Good, Bad, Cheap, and Expensive Debt
I mentioned I was going to tell you about the different kinds of debt and examine how it could help. This also ties in with the Snowballing versus Avalanching, too.
I am looking at:
Good Debt vs. Bad Debt
or is it
Cheap Debt vs. Expensive Debt
The derived insight comes from Adrian’s site How to Make 7 Million in 7 Years, (here). I thought this was a Very Good Read (especially like the pic) about Good & Bad Debt versus Cheap & Expensive Debt and how ridding of debt to invest the money later can lead to a long road nowhere. Interesting, hmmmmm…. (isn’t this where all of us PFers are going?)
Now, read the post and reread the post. It took me a couple times to completely follow. But, I will tell you that I am really glad I did. Why? Well, because it could end up saving me $35,328!
For me to truly understand the post I had to run the numbers. I used Adrian’s senerio, but instead of the student loan costing $25 a month… I used a realistic amount of $99 month or 30 year payback term on a $25,000 student loan @ 2.5%.
Fictional Senerio:
You have $25,000 Student Loan @ 2.5%: $99 per month
You just finished paying off a car: $150 month
You want to invest in a piece of property
Question:
Now that the car payment is free, do you Snowball that payment on to your really low interest rate student loan? Or do you save up that $150 for a down payment of $20,000 on an investment property first?
So I ran the figures (see below). All the hard work has been done for you. Why? Because I love you. lol! 🙂
Cuz I’m a nerd. And I needed answers. And I love to share the knowledge!
The Numbers:
If I buy the House ($20,000 saved down payment & $80,000 loan @ 6.5%):
(Time it will take to pay + the interest paid using that method)
30 years = $99,848 interest paid
16 years + $150 car payment = $51,010 interest paid
13.2 years + 150 car payment + 99 student loan payment = $38,397 interest paidIf I just continue to pay off my Student Loan ($25,000 @ 2.5%):
(Time it will take to pay + the interest paid using that method)
30 years @ $99 norm payment: $10,422 interest paid
9.4 years + 150 car payment = $2,997 interest paid
Considerations:
It would take 8.3 years to save $20,000 for a down payment after paying my student loan. Do I want to wait (8.3 + 9.4) 17.7 years to buy an investment property?
Or…
Wait 11 years to save up $20,000 down payment @ $150(car payment) and gain a myraid of benefits from owning investment property. Did you know you could write of travel expenses for an investment property? What about property in… say… Mexico? or Belize? Hmmm…think I might be onto something)
Now, if you don’t plan on buying property than this won’t apply to you. But, I plan on rolling in the dough… okay, maybe just live comfortably. 🙂
I have every intention of buying a rental property. And now it maybe bought even further away than thought (love the sound of writing off travel expenses – lol!)
The Numerical Results:
Snowballing with Dave Ramsey:
::My student loan: pay: $2,997.00 (saving $7,425) interest
::My House: pay $99,848 in interest when I buy the propertyTotal pay: $96,851
Cheap Debt/Expensive Debt:
::My Student Loan: pay $10,422 interest (save: $26 on my student loan)(assuming I snowball the student loan when the house is PIF)
::My house: pay $51,101 interest (saving $56,634)Total pay: $61,523
Verdict:
Total saving cheap debt/expensive debt: $35,328
It’s not too hard to see where I’ll be going?
What about you?
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it’s been a very long day and although it’s 5:15 pm EST, i’m only 1/2 way through the day. now that you have my caveat, i’m having a hard time following the calculation. i’ll read it again when i’m refreshed, i’m sure it’s pretty straight forward.
I think I am lost too — so are you saying that you will pif your mortgage before all other debts?
Hi there-a very fascinating concept indeed, it really does sounds very exciting too! Thanks so much for your well wishes and support my dear, its been much appreciated and I wish you well with your financial goals for the future, take care.
I think many experts will also advise against paying off student loans at relative cheap APR, if it means not saving or accomplishing other important financial goals. But for me, paying off my SL is extremely important, especially my variable interest private loans. Additionally, since I expect to be single all my life, I only have myself to rely upon. I don’t want to juggle multiple debts. I’ll pay off my SLs before I take the real estate plunge regardless of the interest picture.
@ MMC: It does seem a little complex, but once you get it… well, I think it is kind of neat. Glad to have you back. 🙂
@jpkittie: its looking at how the Dave Ramsey’s snowball method can actually costs you more in the long run if you plan on buying a house.
It shows how buying a house before you pay off the student loan (or a low interest loan) can save you lots of money.
@ sharon rose: you will be missed. I am glad that you found a financial track that you can prosper from. That is what we are here for.
@ shtinkykat: I like your comments for their contrasting views. 😉
Ya, variable I could understand. I know one of my friend’s loan has a rather high SL APR. And this would not suffice for her either.
So, not to juggle multiple debts… will we ever be completely debt free? I think there is always bound to be bills. Its just the kind of bills we choose to pay.
I got it!!!! Ding Ding Ding – it clicked 😉 haha
That’s the one point of the DR method that I don’t agree with. For example, no matter how many times he tries to explain the benefits of paying off all debts and renting while you do this never made much sense to me. Then again, I’m still new to PF and all this, so take my opinion with a grain of salt.
If you can get a mortgage and pay $1500 month towards it, what’s the difference between having some/most of that payment go towards interest vs. the entire payment going towards someone else for rent? Rent around here in the crappy areas will run over $1000, while our mortgage on a 15-yr loan is about $1300/month.
What about tax costs and maintenance costs on the real estate? You have to add that to your calculations. And where in the heck can I find 2.5% student loans? This is kinda bogus to me. My loans range from 4% to 6%. Help me out please.
@ Paideia Math:
If I were to buy property it would be with the assumption that taxes are included in the monthly mortgage already. So, I don’t get slammed with a big ole’ bill at the end of the year.
Maintenance, is a different story. i would need to save at least 10% of my pay annually to keep up with maintenance.
But, any which way… if those were the circumstances… it would still be better to buy the property before paying off my student loan.
I do have a 3.25% student loan locked in. This was from some years ago when the government made things nice. Things have definitely changed.