Student Loan Update – April 2017

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When I graduated in May of 2017, I chose not to think about my student loans. It was a hot humid day but people traveled from different states to come see me complete another milestone. I was juggling full time work and a part time MBA program right when my husband was settling into a new job. I had a lot to be thankful for and a number of people were proud of me. The Department of Education was going to grant me 10 years starting in December 2015 to agonize over student loans but I was never going to get another graduation day.

I picked up my diploma after the ceremony and I sat in the front seat of my husband’s car running my fingers on it back and forth as my parents sat in the back. I was pretty impressed with myself. Not in a gloating kind of way but more so in a “I actually did it…” Almost as if I couldn’t believe it.

The next day, things went back to normal and I decided that the honeymoon period with the diploma was over. Real world responsibilities required me to know what my balance was and what my monthly payments were projected to be. It was nothing that I could not afford but it was painful. Over $350 a month a and $40k+ balance. I could get a whole new car with that! I devised an aggressive pay down plan as follows:

  1. Start paying immediately rather than waiting for the grace period
  2. Apply all raises to the monthly payment and all bonuses to the balance
  3. Apply all tax refunds if any to the balance

3 simple steps. The toughest part was the discipline of not eating out as much as we would have liked and not splurging at the mall. However, 23 months later, that plan has worked so well that I am dancing for joy.

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In case you are having trouble reading the small font, this says:

Current balance $11,641.17 & Due date 7/18/2020

While there are no guarantees, these numbers indicate that I am likely on track to finish paying the debt off by the end of the year if all goes as planned. That will be 8 years ahead of schedule. This is more than I could ever hope to achieve. When I said I was determined to pay and save myself an astronomical amount of money in interest, I was not joking.

I am grateful for the discipline I have that allows me to focus on long term independence goals rather than instant gratification. I’m also thankful that I have a supportive husband who understands my goals and can see my vision for our family. Some people would have valued the high life over a debt free life and it could have been a source of friction. Instead, he trusts my judgement and is happy delaying a little bit of gratification in favor of peace of mind.

Dear DOE, thank you but no thank you. I will decline your offer to take a 3-year hiatus from my obligation. You’re going to collect these payments and you’re going to like it. But better yet, you will set me free.

 

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Debt vs. Savings: What to Prioritize

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Two of the building blocks of personal finance are saving money and paying off debt. Everything flows from these two principles. You can’t invest, start a business or retire if you are not saving and/or you are crippled by a mountain of debt. In an ideal world, we’d be maxing out our 401k and crushing our debt, getting ever closer to eliminating them every month. Alas, we live in the real world with tons of responsibility and a finite amount of money to work with. So how do we prioritize?

While the exact answer might vary from person to person depending on their respective situation, the steps we use to reach the appropriate conclusion are the same. To make it easier, I will eliminate the variables in a hypothetical situation by using myself as an example.

Currently, I have 3 savings account: one is a CD where I get the best return I’m going to get in this interest environment. It pays me 1.25%. The other one is a money market account that pays 0.05%. It’s not as lucrative as the CD but my money is accessible with few penalties. However, money markets have an important restriction. While you can deposit money any time you want, they cap how many times per month you can withdraw before you incur a fee. It’s a fantastic tool that forces you to keep your hand out of the honeypot. But life happens and we sometimes need to access money more often than we want to. That’s where my regular savings account comes in. Hold on to your hat folks, this return might blow you away: 0.01%. I’ll try not to spend it all in one place. If you’re wondering what this has to do with anything, be patient…

The debt that is currently the biggest thorn in my side is my student loan debt. As much as I would love to keep fattening up my savings, the interest rate on that debt is 5.16%. That means, for every hundred dollar I chose to add to my savings (let’s assume we’re talking about the CD since it offers the best rate) over paying off my student loans, I am getting a return of 1.25% that is costing me 5.16%. That puts me in a whole of close to 4% annually on that $100. Of course, student loan interest is tax deductible if you itemize (which I do), but you don’t get all of it back. The IRS caps it at $2,500 gradually decreasing it as your income goes up until it disappears. So we’re talking a saving of 1% to maybe 2%, and I’m being generous, which will then net you a negative return of almost 2% and we aren’t adjusting for inflation.

So what do I prioritize?

  1. Having an emergency fund: This buys you peace of mind and keeps you from falling into debt when tragedy strikes. How much you need depends on your particular situation. But I recommend a minimum of 6 months.
  2. Saving for retirement: The most important part of saving and investing for retirement is time. The longer you save, the more time that compound interest has to work in your favor. Also, the more time you have to recover from dips in the market.
  3. Paying off high interest debt: My student loan debt at over 5% is in stark contrast with this loan I took out for an energy efficient central AC which is a 0% loan. I am in no rush to pay that off. If they want to extend it 10 more years, I’ll take it! However, I am very aggressive with my student loan debt where I send every extra unexpected funds to Nelnet. Whether it’s a raise, a bonus or a tax return check, it goes towards my student loans. I have paid off over $23,000 in the past 18 months and I have no plans of slowing down until it’s gone.

While your situation might be different, for me, this is the least expensive and most sensible order in which I can allocate my funds. If I do anything else, I am not maximizing all of my dollars. Have you taken the time to consider if your debt repayment plan and your savings strategy are optimized?

Applying for a Mortgage: The 5 Cs

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I talk a lot about real estate, but we all know real estate is expensive. There are few, if any, of us with the capabilities of buying real property with cash. Even some of the people who are in a position to do it, choose to leverage their net worth and maximize their purchasing power using borrowings. In a consumer-driven society, lending is king and that is why something as minor as a 25 basis point shift in interest rates is a news headline and a stock market mover. We hear about rates, banks and borrowers. Everyone talks about how you have to have a good credit score and some type of down payment. However the discussion usually does not expand beyond these points.

I have put a little guide together that might give you a better understanding of why they request the documents they do. But most importantly, it helps you prepare your finances so you present yourself as the type of borrower they wish to lend to.

Credit: The first thing the lender will do is look at your credit history to determine if you are “credit worthy”. In the simplest of terms, they will look at your credit score and history. These 2 things will tell them whether or not you pay your bills on time, every time. This will help them decide if they even want to move forward without or if the risk is too great that you will turn out to be a problem borrower and will default, leaving them holding the bag.

Capacity: This evaluates your ability to take on any additional debt and pay on time. This is what they mean by “debt-to-income ratio”. You may be very good at paying all your bills, but if you are breaking even every month, you are likely not able to continue meeting all your financial obligations should you take on more debt.

Collateral: Also known as “protection”, collateral is something that you own but a lender puts a claim on it, as a way of protecting their investment. The law allows them to take possession of that asset to offset any loss from you not paying your debt. In real estate, the asset used as collateral is the very property you’re buying. In rare cases where the loan is more than what the purchased property is worth, you can use another property as a second piece of collateral.

Capital: That is usually liquid assets that you may have. Primarily they want to see that you have the ability to give a down payment or at the very least pay your closing costs. If the purpose is to get an investment property, they want to see a few months worth of reserves should you have vacancies. It’s also a way to evaluate whether or not you have other sources to tap and make payments if you were to ever lose your job.

Condition: This is the purpose of the loan. Some loans are higher risk than others depending on their purpose. Not all real estate loans are created equal. A loan for a residential building will have a better interest rate than a loan for a strip mall because of the risk involved. A used car loan will also be more expensive than a new car loan. Whether it’s an equity line or a purchase or refinance will also matter.

I hope this will give you a better understanding and some of the information you need to prepare for a successful mortgage application.

“Use this one simple trick, banks HATE it!”

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I can’t be the only person who has seen those ads around the Internet. Usually they’re referring to mortgages and as a result, they’re one of the most successful click-baits. Why? Because whether you own or rent, housing is usually your biggest expense. And if you made the mistake of buying too late in life, you might be one of those people who is worried about retiring or even dying with mortgage debt. This means that articles or services promising to teach you about how you can eliminate that debt as quickly as possible will get your attention.  Unfortunately, many of these people are also trying to sell you something. Well, I’m not, and today, I decided that I was going to make sure you never have to click on those links again, by telling you these “simple tricks banks HATE!”

Before I start, let me highlight the importance of eliminating mortgage debt.

  • Housing is not just a huge expense, it’s also a necessity. You’ll always need a place to live, and given the way rent and housing prices are, if you can have a roof over your head for only the cost something as relatively marginal as property taxes, you are doing better than most.
  • You’re less likely to lose your house if your debt is paid off. Think about how many people lose their houses to banks because they couldn’t afford the mortgage, versus house many people lose their house to a tax lien.
  • It’s one of the few things you can guarantee will pass on to your heirs. The building might fall apart, but barring an environmental crisis in your immediate area, the land will always be there. If you can help it, don’t pass on debt.
  • Depending on houshing type, location and maintenance costs, it could become a good source of income. (More later on how I became an accidental landlord.)

The “tricks”

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With these reasons in mind, the point is to pay off your mortgage as quickly as you can. The following methods will help you achieve that goal. Some of these rely on good habits and discipline. Others rely on a windfall and some rely on your type of financing. You may even do a combination of them to see which one suits you best.

  1. Your terms are key. Do you have a 30-year mortgage or a 15-year mortgage? What’s your interest rate? If you have a 30-year mortgage, you will be in debt for twice as long and you will pay more in interest. You’ll also have a much lower monthly payment. What about your rate and down payment? If you have great credit (740+), steady employment and a low debt to income ratio, you’re almost guaranteed the best available rate. This means you’re paying as little as possible on your debt and may be able to own for as much or even less as you would rent (depending on your local housing market.) And of course, the more you put down, the less you have to borrow. So the key to borrowing cheaply for a shorter period, really starts before you get a loan. It’s about cleaning up your credit, saving as much as possible and choosing the mortgage that is right for you.
  2. But what if you already bought a house? Fret not. You can always refinance. Those who bought back in 2005-2006, were borrowing money at ridiculously high rates. Although I didn’t have any money to buy a house at that time, in 2007, I had a CD that was paying me 5%. If you know anything about banking, you can try to guess how much mortgages were. If not, you can look up historical mortgage rates and get confirmation right here. So what would a smart person have done in 2012 if they bought a house in 2006? Assuming they kept their credit clean and continued to qualify for great rates, they would have refinanced their mortgage to a 15-year mortgage at 2.5% and NOT TAKEN ANY EQUITY OUT. What would that achieve? It would have not only sliced their rate in half, but also their term. This would have probably kept their mortgage payment close to the same but they would be out of debt in before 2030, instead of after 2036. If you think about how much you pay towards your mortgage (or rent) every month I want you to multiply that by 72. This is all the extra money they could save, reinvest or use toward something else over the course of 6 years.
  3. At the same time, some people just wanted a break. Many of us really over extended ourselves when we bought homes before the bubble. This means we wanted relief from our high payments, not to keep them the same. Good news! You can also refinance to another 30-year mortgage. You do the same thing above: apply for a new rate, don’t borrow against your equity but keep your 30-year. You don’t get a 2.5% rate, but you might have been able to get 3.5%. Anyone looking at houses now might find it hard to believe, but these rates were definitely available as recently as 2012. I got my house in 2013 and I have 3.75% fixed. But ultimately, going from 5-6% to less than 4%  reduces your monthly payment amount. The biggest benefit is that you can continue to pay the difference towar your principal balance IF you can afford it. But if a bi expense comes up and you need that money for something else, you can reallocate your finds accordingly. You are not bound to the bank to make the higher monthly payments on their schedule.
  4. But what if you already have a great rate and refinancing makes no sense? Well I have a “one simple trick” for your situation too. Before I go into it, let’s remember this basic principle of time: 12 months and 52 weeks in a year. Say your mortgage is $1,000 a month. You can pay $1,000 a month so $12,000 a year ($1,000 x 12 = $12,000). Or you can pay $500 every 2 weeks, so $13,000 a year (52/2 = 26 payments, $500 x 26 = $13,000). It’s like magic! So it’s like making one whole extra payment a year. You can also achieve this same result by making your payments as scheduled, but for the last payment of the year, making an extra payment and applying it to your principal. You can also take the extra payment and divide by 12, and add that number to your principal every month. (In our example this would be $1,000/12 = $84, monthly payment = 1,000 + 84 = $1,084). This can and should shave years off your mortgage. Will it be 6-7 years? Probably not. But if you can save 2-3 years or even 1, that’s 12-36 payments you don’t have to make. That’s money you don’t have to pay interest on. That’s 1-3 years of worry free living.
  5. What if you can afford extra payments on a regular basis? Take advantage of windfalls. This doesn’t require any math or the same discipline as making extra payments, and it doesn’t even rely on you having good credit. The point is to take any and all unexpected monies and put it towards your house.  Gifts, inheritance, bonus, lotto winnings, tax returns, that $100 bill you found in the parking lot of the grocery store, etc. As long as you weren’t relying on it as s regular source of income, if it comes in, pay your debt.

Here you have it: my 5 “one simple trick” to pay off your mortgage faster. But remember, you must assess your own situation individually. If you get a condo, they may not have association dues or they may not include your homeowner’s insurance. Not everything works for everyone. So don’t come back here trying to sue me if you didn’t like your results lol. I am a big fan of the banking calculators. You can them on bankrate, zillow, etc. While they’re great at giving you a snapshot of your mortgage, be careful, because they don’t always included all your housing costs. You can even use them to test some of my theories.