Snowball or Avalanche?

Anonymous · ‎01-09-2018

I have a tentative plan on tackling my student loans (roughly $46,000) using small 0% balance transfer offers on my credit card. I usually pay $100 extra on my loans, so my plan is to make $100 payment to my CC instead of the student loan provider. The 0% offer is for 9 months, so I was thinking of just doing $700-$900 or so. While this will increase utilization on that card, I will be saving on interest. I have 11 different loans ranging from $560 - $10,500 with interest rates ranging from 4% - 6.8%. My initial thought was to pay the smallest loan mostly off (leaving $50-$100) and advance the payments. The question then becomes snowball or avalanche? The minimum payments on the smaller loans are so small (less than $10) that I don't feel like I will really make much progress. If I start tackling the larger loans I will at least be saving on interest. Strangely, my higher interest loans are the largest and smallest loans. The ones in the middle have the lowest interest rates. I am also closing on a house on Thursday, so overall installment utilization will not be making any changes and I will not see any scoring benefit from that for a very long time. Is there an individual utilization penalty like with credit cards? Or is it just overall?

Thoughts?

Anonymous · ‎01-09-2018

What's your goal here? Speed to pay off, reducing interest?

I suggest the following process to everyone and have gotten a lot of rave reviews on it:

Set aside income to total MINIMUM payment due each month
Take 10% of net income remaining and force into emergency savings to only be used for paying credit card minimums in the event of an emergency/job loss
Take remainder of net income and pay down highest interest debt first, to save interest

If you have emergency savings of less than 6 months, you're taking a huge huge risk that can't be calculated with pen and paper.

Anonymous · ‎01-09-2018

I guess my goal is both. I am currently on an IBR plan and would like to pay them off faster, but also reducing the amount of interest if possible. Given that the largest loan also is one of several with the highest (6.8%) interest rate, it seems like that would be the best place to start. If it helps, here is the breakdown of my loans:

Current Balance Interest Rate Minimum Payment

Loan #1 $1781.98 6.8% $7.94

Loan #2 $4753.57 6.8% $21.19

Loan #3 $1358.25 6.8% $6.05

Loan #4 $1358.25 6.8% $6.05

Loan #5 $7177.87 6.0% $32.46

Loan #6 $7027.52 5.6% $32.04

Loan #7 $6229.28 4.5% $29.16

Loan #8 $549.24 6.8% not showing because it is paid ahead, but roughly $4.25

Loan #9 $2716.59 6.8% $12.08

Loan #10 $2522.12 6.8% $11.21

Loan #11 $10460.53 6.8% $47.38

Current Total: $45,935.20

As you can see, tackling the smallest ones first would add less than $10 monthly. Most of them have an interest rate of 6.8%, which leads me to believe that avalanche may be the way to go. The IBR plan alone is basically covering interest and maybe $4 of principal a month amongst all 11 loans and then whatever extra I throw towards them (usually $100).

I have savings set aside that would last me quite a while (inheritance). My financial advisor recomended not paying the loans off as I have a better rate of return on the investment than I am paying in interest and I am fine with that. Whenever I take money out of the investment account I always take a little extra out and put it towards my loans anyways.

Anonymous · ‎01-09-2018

@Anonymous wrote:
.

I have savings set aside that would last me quite a while (inheritance). My financial advisor recomended not paying the loans off as I have a better rate of return on the investment than I am paying in interest and I am fine with that. Whenever I take money out of the investment account I always take a little extra out and put it towards my loans anyways.

You're a unicorn in this case -- if a person IS getting more out of investments than they pay in interest, only pay the minimum. The thing is, 99% of folks who give me that excuse in real life AREN'T invested, they just pretend they'd make more but instead spend it on $99 mega cupcakes and 23 different streaming subscriptions, lol.

If you ARE invested, and ARE returning more than your interest rate, don't pay more than the minimum unless you have a need to increase your FICO score AND your scores are hurt by high installment utilization.

For me, reducing interest is only important if it doesn't harm investment income that is greater than the interest.

I have an estate planner only because I have some oddities in my investments and incomes (foreign owned assets, trusts I created to manage some assets, etc). It's worth it for me to pay them the hefty fee in exchange for proven tax knowledge versus trying to figure it out myself. My investments over 25 years have paid out massively even though I was FICO poor for probably 19 of those years -- and this is proven that me going late and defaulting on some debts made more sense than liquidating an illiquid investment that was paying out annual dividends greater than my losses. A lot of it is guess work, of course, but the law supports a lot of odd financial decisions.

Anonymous · ‎01-09-2018

My biggest concern is that once I finish making all of the payments, the loan balance disappears, which is great but the balance ends up becoming taxable income for me. If my income increases as expected, then I will still have about $25,000 left at the end. Not something I really want, which is why I am paying more and hoping to get ahead on them. I am being dinged for installment utilization, but my scores were good enough to qualify for my mortgage, and honestly I would have to make a pretty hefty payment to even make a dent to improve my scoring for that. Oddly, adding the mortgage will actually help lower my utilization slightly since all but one of the SL is above 100% utilization due to recently (May) being out of default on them and the accrued interest becoming amoritized. The inheiritance was recent development. The much bigger factors for me are my late payments. 2012 and 2015 were bad years for me, but by 2022 my profile will look much nicer. I have definitely had to struggle, but I think I have learned my lesson thanks to hitting very close to rock bottom financially. It is only up from here!

arkane · ‎01-09-2018

@Anonymous wrote:

I have savings set aside that would last me quite a while (inheritance). My financial advisor recomended not paying the loans off as I have a better rate of return on the investment than I am paying in interest and I am fine with that. Whenever I take money out of the investment account I always take a little extra out and put it towards my loans anyways.

Well d*mn, what are you investing in that has a >6.8% RoR?

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6/8/20:

Anonymous · ‎01-09-2018

@arkane wrote:
@Anonymous wrote:

I have savings set aside that would last me quite a while (inheritance). My financial advisor recomended not paying the loans off as I have a better rate of return on the investment than I am paying in interest and I am fine with that. Whenever I take money out of the investment account I always take a little extra out and put it towards my loans anyways.
Well d*mn, what are you investing in that has a >6.8% RoR?

I have no clue! (yes, I know that is a terrible answer) It is a mixture of average and aggressive growth. I average slightly better than a 7% return, so for the higher interest rate loans it would pretty much be a wash, but the recomendation was to keep it invested. I'm young enough that if I keep it invested I could definitely retire early if I don't take too much out. I just took out a good chunk for the down payment on my house and a car, but other than that, I have no immediate plans for large purchases that I would need it for.

arkane · ‎01-09-2018

@Anonymous wrote:
@arkane wrote:
@Anonymous wrote:

I have savings set aside that would last me quite a while (inheritance). My financial advisor recomended not paying the loans off as I have a better rate of return on the investment than I am paying in interest and I am fine with that. Whenever I take money out of the investment account I always take a little extra out and put it towards my loans anyways.
Well d*mn, what are you investing in that has a >6.8% RoR?
I have no clue! (yes, I know that is a terrible answer) It is a mixture of average and aggressive growth. I average slightly better than a 7% return, so for the higher interest rate loans it would pretty much be a wash, but the recomendation was to keep it invested. I'm young enough that if I keep it invested I could definitely retire early if I don't take too much out. I just took out a good chunk for the down payment on my house and a car, but other than that, I have no immediate plans for large purchases that I would need it for.

I'm going to assume you're probably invested in a mix of securities then. So this is purely what I would do and is strictly just my own opinion. (I am also most definitely NOT a financial advisor)

I'm of the view that unless you have a guaranteed RoR (a locked in CD rate for example), it's never worth it to keep losing money to interest unless

a) the spread is very large (at least 10%) OR

b) your investment is much larger than your total outstanding debts

The idea is to have enough of a buffer against any natural fluctuations so you come out net positive over the life of your loans. In your case, if you're averaging slightly better than 7% RoR, then your real RoR is probably <0.5%. So unless you have significantly more than $46K invested, I'd just start with paying off the largest 6.8% loans and then assess from there.

Again, this is purely what I would do and is in no way a recommendation of any sorts.

Active:

Closed:

6/8/20:

Anonymous · ‎01-09-2018

@arkane wrote:
@Anonymous wrote:
@arkane wrote:
@Anonymous wrote:

I have savings set aside that would last me quite a while (inheritance). My financial advisor recomended not paying the loans off as I have a better rate of return on the investment than I am paying in interest and I am fine with that. Whenever I take money out of the investment account I always take a little extra out and put it towards my loans anyways.
Well d*mn, what are you investing in that has a >6.8% RoR?
I have no clue! (yes, I know that is a terrible answer) It is a mixture of average and aggressive growth. I average slightly better than a 7% return, so for the higher interest rate loans it would pretty much be a wash, but the recomendation was to keep it invested. I'm young enough that if I keep it invested I could definitely retire early if I don't take too much out. I just took out a good chunk for the down payment on my house and a car, but other than that, I have no immediate plans for large purchases that I would need it for.
I'm going to assume you're probably invested in a mix of securities then. So this is purely what I would do and is strictly just my own opinion. (I am also most definitely NOT a financial advisor)

I'm of the view that unless you have a guaranteed RoR (a locked in CD rate for example), it's never worth it to keep losing money to interest unless

a) the spread is very large (at least 10%) OR
b) your investment is much larger than your total outstanding debts

The idea is to have enough of a buffer against any natural fluctuations so you come out net positive over the life of your loans. In your case, if you're averaging slightly better than 7% RoR, then your real RoR is probably <0.5%. So unless you have significantly more than $46K invested, I'd just start with paying off the largest 6.8% loans and then assess from there.

Again, this is purely what I would do and is in no way a recommendation of any sorts.

It is significantly more than my student loan debt. Now if the economy corrects itself, as many are predicting, then I likely will pay off my loans and/or put a good amount towards my house and let the rest of the money ride it out.

Back to the original question though, I am definitely okay with tackling the larger loans first. Thoughts on if I should pay them off and then move to the next, or pay down significantly advancing the payments a long way out (but still make the normal payment every month) and switch to the next loan? Say 50% paid off? Is there an individual scoring penalty for utilization or is it just overall utilization? If just overall, I will need to pay a very large amount off just to get under 90% total utilization. I know this is more of a long-term strategy, but thats what credit should be, right? Also, I have asked this question before in the student loan forum, but no one knows the answer. Since newly rehabbed loans amoritize the prior interest, does that new principal amount become the number used for calculating utilization or is it the original loan amount?

Kree · ‎01-10-2018

hintzmk10 wrote:.
It is significantly more than my student loan debt. Now if the economy corrects itself, as many are predicting, then I likely will pay off my loans and/or put a good amount towards my house and let the rest of the money ride it out.

OPINION NOT LEGALLY RESPONSIBLE FOR BAD MATH

This is the opposite of what you should do. I think. If the market corrects, then you've just lost your position. Better to pay off now, before any chance of correction.. Or ride out the correction and re-examine position in a few years.

Also you mentioned having an income based repayment plan (unless I have my threads mixed up), so if most of your income is in long term investments, you will definitely get loan forgiveness after 20 years. Quick math says the tax liability on that will be far less than even modest returns on investment over time. I believe the breakeven point would be 3.4% return compared to 6.5% loan interest.

And that is at max taxation. If you happen to have a loss you can sell off at the right time, your tax liability goes down, or if you take a sebatical from work for the year, your tax liability would go down. Or both.

EDIT: Changed breakeven return to 3.4% from 3.8%.