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Then again... there is no basis to support that view.
If anything the evidence says the opposite..
How? If he spends $40K on the student loans, those loans are GONE, permanently; unlike credit card debt, he's in no danger of spending himself back into the same (student loan) debt hole. And he'll only be left with $10K of cash in danger of being piddled away rather than used sensibly. Since student loan debt cannot be discharged in bankruptcy, getting rid of it ASAP is a safe move.
Certainly paying off the loan debt more slowly and putting the entire $50K into an emergency fund can also be defended (and clearly it's some posters' preference), but without knowing how good this fellow is when it comes to not raiding the cookie jar, I'm more hesitant to recommend that approach.
Thank you all for the advice you have provided so far. To answer a few questions:
- retirement accounts are maxed with company matching on the first 5%
- PMI is around $250 / month, $40k in principal payments eliminate this charge
- the large Midwestern city is indeed Chicago.
- the $50k has "suddenly shown up" thanks to a year of diligent savings and a bonus
My friend has burned his share of calories on the hedonistic treadmill, perhaps more so from living paycheck-to-paycheck on a large paycheck, and "not piddling away" nest eggs (thanks though!) as his income has scaled up.
Progress has been made, as the $40k in SLs is down from $120k, but we're trying to find what the next best step is.
Then putting the money away in a CD ladder or a short-term bond fund which he will never, NEVER touch except in the event of unemployment or a huge medical bill may be a sensible move. Certainly he'll sleep better at night for having the cash around. He just needs to make sure it's not TOO easy to get to.
I think he should forget any actual investing outside of his retirement accounts until he's less leveraged. Once the student loan debt is gone, he'll have the funds to first get rid of the PMI on his mortgage, and then to do some real investing.
He'll still have $10K in cash he didn't have before - and he'll be free of a debt burden he can't get rid of in any other way than by paying it off. Whichever approach he takes, it's going to be years before he's out of the woods financially. At least if he pays off the loans, they're gone for good and there's no danger he'll piddle away that $40K of cash. If he keeps the entire $50K liquid, he's got a good emergency fund - but ONLY if he has the self -discipline not to dip into it to pay for non-emergencies. I think it's just a question of which risk he'd prefer to take.
but the debt is not the woods. the woods is that he seems to have accumulated no savings and is living paycheck to paycheck on a 200k income. debt is just a line in the balance sheet and it isnt worth dumping your "current assets" line to reduce your long term debt line.
Thank you all for the advice you have provided so far. To answer a few questions:
- retirement accounts are maxed with company matching on the first 5%
- PMI is around $250 / month, $40k in principal payments eliminate this charge
- the large Midwestern city is indeed Chicago.
- the $50k has "suddenly shown up" thanks to a year of diligent savings and a bonus
My friend has burned his share of calories on the hedonistic treadmill, perhaps more so from living paycheck-to-paycheck on a large paycheck, and "not piddling away" nest eggs (thanks though!) as his income has scaled up.
Progress has been made, as the $40k in SLs is down from $120k, but we're trying to find what the next best step is.
I say pay the mortgage down to get rid of PMI. $250/month on $40k is a "return" of 7.5%, and there is an additional "return" from the saved mortgage interest on the $40k. If it's 4%, the total "return" on the "investment" is 11.5%, guaranteed.
Keep $10k as an emergency fund, and throw the other $40k at the mortgage to drop PMI.
And then get the lifestyle under control to build the emergency fund up more. I don't know how they are blowing such good money, but surely some of it can be cut.
Even if there is a $16k emergency, at worst this equates to $6k in credit card debt. $6k of credit card debt at 18% interest is $1080/year. They're saving $4600/year on the PMI and mortgage, so they'd still come out far ahead!
And then get the lifestyle under control to build the emergency fund up more. I don't know how they are blowing such good money, but surely some of it can be cut.
Well, the OP did say later that his friend originally had $120K in student loan debt, which is now down to $40K, so clearly some of that good paycheck has gone to paying down his loans. The big problem seems to be that he bought more house than he can really afford at this point in his life, which has left him cash-strapped and debt-heavy. Fortunately, if he's lucky for the next few years and if he doesn't buy and more "big income toys" like a fancy car or expensive vacations, he's in a hole he can dig himself out of.
I would actually put 40K toward the student loans and be done with them because you can't claim bankruptcy with them. Then I'd put the other 10K toward the mortgage to chip away at PMI.
I'd take whatever the student loan payments are and put them in the 401K if not already maxing out. If already maxing out 401K, put the student loan payments in the college fund for the kid.
Think about this.
PMI is 3k/year.
Putting 40k toward the mortgage saves him at least 3k/year. That's approximately 6% annual return guaranteed.
What other options does he have that come even close?
Everything else can be covered by the cash flow which is now more positive thanks to the elimination of the PMI. The student loans, for example, will be paid off in about 6 months.
Keep the other 10k in emergency fund. You'll appreciate the flexibility of having cash on hand.
I would actually put 40K toward the student loans and be done with them because you can't claim bankruptcy with them. Then I'd put the other 10K toward the mortgage to chip away at PMI.
I'd take whatever the student loan payments are and put them in the 401K if not already maxing out. If already maxing out 401K, put the student loan payments in the college fund for the kid.
Why? Federal student loans aren't bankruptable but they do have IBR in order to protect against income interruptions, etc.
Private loans are worse, but they do have a statute of limitations, unlike federal loans. If there was a serious crisis and you failed to get deferment or forbearance, you could just default. They usually don't take people to court.
Why? Federal student loans aren't bankruptable but they do have IBR in order to protect against income interruptions, etc.
Private loans are worse, but they do have a statute of limitations, unlike federal loans. If there was a serious crisis and you failed to get deferment or forbearance, you could just default. They usually don't take people to court.
Eh, I just think it's better to get rid of them given the current laws, but reasonable people can disagree.
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