would have about $35k to marshall into a down payment, I think,) or should I put it all into loans" question. Everything I can conjure up points to "kill the 8.5% loan," because if I apply everything I can marshall, I'll knock out my one 8.5% GradPLUS loan and put a dent into my 7.9% GradPLUS loan.

Re: Having to "pay the debt eventually" - unless you're going to take a public interest job (which will be *incredibly* difficult to get after being Lathamed, because you won't have public interest bona-fides) or are OK with being in IBR for 25 years (and suffering the massive, massive DOI hit at year 25 - assuming the discharge is still around in 25 years,) you will have to pay it back. Emergency living expenses and such, on the other hand? If those really get bad, you actually *can* discharge those.

This is directed at albus' post:

There is a compounding effect on paying down loan principal more quickly, too.

User avatar
albusdumbledore
Posts: 1132
Joined: Thu Nov 05, 2009 4:38 pm

Re: How much debt can one reasonably repay per year?

Postby albusdumbledore » Tue Aug 02, 2011 5:44 pm

ToTransferOrNot wrote:This is directed at albus' post:

There is a compounding effect on paying down loan principal more quickly, too.

Of course there is. But the life of your loans will not be as great as the length of your stay in the work force. Or even very close hopefully. Even if you take 20 years to pay them, you're gonna be working for 40 if you make it to retirement.

User avatar
birdlaw117
Posts: 2167
Joined: Thu Sep 16, 2010 12:19 am

Re: How much debt can one reasonably repay per year?

Postby birdlaw117 » Tue Aug 02, 2011 5:45 pm

albusdumbledore wrote:
DaveBear07 wrote:I'm open to other plans because money is money--- but everything I've read and heard points towards:

1) Budget (rent, utilities, food, insurance, emergency, 6-8 months of income, etc.)
2) Debt at approx. 8% interest.
3) Down Payment on House and Matching 401k.
4) Investing for currently-decades-away-matters such as kids' college and retirement.

Thoughts?

I have an issue with #3 too. I constantly see people on here rationalize paying off their debts before doing something like maxing out their 401k contribution because "there's no way you're gonna beat the guaranteed 7% interest rate on the loans". Well, sure, for a single year. The issue is that if you wait to contribute to your 401k and instead you hammer those loans a little bit faster, the amount you're giving up isn't a single 7% return. The amount you're giving up is the amount you would have paid in for that year, compounded at 7%(or whatever return you end up making in the markets) for every year until you retire. Which is a whole hell of a lot more than a 7% return.

This. Sure, both interest rates compound, but the 401k will keep compounding after you've paid off the debt, and at that point the compounding interest will earn a bunch. Plus, loans will be compounding on gradually decreasing amounts while retirement accounts will compound on gradually increasing amounts.

ETA: Albus, you beat me to it.

ToTransferOrNot
Posts: 1928
Joined: Thu Jan 22, 2009 12:45 am

Re: How much debt can one reasonably repay per year?

Postby ToTransferOrNot » Tue Aug 02, 2011 5:50 pm

birdlaw117 wrote:
albusdumbledore wrote:
DaveBear07 wrote:I'm open to other plans because money is money--- but everything I've read and heard points towards:

1) Budget (rent, utilities, food, insurance, emergency, 6-8 months of income, etc.)
2) Debt at approx. 8% interest.
3) Down Payment on House and Matching 401k.
4) Investing for currently-decades-away-matters such as kids' college and retirement.

Thoughts?

I have an issue with #3 too. I constantly see people on here rationalize paying off their debts before doing something like maxing out their 401k contribution because "there's no way you're gonna beat the guaranteed 7% interest rate on the loans". Well, sure, for a single year. The issue is that if you wait to contribute to your 401k and instead you hammer those loans a little bit faster, the amount you're giving up isn't a single 7% return. The amount you're giving up is the amount you would have paid in for that year, compounded at 7%(or whatever return you end up making in the markets) for every year until you retire. Which is a whole hell of a lot more than a 7% return.

This. Sure, both interest rates compound, but the 401k will keep compounding after you've paid off the debt, and at that point the compounding interest will earn a bunch. Plus, loans will be compounding on gradually decreasing amounts while retirement accounts will compound on gradually increasing amounts.

ETA: Albus, you beat me to it.


How would the ability to make greater payment to savings after year 4 (to wit, the amount you otherwise would be paying into the loans in years 5-10) not make up for the nominal amount of additional compounding you would get from the 401k in years 1-4?

I do admit that I am skeptical about the value of the tax deferral though, because I think we're going to be taxed at a significantly lower rate in years 1-4 of our careers than we will be in retirement. That's a claim about future tax rates that I really can't back up (but if there is some tax rate default swap option magic that I could buy to place a bet on it, I would). I guess that, at least unlike other kinds of investments, you are only taxed once on the 401k proceeds.

User avatar
IAFG
Posts: 6665
Joined: Mon Jun 15, 2009 1:26 pm

Re: How much debt can one reasonably repay per year?

Postby IAFG » Tue Aug 02, 2011 5:52 pm

With so many unknown variables, I think you should do whatever helps you sleep at night. If that is "buying your freedom" by paying off your loans, do that. If it's keeping cash available/in low risk investments, do that. The unknowns eat up the margin btw the two, so neither answer is obviously right or wrong. Except blowing it all on models and bottles.

ToTransferOrNot
Posts: 1928
Joined: Thu Jan 22, 2009 12:45 am

Re: How much debt can one reasonably repay per year?

Postby ToTransferOrNot » Tue Aug 02, 2011 5:53 pm

IAFG wrote:With so many unknown variables, I think you should do whatever helps you sleep at night. If that is "buying your freedom" by paying off your loans, do that. If it's keeping cash available/in low risk investments, do that. The unknowns eat up the margin btw the two, so neither answer is obviously right or wrong. Except blowing it all on models and bottles.


Obviously the right answer.

Edit: Also, seriously, if you have any insight into the "buying a house" thing that you think I'm missing, please let me know. I'm not trying to be snipeish on that - it really is a question I've agonized over, since I have to make up my mind pretty soon.

User avatar
birdlaw117
Posts: 2167
Joined: Thu Sep 16, 2010 12:19 am

Re: How much debt can one reasonably repay per year?

Postby birdlaw117 » Tue Aug 02, 2011 5:54 pm

ToTransferOrNot wrote:
birdlaw117 wrote:
albusdumbledore wrote:
DaveBear07 wrote:I'm open to other plans because money is money--- but everything I've read and heard points towards:

1) Budget (rent, utilities, food, insurance, emergency, 6-8 months of income, etc.)
2) Debt at approx. 8% interest.
3) Down Payment on House and Matching 401k.
4) Investing for currently-decades-away-matters such as kids' college and retirement.

Thoughts?

I have an issue with #3 too. I constantly see people on here rationalize paying off their debts before doing something like maxing out their 401k contribution because "there's no way you're gonna beat the guaranteed 7% interest rate on the loans". Well, sure, for a single year. The issue is that if you wait to contribute to your 401k and instead you hammer those loans a little bit faster, the amount you're giving up isn't a single 7% return. The amount you're giving up is the amount you would have paid in for that year, compounded at 7%(or whatever return you end up making in the markets) for every year until you retire. Which is a whole hell of a lot more than a 7% return.

This. Sure, both interest rates compound, but the 401k will keep compounding after you've paid off the debt, and at that point the compounding interest will earn a bunch. Plus, loans will be compounding on gradually decreasing amounts while retirement accounts will compound on gradually increasing amounts.

ETA: Albus, you beat me to it.


How would the ability to make greater payment to savings after year 4 (to wit, the amount you otherwise would be paying into the loans in years 5-10) not make up for the nominal amount of additional compounding you would get from the 401k in years 1-4?

I do admit that I am skeptical about the value of the tax deferral though, because I think we're going to be taxed at a significantly lower rate in years 1-4 of our careers than we will be in retirement. That's a claim about future tax rates that I really can't back up. I guess that, at least unlike other kinds of investments, you are only taxed once on the 401k proceeds.

I guess all I can say is do the math. That extra amount will get compounded 40 times. Compare that to the 3 or 4 or whatever number of times it would get compounded on your loan. The number getting compounded 40 times is going to be a lot bigger than the one being compounded only a handful of times.

ToTransferOrNot
Posts: 1928
Joined: Thu Jan 22, 2009 12:45 am

Re: How much debt can one reasonably repay per year?

Postby ToTransferOrNot » Tue Aug 02, 2011 5:55 pm

bird:

The "extra amount" would only get compounded an "extra" 40 times if you were never going to make additional payments to the 401k in years 5-10 to make up for what you didn't put in in years 1-4. That's not what I'm suggesting at all.

User avatar
birdlaw117
Posts: 2167
Joined: Thu Sep 16, 2010 12:19 am

Re: How much debt can one reasonably repay per year?

Postby birdlaw117 » Tue Aug 02, 2011 5:58 pm

ToTransferOrNot wrote:bird:

The "extra amount" would only get compounded an "extra" 40 times if you were never going to make additional payments to the 401k in years 5-10 to make up for what you didn't put in in years 1-4. That's not what I'm suggesting at all.

The amount in those first 1-4 years will be more than what you can simply just make up, because of the interest. That difference is what is compounded 40 times. I'm not sure if I'm explaining that in the best way...

User avatar
albusdumbledore
Posts: 1132
Joined: Thu Nov 05, 2009 4:38 pm

Re: How much debt can one reasonably repay per year?

Postby albusdumbledore » Tue Aug 02, 2011 6:01 pm

ToTransferOrNot wrote:bird:

The "extra amount" would only get compounded an "extra" 40 times if you were never going to make additional payments to the 401k in years 5-10 to make up for what you didn't put in in years 1-4. That's not what I'm suggesting at all.

True. But 401ks have a maximum of 16500 for a yearly contribution. IRA's have a max of 5k. So for what you're saying to hold true, you'd have to be contributing 50% or less of the max contribution every year. At which point you're already screwing yourself out of those returns.




Return to “Financial Aid”

Who is online

Users browsing this forum: No registered users and 1 guest