Loan payoff strategy (and other finance advice)

[legobikes]

I'm a pediatrician in my second year of practice. I qualify for PSLF and have about 2 years of payments, but I doubt it will remain operative or that I will be 'grandfathered in' just because I filled out the certification form.

I have little to no financial education, and relatedly, absolutely no investments or insurance policies except for liability-only vehicle insurance on my old Honda and my bike. For the longest time I refused to think at all about my loans; the assumption was I'd just have to pay it for 25 years. I have $350k federal loans at 7% with $25k of interest, and I just found out that because I missed a recent IBR recertification date, the interest is set to capitalize in June. This last surprise made me determined to pay it all off.

The numbers:
My income is 200k, family size is 3, we rent a home for $1200.
Basically I make a little over $10k/month and can save a little over $7k, of which $1700 currently goes towards IBR (and my undergrad $10k loan @2.something%).

I have NO tax shelters set up and only started learning about them in the past couple of days. I was also planning, with the $60k we saved in the last year, to make a downpayment for a home. We would have more saved but we did do a fair bit of travelling in the past year, I paid back a $10k debt to family, and also I took unpaid time off right after I started working for bonding with the baby.

My plan:
I am fortunate to have family who are willing to lend me an interest-free $100k. My plan is to take that loan and $50k of my money, pay down the debt from $375k to $225k, and refinance that $225k on a 5 year plan. I looked at SoFi, CommonBond and Earnest, and the first two both gave me similar numbers of about $4.1k/month (around 4% interest).

During that time I would still have an extra $2.5 - 3k/month of income that I could use to slowly pay back my family or put together a home downpayment, or both.

My questions:
Essentially, is there a better way to do this? If I refinance, I'd save roughly $300k over the life of the loan. Is paying ~$425k over 5 years definitely better than $~725k over 22 more years?

1. Use the initial chunk of money or part of it, toward a home? 60k = 20% on a 300k home. I have excellent credit, this seems to give me about 3-3.5% interest rate for 15 years.
2. Refinance fixed vs variable rates? Are rates just likely to go up, and does it even matter over a period of 5 years?
3. What else should I be doing with my money? Should I use the additional 3k of income/month towards the 403b/457 my company offers?

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[legobikes]

Anyone? I really can't tell if, discounting the possibility of PSLF, this is a better plan than paying IBR x22 more years and putting the money I make now towards retirement and a home.

 

[TexasPhysician]

I would start by maxing out retirement plans yearly for tax purposes/deductions.

Refinancing the loan is a good idea, and then pay it off as quickly as possible. No one knows what future rates will do, but I'd go fixed.

I would hold off on big purchases until you pay down that large debt. Housing price are high again, and a 300k home raises your expenses considerably compared to your current rent.

 

[goodoldalky]

My questions:
Is paying ~$425k over 5 years definitely better than $~725k over 22 more years?

Yes.

1. Use the initial chunk of money or part of it, toward a home? 60k = 20% on a 300k home. I have excellent credit, this seems to give me about 3-3.5% interest rate for 15 years.
2. Refinance fixed vs variable rates? Are rates just likely to go up, and does it even matter over a period of 5 years?
3. What else should I be doing with my money? Should I use the additional 3k of income/month towards the 403b/457 my company offers?

It's great that you are serious about getting rid of these loans. Keep in mind Michael Corleone's famous line... family and money, oil and water... that said, if you take the loan, I completely agree with your initial plan: I would take that 100K interest free loan, the 50K you have saved up (assuming you have an emergency fund in excess of this), pay your student loans down to $225K, refinance it on a 5 year fixed plan. Keep in mind you'll have to pay that 100K back, you're still 325K in the red after you do this.

I would then take the boring old advice to really limit expenses and hammer those loans. If you can get your interest rates below 4 then you should make sure you are maxing out a backdoor roth and with regards to your 457/403 I will direct you here, and the answer is that it depends: Should You Use Your 457(b)? .

Depending on your need for owning a house, you can start to save up for that once you have your student loans at a manageable number. Your clock is probably around kindergarten age you'll need to have something locked up for school district purposes, but you have time.

It's hard to break this down too far down the road. If I were you, I'd focus on the first year for now: Pay that loan down as much as you can, and then reevaluate where you are. Then do the same thing in year two, and three...

I would not use any of the family loan for an initial downpayment for a house. You're piling more debt on more debt with money that you borrowed from someone else. A house is going to increase your expenses significantly in non-mortgage categories... insurance, maintenance, tools, all sorts of stuff.

Do this right and you'll be set up for success after a couple of lean years up front.

One caveat to this... I hate to even bring this up. Are you 5 years into IBR at a 503c/nonprofit that would qualify for PSLF?

 

[legobikes]

I would then take the boring old advice to really limit expenses and hammer those loans. If you can get your interest rates below 4 then you should make sure you are maxing out a backdoor roth and with regards to your 457/403 I will direct you here, and the answer is that it depends: Should You Use Your 457(b)? .

Thanks all of that is really helpful.

Aside from the refinanced loan repayments, I think we will be able save up at least $2.5k/month towards retirement. I need to keep reading but is there some default order of preference in regards to the backdoor IRA and the 403b? (And, depending on the specifics, +/- the 457b)?

As far as the home, it is mostly a want and not a need. We're planning on homeschooling. I suppose we can save up for a down payment near the end of the term of the refinanced loan.

One caveat to this... I hate to even bring this up. Are you 5 years into IBR at a 503c/nonprofit that would qualify for PSLF?

I am only about 2.5 years into qualifying for PSLF, although I do work for a 501(c)3. I just can't imagine it remaining for 8 more cycles when there's already word that it's on the chopping block before the first physician has even had their loans forgiven. I know the savings would be massive (to the tune of $300k+) but I don't want to live under the shadow of that probability.

 

[deleted480308]

And buy @The White Coat Investor 's book

 

[NewRPh2006]

First, I would like to commend you on a couple things. #1 Amazing job on keeping your cost of living low with a $200K income. #2 Good job on setting a reasonable house budget.

I had numbers similar to yours, so I think I can offer some helpful tips.

As a side note: I don't know too much about IBR, but find it surprising that your monthly IBR payment has been $1700/month for a $350K loan @ 7% interest. That monthly payment obviously doesn't even pay the interest ($2000+/month). Yikes! Then again, IBR is a plan that was devised by the federal government, so on second thought it doesn't really surprise me...

Your plan is not bad. It's better than what the government planned for you, which was to have you carry the debt around like a pet chihuahua for 10+ years - caressing it and feeding it interest instead of kibbles and bits. There are a couple things I would change. First, accepting a $100K family loan merely shifts the debt to a much more awkward place (to family). I suppose it depends on the culture you grew up in, but I would never take a loan of more than $50 on a 1-day term at 0% interest from a family member. I would suggest refinancing the whole $350K for a lower interest rate and keep the family out of it.

Another side note: I am confused why some docs seem to feel so strongly about the back door Roth IRA when still in debt. I have seen this recommendation in other threads. Obviously, the Roth doesn't provide any tax benefit today. The tax benefit is realized in retirement. As a doc today, your income puts you in a high income tax bracket. Unless you expect to be in an even higher income tax bracket in retirement (which is not common, but not impossible...), then it may be less beneficial than a 401(k) or the like. Don't get me wrong. I'm generally on the Roth bandwagon, but if I am in a high income tax bracket AND have $350K in student loans, there is no way I am doing a backdoor Roth until the loans are paid off.

Right now, you are considering working on 3 goals simultaneously...
#1 Pay off student loans.
#2 Buy a house.
#3 Save for retirement.

Speaking from personal experience, I can tell you that it is most rewarding to focus (intensely) on one financial goal at a time. You will see and feel results much faster. It will motivate you to keep growing and learning and building and investing. There are some broad underlying concepts you have to subscribe to first.

#1 Debt destroys wealth and represents risk. Debt is bad. You'll hear people try to shed a positive light on their debt by calling it "leverage" and "good debt." Debt only seems "good" when things are going according to plan. Ask people how "good" the debt is when everything stops going their way for a period of time. In times of adversity (which are usually completely unpredictable), you'll experience the true nature of the beast. Debt (all debt) is bad. It's basic accounting - assets and liabilities. Debt is always a liability. If you can't subscribe to hard positions like this, you'll spend your life making excuses and exceptions and focusing on one or two percentage points in every transaction. You'll be much less likely to accomplish anything significant with money (i.e. you'll be "most people"). Imagine you're in the wilderness. If you were dropped in the middle of the woods with a bear and a wolf lurking in the bushes, what would you do first? Would you pretend they weren't there and start building a hut out of sticks. Of course not. You would do everything in your power to eliminate the threats (the bear and the wolf). Only then would you start to think about building a hut. So, how do you go about killing a bear and a wolf? It's not a pleasant experience. If there was any way to avoid the situation and kick the can down the road then you would, but these predators have you in their sights and they're not going away. Same concept with the student loans. There are twenty ways you could kick the can down the road, but they'll never go away until you address them head-on. Your expenses are already low, and your plan of 5-year repayment is moderately aggressive. I would suggest maintaining your current lifestyle (low expenses) and chunking $55K of your $60K plus the whole $7K/month extra at the student loans. Keep a few grand on-hand - if a rabid raccoon tries to bite you as your fighting the bear and wolf, you'll need that stick to swat the raccoon away. All that being said, if you chunked $7K/month at the loans, I'm guessing it would still take you a bit over 4 years. For me, that is a bit too long. I would strongly consider one of the AAMC Loan Repayment/Forgiveness Programs. For instance, Delaware has one I believe that offers $100K of loan repayment for a 2-year contract.

#2 Assets produce wealth. Once you've eliminated all the risks (the debt), then you can safely start building your hut (i.e. buy a house and start investing). In fact, since the bear and the wolf are gone, now you can go all Swiss Family Robinson on your hut. Deck it out. Put a rope bridge and a stream-powered generator on that bad boy. Build a security fence. Whittle a barrel out of a tree stump and use it to store mixed nuts... be the envy of all the squirrels. Heck, invite the squirrels over for dinner sometime. Maybe you can even start a side business in the nut butter industry and employ a few squirrels. Hire a nice raccoon to work in sanitation. After you pay off those student loans, that $7K/month is monopoly money.

Regarding order of preference for retirement accounts, the best is anything that the employer-matches (usually a 401(k) or 403(b)), then I'm torn between non-matched contributions to max out the 401(k) or 403(b), a 457(b) and a backdoor Roth IRA. They all have a tax benefit. Normally, I would say backdoor Roth IRA, but for high income earners, the benefit is less obvious unless you predict being extremely wealthy in retirement - in which case I would lean in the direction of the Roth IRA. If you don't want to be limited to by the rules and investment options within the 401(k), 403(b), and 457(b), then at least contribute enough to get the full employer match (if applicable). You can always invest additional money outside of retirement accounts (e.g. real estate and index funds) and do well too.

 

[BorntobeDO?]

First, I would like to commend you on a couple things. #1 Amazing job on keeping your cost of living low with a $200K income. #2 Good job on setting a reasonable house budget.

I had numbers similar to yours, so I think I can offer some helpful tips.

As a side note: I don't know too much about IBR, but find it surprising that your monthly IBR payment has been $1700/month for a $350K loan @ 7% interest. That monthly payment obviously doesn't even pay the interest ($2000+/month). Yikes! Then again, IBR is a plan that was devised by the federal government, so on second thought it doesn't really surprise me...

Your plan is not bad. It's better than what the government planned for you, which was to have you carry the debt around like a pet chihuahua for 10+ years - caressing it and feeding it interest instead of kibbles and bits. There are a couple things I would change. First, accepting a $100K family loan merely shifts the debt to a much more awkward place (to family). I suppose it depends on the culture you grew up in, but I would never take a loan of more than $50 on a 1-day term at 0% interest from a family member. I would suggest refinancing the whole $350K for a lower interest rate and keep the family out of it.

Another side note: I am confused why some docs seem to feel so strongly about the back door Roth IRA when still in debt. I have seen this recommendation in other threads. Obviously, the Roth doesn't provide any tax benefit today. The tax benefit is realized in retirement. As a doc today, your income puts you in a high income tax bracket. Unless you expect to be in an even higher income tax bracket in retirement (which is not common, but not impossible...), then it may be less beneficial than a 401(k) or the like. Don't get me wrong. I'm generally on the Roth bandwagon, but if I am in a high income tax bracket AND have $350K in student loans, there is no way I am doing a backdoor Roth until the loans are paid off.

Right now, you are considering working on 3 goals simultaneously...
#1 Pay off student loans.
#2 Buy a house.
#3 Save for retirement.

Speaking from personal experience, I can tell you that it is most rewarding to focus (intensely) on one financial goal at a time. You will see and feel results much faster. It will motivate you to keep growing and learning and building and investing. There are some broad underlying concepts you have to subscribe to first.

#1 Debt destroys wealth and represents risk. Debt is bad. You'll hear people try to shed a positive light on their debt by calling it "leverage" and "good debt." Debt only seems "good" when things are going according to plan. Ask people how "good" the debt is when everything stops going their way for a period of time. In times of adversity (which are usually completely unpredictable), you'll experience the true nature of the beast. Debt (all debt) is bad. It's basic accounting - assets and liabilities. Debt is always a liability. If you can't subscribe to hard positions like this, you'll spend your life making excuses and exceptions and focusing on one or two percentage points in every transaction. You'll be much less likely to accomplish anything significant with money (i.e. you'll be "most people"). Imagine you're in the wilderness. If you were dropped in the middle of the woods with a bear and a wolf lurking in the bushes, what would you do first? Would you pretend they weren't there and start building a hut out of sticks. Of course not. You would do everything in your power to eliminate the threats (the bear and the wolf). Only then would you start to think about building a hut. So, how do you go about killing a bear and a wolf? It's not a pleasant experience. If there was any way to avoid the situation and kick the can down the road then you would, but these predators have you in their sights and they're not going away. Same concept with the student loans. There are twenty ways you could kick the can down the road, but they'll never go away until you address them head-on. Your expenses are already low, and your plan of 5-year repayment is moderately aggressive. I would suggest maintaining your current lifestyle (low expenses) and chunking $55K of your $60K plus the whole $7K/month extra at the student loans. Keep a few grand on-hand - if a rabid raccoon tries to bite you as your fighting the bear and wolf, you'll need that stick to swat the raccoon away. All that being said, if you chunked $7K/month at the loans, I'm guessing it would still take you a bit over 4 years. For me, that is a bit too long. I would strongly consider one of the AAMC Loan Repayment/Forgiveness Programs. For instance, Delaware has one I believe that offers $100K of loan repayment for a 2-year contract.

#2 Assets produce wealth. Once you've eliminated all the risks (the debt), then you can safely start building your hut (i.e. buy a house and start investing). In fact, since the bear and the wolf are gone, now you can go all Swiss Family Robinson on your hut. Deck it out. Put a rope bridge and a stream-powered generator on that bad boy. Build a security fence. Whittle a barrel out of a tree stump and use it to store mixed nuts... be the envy of all the squirrels. Heck, invite the squirrels over for dinner sometime. Maybe you can even start a side business in the nut butter industry and employ a few squirrels. Hire a nice raccoon to work in sanitation. After you pay off those student loans, that $7K/month is monopoly money.

Regarding order of preference for retirement accounts, the best is anything that the employer-matches (usually a 401(k) or 403(b)), then I'm torn between non-matched contributions to max out the 401(k) or 403(b), a 457(b) and a backdoor Roth IRA. They all have a tax benefit. Normally, I would say backdoor Roth IRA, but for high income earners, the benefit is less obvious unless you predict being extremely wealthy in retirement - in which case I would lean in the direction of the Roth IRA. If you don't want to be limited to by the rules and investment options within the 401(k), 403(b), and 457(b), then at least contribute enough to get the full employer match (if applicable). You can always invest additional money outside of retirement accounts (e.g. real estate and index funds) and do well too.

Love this, completely agree about the debt. Also agree about only using tax deferred accounts upto the employer match. Assuming your tax rate will be lower in the future when our national debt is only going higher is kind of a fools errand IMO. The government is going broke, taxes are not going to go down. Also nobody who was a doctor should be living like a retired teacher when they are retired (50k a year) so we will probably still be in one of the 'higher' brackets. Also I doubt they will raise the brackets even as the money becomes less valuable, so even tho 300k may only be worth 100k of todays money, they will tax it like they currently tax 300k probably, which would be a 'silent' way of raising the taxes even if they don't raise them (i.e. inflation, the tax on the poor that no one needs to approve).

Getting rid of debt first is the big one, and avoiding family loans is a big deal to me too. Nothing but trouble can come of that.

 

[NewRPh2006]

Assuming your tax rate will be lower in the future when our national debt is only going higher is kind of a fools errand IMO.

I've heard people say federal income tax rates are now about as low as they have ever been, and we should expect to see them go back up in the future. I never looked at the historical tax rates, but your comment ending up motivating me to check it out. You are absolutely right. See graphs below. I never would have known there was a time in recent history when federal income tax rates were that out of control/high (90% for highest tax bracket in the early 60s). Downright scary. I will strongly consider converting my old traditional IRA to a Roth plus add a backdoor for 2017. Seriously this changes everything. I may stop all non-matched 401(k) contributions and put the after-tax money in low-turnover index funds. Capital gains tax rate has been much less erratic.

 

[BorntobeDO?]

I've heard people say federal income tax rates are now about as low as they have ever been, and we should expect to see them go back up in the future. I never looked at the historical tax rates, but your comment ending up motivating me to check it out. You are absolutely right. See graphs below. I never would have known there was a time in recent history when federal income tax rates were that out of control/high (90% for highest tax bracket in the early 60s). Downright scary. I will strongly consider converting my old traditional IRA to a Roth plus add a backdoor for 2017. Seriously this changes everything. I may stop all non-matched 401(k) contributions and put the after-tax money in low-turnover index funds. Capital gains tax rate has been much less erratic.

Capital gains is for the 'really' rich, so it will never fool around like the income does. Wise moves your considering on your part.