Third Time is a Charm

 Indeed, the third time is the charm!  Twice before I’ve been the recipient of misdirected questions.  Visitors looking for Ramsey were stuck with Ozment.

But today, the training wheels come off.  I get my very own question to engage.  Granted, my first inclination was that I had been misidentified again, but validation rang through.  Indeed, the question was mine.  I trust I fared well in the endeavor.

OK enough lead in, now on to the good part – sharing information and helping folks.

Below is the email I collected followed by my response and a subsequent exchange of question and answer.  Give it a read and let me know what you think.  I believe there may be elements here that are applicable to your situation.

 

Hello  

I have a question about the order of the baby steps that I was hoping you can answer.  

 – We currently have a car loan, first and second mortgage.

 – We also are paying for 1 more year of college for our daughter from cash flow and college savings.

 – We committed to her that we would pay for school, including a student loan of about $ 20,000.  

Should we consider the student loan as part of baby step 2 or should we go on to baby step 3 after the auto loan is paid off?  

Thanks…   

 

 My Response

 Hey…, thanks for your email.     

First off, I want to reconfirm that I am not Dave Ramsey.  Of course you probably read the many disclaimers on my site so you know that.  However, I am a huge fan of Dave’s… thus the naming of my site.  

To contact Dave Ramsey, here’s the email he always gives out on his radio show – DaveOnAir@DaveRamsey.com  

Now, to answer your question…. the key piece of information Ramsey always asks in these situations is your household income.  I believe he would also seek clarification on the student loan if you’re actually cash flowing college. 

Those are clarifications I would need to discuss a specific course of action for you.   However, in broad terms, the answer to this type of question is generally that you pay off student loans as part of BS 2. 

Exceptions might be a real low income (in which case you should probably sell the car and rethink paying for college) or a super high student loan debt (like medical school).   Another angle to consider the cost of this final year of college, the amount you’re able to cash flow each month, and the amount you have remaining in your college savings.  

IF (I’m using extremes here to paint a picture) you have 25k in savings and can cash flow 3k per month and the remaining college costs are 10k… then I’d look at paying off the student loan now and paying the last year with the remaining 5k and cash flow.  

On the other hand… (or extreme)…   IF you have $500 left in savings and can cash flow only 1k per month and the final year costs 20k…. then you might want to consider taking a year off from school because you simply can’t afford it without acquiring new debt.  

Like I said, those are extremes so you’ll need to sketch in your details and plot accordingly.  I (Dave Ozment) will be happy to serve as a sounding board if you’re so interested.  Just drop me another note.  

In your position, another thing I’d revisit as I run and plan the numbers is that this is indeed the final year of school.  You don’t want your generosity to be twisted into support for a career student.  I doubt that is the case here but it’s at least worth a mention.  

Thanks again for your email and good luck!

 At this point, I expected the story to end.  I still suspected that I had been misidentified and I expected little less than a polite acknowledgement of the misdirected email.  Expectations earned in my experience to date.

However, the follow-up I did receive was a pleasant surprise.  Hey, I do have an audience out there.  That is encouraging to me personally as I sometimes wonder  to where my words go… if anywhere.

But enough self actualization and on with the exchange!

Mr. Ozment:

I appreciate you taking the time to answer me.

Yes, I knew that you are not Dave Ramsey, but I love reading your emails and blog.

 The college costs for each semester is 17K.  We applied for and received a deferred loan for 2700 each of the 8 semesters.  It does not have to be paid until 6 months after she graduates in May 2010.  The rest is being paid through cash flow and college savings.   The car loan has a balance of 5400 and we can pay that off with in 5 months.

My question was really aimed at the student loan which accrues no interest until November 2010.  Should I go on to step 3 after the car loan, and wait to pay off the student loan in full with savings in November 2010?

 I hope that you do not mind my questions.

 Thanks…

My Response

Hey, no worries on the questions…. I’m glad that you were actually asking ME.

 Well, it sure sounds like you have a high income.  Congrats to you!  You’re cash flowing ~14k per semester and attacking a car loan at an 1100/month clip.  Given a 4 month semester, I’m… thumb in the air…. thinking 4600/month is deployed in these pursuits above your normal household expenses.  Again, good for you.

 I suppose a question is the November 2010 timeline and your ability to pay the loan in full at that time.  I assume that will be the result of accrued savings between now and then, rather than money currently available as college savings (separate from retirement and emergency savings)?

 You know, here’s what I’d do based on my understanding of these numbers… and making some rough assumptions with timelines.  Starting in January you’ll be without a car note.  That should free up 1100 per month.  I’d toss 1k at the student loan each month and then treat my wife to a nice date night each month (in the paid for car) with the extra 100.  Then come June, once school is done I’d toss the ~3500/month tuition cash flow at the loan.

 Jan-May is 5 months so 5k is paid against the 20k and with a full 4500 going that way starting in June you’ll have it knocked out in mid September next year.

 I’m being a little frivolous with this – the $100 date nights aren’t exactly frugal.  But you appear to already be in a great place so my messaging really is to not delay the student loan payoff just for the sake of 0% because the small amount of arbitrage you would gain by banking the money is inconsequential to your life.  You’ll simply sleep better knowing you – and your daughter – are forever free of student loans.

 I hope this helps.  Let me know if I’m off the mark with my math or interpretations and I’ll modify accordingly.

 Thanks!

 So there you have it, my first solo flight around the ole personal finance world.  How do you think I fared? How would you have responded if a friend approached you with a similar question?

As a postscript to the emails – and lagniappe to the reader who has just finished re-reading his own mail – I want to share my opinion on a reasonable pushback to my advice.

If you have a 0% debt and an interest bearing savings account then why not accrue the payments, earn some interest and pay off the debt in full prior to the loan actually coming due?

Mathematically, I 100% agree with that approach.  A couple 100 bucks might be earned with zero interest paid out – arbitrage at its finest.

However, I subscribe to the idea that personal finance is about more than just math.  It’s personal, and as such, is given to the whims of the moment.  If you’ve accumulated 20k in an account, it is easy to become distracted by all the possibilities that money represents.  That is especially true when you consider – read,  rationalize – that a student loan represents a small payment and the interest is tax deductible.  Then, before you know it… 5, 10 years later that student loan is still hanging out and the 20k is long gone.  I’m not suggesting that would be the case with this particular emailer, but as a rule, this outcome is pretty typical.

Using the same concept – personal finance – going the other way, watching your debt erode with each passing month is a satisfying experience.  Waking up free of all non-mortgage debt is (I will soon know) an exciting possibility.  With no claims to your wallet and mind, you are free to be free and fortified with the knowledge that you know how to say “no” to yourself in the now for the betterment of your future.

Your Turn – If you enjoyed this article, I would personally appreciate it if you would consider commenting below and/or subscribing to our Free Updates via email or RSS updates.  Thanks!

Category: Naming Conventions, Personal Finance, Recommendations

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