Advice wanted for financial situation

[MrRuz]

I’m soliciting for advice in three areas: home purchase, student loan payoff, and retirement matching within the context of smart personal finance management, including aspects that account for emergency fund, insurance, tithing/charity, etc…

So here’s our situation:

My wife and I are recent graduates and have a probable combined gross annual salary of $110,000. We have a high probability of making this income for the next two years, after which we expect our income to increase. How much we expect it to increase is uncertain. According to the IRS withholding tool, our federal income taxes should be about $14,000. Combine this with FICA taxes, we expect total tax expenses of approximately $24,000.


It’s embarrassing to admit that we estimate to have about $120,000, after the grace period, in student loans, with a weighted average interest rate of 5.89 percent. This comes out to approximately $1,326 in minimum/required monthly payments. I feel badly about this excessive debt load, but I can't do anything now but pay it.

If we keep our lifestyle as it has been, we should average about $3,250 per month in fixed and variable expenses, including everything required to operate our household. This is higher than we like, but we live in a state that is rather expensive. We live in a single bedroom apartment that costs $950/month, which is a good deal considering our market. We can reduce this expense, but not significantly.

If I break everything down to a monthly amount, we expect the following:
Gross income: $9,200
Less: Charity/Tithing: 920
Less: Estimated Tax: 2,000
Less: Health Ins. Exp.: 300
Net Income: 5,980
Less: Student loan PMT: 1,326
Less: Living Expenses: 3,250
Free Cash Flow: 1,404

If we take the free cash flow and pay it all towards debt, we estimate that we can pay off the debt in 3 to 4 years. However, I’m uneasy with paying rent so long. I’d be okay with 2-3 years, but we’re approaching almost half of a decade. If we redirected this money to paying for a house, that would postpone our debt to 5-7 years (longer range because more uncertain) and increase our living expenses by an estimated $500. If we contribute for retirement, which the mathematician in me says I should do, then we’ll have almost nothing left extra towards the excessive debt load for some time to come.

Thoughts, opinions, advice?

P.S. On a side note, we have an emergency fund of $3,000 already funded.

[snafu]

Making suggestions would be more realistic if we understood how you allocate $ 2,300. that remains after rent. I suggest you write down every dollar spent for at least 30 days to identify where the money goes. Do you have a written budget? I'd start with an Emergency Fund, initially targeting $ 1K each [$2K]. What retirement programs do your employers offer? Are there matching sums? When are you eligible? Who are the administrators? What are the fees [whatever they call it]?

What are your transportation costs including insurance ? What sum do you set for food including take-out/restaurant etc? Other than student loans, do you have any other cost of credit accounts?

Answers to questions have potential to set direction to accomplish goals.

[JoeP]

You used word like expect, should, probable, and estimate. While it is OK to have a game plan, it sounds like a lot is hinging upon landing jobs at the income level you expect. My advice would be to first land jobs and see where that takes you career-wise and also location-wise. It is a good idea to stay flexible in your first couple years, and renting makes sense there.

The purists here will suggest you pay off your student loans while you save 20% down on a house that will be purchased with a 15 year fixed rate mortgage. I like your proposal of renting while you pay off the student loans.

[autoxer]

If we take the free cash flow and pay it all towards debt, we estimate that we can pay off the debt in 3 to 4 years. However, I’m uneasy with paying rent so long. I’d be okay with 2-3 years, but we’re approaching almost half of a decade. If we redirected this money to paying for a house, that would postpone our debt to 5-7 years (longer range because more uncertain) and increase our living expenses by an estimated $500. If we contribute for retirement, which the mathematician in me says I should do, then we’ll have almost nothing left extra towards the excessive debt load for some time to come.

You should be uneasy about home ownership. Break down the costs of home ownership and you'll see that only a small portion actually goes towards your bottom line. You also take on more risk with the maintenance costs and fluctations with the property value. Paying rent isn't throwing away money, it covers many of the same costs, including real estate tax, insurance & maintenance.

If you were going to remove all emotion and let a mathematician decide, then you would pay off all 6% debt, before considering home ownership, because your primary residence isn't likely to return anywhere near that as an investment. Emotionally home ownership is very rewarding, but from a purely financial standpoint, it's not a great investment.

[daledegagne]

If we take the free cash flow and pay it all towards debt, we estimate that we can pay off the debt in 3 to 4 years. However, I’m uneasy with paying rent so long. I’d be okay with 2-3 years, but we’re approaching almost half of a decade. If we redirected this money to paying for a house, that would postpone our debt to 5-7 years (longer range because more uncertain) and increase our living expenses by an estimated $500. If we contribute for retirement, which the mathematician in me says I should do, then we’ll have almost nothing left extra towards the excessive debt load for some time to come.

Thoughts, opinions, advice?

P.S. On a side note, we have an emergency fund of $3,000 already funded.

General suggestion is not to over-complicate things by planning further than 5 years out or up to the next big life change (ie a baby in 3 years means don't make a detailed plan past the baby because things will change to make that plan irrelevant anyways).

Suggestions

1. Ignore retirement at this point unless it's more important to you than the house or the student loans. When you start stretching yourself and your money over too many financial goals, it adds stress to your life because you work hard at all of them, and struggle to meet any of them. One to two goals is plenty to focus on for now.

Also - in terms of efficiency, paying 5.89% in student loans is comparable to a 5%, tax free growth return in the market (because your loans give you a tax deduction and assuming you invest in a tax sheltered account). That may or may not be far off from the actual returns of the market which are unknown until they happen.

2. Understand that a house is not an investment and there is no need to rush it.

A home is a consumer good in the form of an appreciating asset. An investment earns you money. While a home increases in value, it also costs you money to maintain/operate. Yes it's a good purchase, but compare it to say a rental property, and you can see it's not a true investment.

3. Understand the Efficiency Argument

Ignoring the added costs of home ownership, and strictly comparing the value growth of a home vs. your student loan interest rate, you'd be lucky for your home to increase in value by 5.89% per year, making paying off student loans the more financially efficient choice.

4. Create an emergency plan, not just a fund

An emergency fund is a great part of an emergency plan, but also factor in Free Cash Flow. If one of you lost your job, would you start sinking by $3000 a month? $1400? How long would your fund last? Are you comfortable with that? Are your jobs secure enough for that? Or, are they secure enough that you're comfortable with that level of emergency fund for the next couple of years?

If your fund is too small and **** hits the fan, then you'll hurt. But, if you push for 6 months, or 1 year worth of living expenses, this could take you a couple years to build putting you further behind your goals and leave you feeling stupid with $35 000 in the bank and $100 000 still left on your student loans. It's your call - there's no black and white answer.

5. Figure out how much a house will cost you today and how much you need to save for a down payment and see how long it would take you to save that amount.

6. Play with the time lines of how long it will take you to save for the down payment plus pay off student loans and possibly save more for an emergency fund by varying your free cash flow amounts and the order in which you do things. Ignore the fact that the cash flow requirement may seem unreasonable (ie., you have no idea how you could afford $2000 in FCF, when you only have $600 right now)

ie - What if you had $1600 in FCF and paid the loans first, then rolled over the loan repayment of $1300 with the FCF to total $2900 FCF - how long to save the down payment then? What if you just bought a house? What are the costs there? How long would you be carrying your student loans for then? (Hint...given your estimates, I'd estimate that you'd be carrying those loans at least 15 years because you would struggle to do more than make minimums...and that's without having kids)

7. Once you have a solid plan with time line that you want....

Decide what is more important to you. Ask yourself: If it means that I can reach my goal(s) of (down payment, debt free etc in X years) am I willing to try and reduce my lifestyle expenses to make that happen.

If not, then scrap everything and work only with your current expected free cash flow. If you're willing to put in some effort then keep reading.

8. Be creative about making changes without sacrificing

If I was a betting man I would put it all on red and say that you have a healthy dose of status quo bias just like pretty much everyone else. Basically, we all like to think we're spending wisely and efficiently for the most part. The truth is, we can always find ways to do things better, without feeling like we're sacrificing.

My suggestion is to pick one variable expense every month and imagine how you'd do it on less money. Try it for just a couple weeks and if you like the new status quo, stick with it. If not, then revert back and be happy you saved a couple hundred and tried something new.

Doing this, I've watched clients save anywhere from 5-25% of their monthly income.

Possible suggestions: learn to brew your own booze, try different brands at the grocery store, plan cheaper meals, cook more, eat out less, bike to work, carpool to work, self teach yourself a music instrument instead of watching TV (removing the need for cable), camp instead of getting an all expense paid vacation. The key is changes...not sacrifices.


What would I do if I was you

Personal opinion alert here but I would maybe put another $3000 max into my emergency fund, and then plow the money to the student loan while making a habit of finding fun and creative ways to do things better. For me, the thought of changing $1400 FCF into $2000 FCF, then paying off the student loans in 2 to 3 years and having $3300 in FCF is more exciting than owning a home. With the student loan gone, you will be free to buy your own home, and still have some wiggle room in your budget to go on vacations, and invest for retirement.

[GeorgeEastman]

^^ This is a 10/10 post, /thread.

[daledegagne]

^^ This is a 10/10 post, /thread.

Thanks for the thumbs up George.

[GeorgeEastman]

Thanks for the thumbs up George.

No problem, that advice was excellent.