Saturday, October 3, 2015

Personal Finance with Student Loans (Part 2): Loan Management

Student Loans may be the bane of our generation.  Expensive, endless, soul-sucking, predatory, possibly criminal.  At some point you realize you cannot save for your kids because you are still paying for you.  I have heard them described as "paying rent on my job." But for now, they exist, so instead of whining about it, let's get winning about it.

I think of student loans in a very specific way--they are bad to have.  They is little to no tax advantages for the interest, practically non-dischargeable in bankruptcy, and now they factor into mortgages thanks to the scumbag mortgage "crisis."  The rates are no longer low like they used to be, lenders buy/sell your loans and the websites generally suck.  Simply put, my goal is to get rid of them as reasonably fast as I can.  Forget that inflation suggests we will be paying with worthless dollars, the margins there are so slim (and the consequences of inflation are so great) that I'd rather not use that as my winning strategy.

So I see pre-paying loans as a very specific type of cash flow investment: Every month, a fixed amount of money leaves my account until some far away total.  By eliminating the loan, I get that cash flow "back."  As far as I know (but you should check), no student loans have pre-payment penalties.

Put differently, putting money towards student loans above the minimum is the equivalent of investing in a non-compounding investment at that interest rate. So if I pay a 5% loan early, I am effectively earning 5% money back (non-compounding) a gain on which I have to pay no taxes.

Therefore, my loan repayment strategy is effectively:

  1. Reduce interest rates however possible
  2. Organize your loans by interest rate, highest to lowest
  3. Order any investment opportunities you have by return rate, highest to lowest
  4. Decide on your "transition rate"
  5. Consult your budget for how much you "extra" you can spend this month and Go!

Step 1: Reduce Interest Rates

There are basically two ways to reduce interest rates, Autopay discount and Refinancing.  If you aren't already set up for Autopay, which usually has a 0.25% discount, do it.  If you can't afford to Autopay, go back to budgeting.  

Refinancing is a relatively new option in the world of student loans.  Basically someone decides to offer you better terms than your existing lender.  There are bunch of folks doing this so check it out.  We went with Earnest and have not been disappointed.  Best rate, most flexibility, great website, great service.  It is worth shopping around, but they are awesome thus far (about 3 months in). Refinancing for us took a chunk of loans around 7.5% and brought them down to 4.5%.  That is an insane amount of interest saved.  Put differently, for $100 more per month in monthly payment (which was a choice we made, not forced), we pay off the loan in 9.5 years instead of 25. 

Steps 2-4: "Transition" Rate

There are two basic strategies to choose which order to pay back multiple loans known as Snowball and Avalanche.  Snowball manages your emotions because you "win" faster and more frequently.  Avalanche requires more emotional discipline and saves you more money.  Avalanche is the superior strategy.

The "transition" rate is the interest rate/return rate at which you ought to invest rather than pay back loans.  This number is personal, there is no right answer.  It incorporates all of your loans, what investments you have available to you, your tolerance for risk on investments, and the fact that winnings both compound but also get taxed.  

So, line up your loans by rate, highest at the top. is REALLY good for this.

In my world we have a small loan at 5%, a big loan at 4.5% and a medium loan at 4.25%.  Based on that, and my risk tolerance, I decided that 4.5% is my transition rate.  Now my job is to pay the 5% loan down, and spend the rest of my time looking for investment options that I believe will return greater than 4.5%. If I can't find them then I just pay more in loans that month.  

Investment options, What investment options?

Everyone has investment options.  A 60 month CD right now returns 2.25% guaranteed.  If you have access to a 401K, just putting the money in tax free starts you at a return of your tax rate. Beyond that there are stocks that pay dividends, stocks that grow, bonds, private investments, etc. If you don't know anything about this, than your transition rate ought to be the annual CD or savings account interest rate.  Whatever it is, it is never 0.  

Step 5: Go!  
Once you have decided where to put whatever extra money you have, go decide on how much extra money you have. Make sure this money is extra (after regular and emergency liquidity planning) and don't look back. Once it is paid to loans, it is gone.  Once it is invested, it may or may not be gone.  


Friday, October 2, 2015

Personal Finance with Student Loans (Part 1): Budgeting

I am often asked by colleagues about how I manage my families money. Or more accurately, I love the discipline of personal finance to be measurably satisfying so I never stop talking about it. I'm the guy that entered receipts into Quicken for 10 years for what appeared to be religious reasons. So, perhaps being exhausted with my line of conversation, (rarely) interested people break down and ask me about it.

First if you need a good framework on what to do with what money you have, Start Here.  

If you notice, Step 0 is Budgeting & Planning.  
Fundamentally, you have to spend less than you earn.  In order to do that you have to first clearly understand how much you spend an how much you earn.  Planning/Budgeting helps you do that with precision (and accuracy).

Think of "Planning" as the words part of the plan: I want a house, I want to pay student loans with interest rates greater than 4%, I want a new gaming computer.  Think of Budgeting as the "Numbers" part of the plan:  I will spend $300 per month towards student loans beyond the minimum.  They are both fluid and mutually reinforcing, and can take your goals and make them real.

For budgeting, I HIGHLY recommend YNAB. When I got it, I hated it. I thought it was broken, terrible software.  Turns out that my budgeting practices were terrible and broken, the software was phenomenal.  So now I recommend it to everyone.  I awkwardly talk about it at dinner parties. I teach my colleagues when they ask. 

Why is it so great?
First, since YNABing for about 18 months, I now have a laser-like view into our money, and know exactly how much we can afford to spend where.  Pre-YNAB we would let money accumulate in an account and spend it on extra student loans.  Then we would forget about Disability Insurance, or Taxes. Uggh.  

Second, my wife delegated finances to me long ago.  We used to fight about her giving me receipts to enter into Quicken.  After hours of painful work, I still had no clue where we were financially.  Now she can enter expenses on a slick mobile app (or leave them on my desk) and I can show her, at any moment, exactly where we stand financially.  The amount of transparency has made conversations about money painless instead of painful. 

How long does this take?
Months 1-2 are hard.  You don't have enough money, you want too many things, You forget categories, etc.  By month 3, you can spend probably 1 hour a month on your budget and be good to go.  And remember. Earning more money NEVER solves overspending, only a budget does. 

Once you have budgeted, let's talk about Loan management...