Michael Taylor — It’s Complicated
This month, Make Change welcomes Michael Taylor of Banker’s Anonymous to give his take on a common budgeting question for people with student loans. A version of this question appeared on the Banker’s Anonymous website.
Dear It’s Complicated:
After graduating from college and spending one year in the IT consulting world, making $70,000 and being stressed to the detriment of my health, I jumped ship (per the advice of my employer; they noticed I wasn’t sleeping). I left on good terms and with a fair severance package. I’m re-evaluating my life, and at this point, I like the idea of taking however much time is necessary to ensure that misery is not a part of my daily routine at my next gig.
I also have about $30,000 in student loans with interest rates ranging from 3.4 to 5 percent. My monthly expenses run between $1,000 to $1,500 and I have around $15,000 in savings (not including an emergency fund that covers about two to three months of expenses), and a health savings account.
What advice do you have for planning my budget? I want to use all of that $15,000 in savings towards paying off my student loans in order to remove as much principal as possible and lower my interest payments.
Any and all advice would be appreciated, thank you!
Congrats on building that cash cushion.
That’s admirable and rare for anyone one year out of college. It sounds like unemployment is not as scary to you as being stressed out—so the cash cushion allows you to take some time to figure out the next step, which is really great.
You mention three financial factors you’re trying to optimize, and there are a few more unmentioned financial factors that I think you should include in the decision-making mix.
Your mentioned factors:
Cash burn of $1,500 cost/month (unemployment)
$30,000 in student loans
$15,000 in savings (excluding emergency reserves)
Your unmentioned factors:
Maxing out your individual IRA contribution as a person in your early 20s.
Finding work that covers your lifestyle costs and doesn’t leave you stressed out and unhealthy.
In the next year, solving the cash burn issue is your most important financial decision. You’ve got 10 months (that’s $15,000 divided by $1,500 per month) to solve that one before you run out of savings. Ideally, you would focus on unmentioned factor 2—getting work that pays and keeps you healthy. Until you do, I wouldn’t get aggressive about paying down your student loans.
Why do I say that?
It’s very admirable to want to pay down your student loan debts with your savings, but in this situation, I wouldn’t advocate it. If you decide to use your $15,000 cushion to pay down student loan debt, you shorten the time you have to find good, healthy work, which could leave you scrambling, taking another job that doesn’t suit you and leaves you stressed out.
In addition, your student loan debt is low-interest debt that you can pay off over time without racking up tons of interest charges, meaning it is compatible with good long-term financial decisions. (If you told me you had $30,000 in high-interest credit card debt, or any amount of credit card debt for that matter, I’d be strongly advocating that your first priority be paying that down as quickly as possible.)
There’s another—in my opinion better—use for your savings to maximize your current assets. You didn’t mention contributing toward your $5,500 yearly limit in an individual IRA. (Undoubtedly you can do the math showing your $5,500 becoming $101,311 50 years from now at a reasonable 6 percent compound growth rate. Right? Please tell me yes.) Combine that with the 25 percent income tax relief you’d get making a $5,500 contribution this year, given your previous salary (so, you keep up to $1,375, not the federal government), and I think a strong case could be made for prioritizing your IRA contribution over student loan principal repayment.
Are you cautious or aggressive?
Obviously, you have to stay current on your student loans, but my advice is to pay the minimum—at least until you figure out your employment situation.
An implied part of my calculation here is that, given your education and past earning power, you’re capable of getting a high-paying job in the next year. The trickier part is finding a high-paying job that also supports your health and sanity.
I’d suggest one of these two options:
The cautious approach – Hoard your cash long enough to get a good job, pay the minimum on your student loans, but don’t pay down principal on that debt until you’ve figured out how much your new job pays.
The more aggressive wealth-building approach – Contribute generously to your Individual IRA (up to $5,500) and keep the rest in cash. That leaves you more like six months to solve the cash burn problem (aka unemployment), but hopefully that’s enough time for an educated job applicant whose prudent, informed approach to finances bodes well for their dependability and capability as an employee (aka you).
Best of luck!