Happy New Year! It’s a gorgeous and sunny first day of 2013 in Seattle (yes, really!) and this makes me feel excited and optimistic about the new year. It’s a fresh start with all new goals, plans and and shiny new adventures. AND, friends, we didn’t go off the fiscal cliff! I, for one, am happy my taxes won’t go up. WIN! (Sorry if you make over $400,000. Wait…no I’m not.)
As I mentioned before…one of my goals is to get out of debt. Well…not all debt…Dave and I would have to live in a box and eat dirt for a few years in order to do that. I’m talking all debt minus my student loans and our mortgage.
But here’s the deal. I’m confused. I read a LOT of personal finance books and blogs. And here is what they say…
Pay off highest interest debt first!
Pay off smallest debt first!
Get a house!
Don’t even think about FHA loans!
Pay mortgage early!
Pay debt before saving for retirement!
Don’t miss out on retirement savings!
Save 15% of your income!
Save 50% of your income!
There’s a lot of information out there. And a lot of it is contradictory. Even the big names in finance, such as Suze Orman, Dave Bach and Dave Ramsey, can’t seem to agree on personal finance matters. And so little of the info focuses on frugality and the idea of early retirement. In fact, Suze Orman seems to think that you should work PAST 65! No thank you.
Some people say you should just pick one guru and follow his/her lead. That makes some sense. However, should I not learn as much as I can from different sources to be better informed? I mean…you wouldn’t go to college and only take classes from one professor, right? Besides, there cannot be a one-size-fits-all solution for everyone.
Anyway, this is the plan we are going with this year:
1. Pay off all credit cards (will be done-zo next month!)
2. Continue contributing to 401 K to get employer match
3. Contribute to Roth IRA
4. Pay off other no-interest lingering debts – family loans and medical expenses
5. Save, Save, Save all extra money for a healthy emergency fund and investments
As for the big debts, mortgage and student loans, those will take a while longer. At 3.75%, the mortgage interest is so low that it’s hard to justify paying it off early. We are already on a bi-weekly plan which will cut 6 years off our mortgage and will save $40,000 in interest. Woot!
And student loans…UGH. I don’t know. So most financial experts agree, you should pay off your loans ASAP. I know I know! I should! But, I am one of the people who has been helped immensely by the Income Based Repayment Program. My payments are capped at a certain percentage of my income and after 25 years (now 23 years) the balance will be forgiven (although I will have to pay taxes on that). Interest is not compounded. While, this is AMAZING right now…it’s nearly impossible to figure out whether this is a good deal in the long run or not! There are too many factors to consider and I can’t find a good calculator to make a decision. For example:
1. It’s impossible to predict how much I will make in the next 23 years. Based on my current income, I pay hundreds (high hundreds) less than I would on a standard repayment plan.
2. Right now, the loan balance (principle and interest) that is forgiven after 23 years is taxable. However, there is a movement to change this to a non-taxable forgiveness (please, please, puhleeaaseee!). Nevertheless, I don’t think I should base any decisions on a HOPE that they might do this. I should plan on a giant tax bill down the road.
3. Not knowing what the balance will be in 23 years (because I don’t know how much I’ll make and pay off), and therefore, not knowing what my total tax bill makes it difficult to calculate the benefit of paying off early vs. paying over time.
4. If I move into a job in Public Service, my loans can be forgiven, TAX-FREE, in ten years. That’s almost too good to be true.
From my rough calculations, based on my current income, it makes sense to NOT pay my loans off early and to invest my monthly savings. My total amount paid comes up similar whether I pay it off in 10 (standard repayment) or 23 (IBR). Weird I know! But it’s a definite benefit to NOT pay early if the forgiveness is non-taxable. I mean, that is a HUGE factor and I should probably have an accountant really crunch the numbers. But, here’s my compromise, since I am planning to pay a giant tax bill, I am setting up a savings account just for taxes, to which I will contribute for the next 23 years (and hopefully earn interest on). Therefore, I will have money to throw at that tax bill when it comes, OR, I will have 23 years worth of savings for retirement if Congress comes through for people like me.
(God, 23 years is SO FAR AWAY. It kind of messes with my idea of retiring in 15 or less!)
Of course, every other day this changes. Some days, all I want to do is attack this debt with a vengeance…live on Ramen, sell everything, get another job. I’ll read a blog like No More Harvard Debt, and I’m inspired to just get it over and done with already!
And, just so you know, it isn’t lost on me that I DID take out these loans and it is my responsibility to pay them back. With the IBR program, President Obama definitely threw a bone to debtors like me. I know a lot of people are angry about it and think that it encourages students to not take responsibility. I admit…they might be right. But…I do think that student loan debt can prevent people from contributing to our economy and society in other ways — buying houses, having kids, spending money (hopefully locally). I, for one, was able to ditch most credit card debt and buy a house, thanks to IBR.
Besides, there are hundreds of loopholes and incentives for high-earners and corporations. They take advantage of these. Should I not do the same?
Cheers and best of luck to breaking out of your own prisons (debt or otherwise) this year!
PS. If anyone has any good calculators to figure this all out…I’m all ears.
PPS. The MAIN benefit of paying off the loans early is psychological relief. This is huge. Especially considering my neurotic nature.