Pay off Debt with Savings?

I know that everyone says you shouldn't time the market.  BUT- it's been pretty much flat for most of 2018, and after the big gains of the past 7-8 years, it definitely feels like the bull market party may be closer to it's end than to its beginning.

From a long term perspective, I'm prepared to ride it out.  I'm 41, have a good chunk saved for retirement (about 90% in stocks right now) and saving about 20% of my yearly income for retirement.  

But, we have both some short-term money saved, as well as some medium-term debt.  Luckily, no credit card debt.

Here's the breakdown:

Short term savings: 40,000, mostly invested in the market.

Home Equity loans: 23,000 (monthly payment 300) and 6,000 (monthly payment 100), both at 4.5% interest.  

Student loans: 15,000 (monthly payment 150) and 8000 (monthly payment 75), both at 5.5% interest

Mortgage is still 20+ years from being paid off.  

The question is... should I pay off one or more of the above loans with the stock market money and start saving that monthly payment? 

We do itemize, but It gets a little tricky, with the new standard deduction going up next year.  Student loan interest is still deductible regardless, but we may not be able to take the HELOC interest deduction if we don't meet the standard deduction limit.  Our AGI gets us into the 22% tax bracket for 2018, so while our effective tax rate is much lower, any additional income (or reduced deductions) basically gets taxed or deducted at 22%.  

What is the short term savings actually making? If its not higher than the debt is costing, pay off the debt.

Not the worst idea, as it isn't in your retirement accounts. The 4.5% I'd leave. The 5.5% is getting damn close to that uncomfortable range where I can probably do better in the market, but on the short to medium term is going to be iffy. 

If it was me, with the information that I have right in front of me, I'd probably pay off the $15k student loan and leave the others be--but that depends on what other assets, liquid or non-liquid, that you have at your disposal as you do want to keep some powder dry.

If it was me, I would be very tempted to dispatch those 5.5% student loans and keep the $17k balance of the savings to cover miscellaneous taxes etc from divesting, and as reserves.  Then use the $225 payment from the student loans to pay down the home equity loans early.

In reply to mtn :

So the tax stuff iis where it gets interesting.  Student loans are an "above the line" deduction, which means that the tax changes that increased the standard minimum deduction don't affect it. It's still deductible (as long as you're below the income limits, and we are).  So the 5.5% interest on 23k of student loans is about $1300 of interest per year, which reduces our AGI by that much which saves about $300 in taxes.  So the effective interest is about 1000 per year, which means the effective rate is about 4.4%

The HELOC interest is tax deductible (and still will be; HELOC interest under the new rules is deductible if the HELOC is used for home improvements, which our was) BUT it's an after-the-minimum-deduction deduction.  And since the standard minimum deduction doubled for 2018, we may or may not be itemizing that.  So it could just be 4.5% interest cost, which on 28k of HELOC loans is about $1250 per year of interest.  

In reply to D2W :

THe 40k in short term savings did make ~15% last year, but my concern is about what it's doing now (basically, 0% since February) and what it might do in the future given the current protracted bull market.

Also agreed on the dry powder.  I do plan on selling a car or two shortly (getting rid of some projects I have no time for) and still have 25k of available credit on the 4.5% rate HELOC.  We keep our credit cards current and incur no interest on them.  

I may purchase a new car at some point soon, which would likely be financed.  Our credit union does 2.5% financing, so that's very cheap debt.  And it would save some on gas every month.  

Well, I guess I'd be looking at it like this ultimately: 

You have two choices. Either we're due for a market correction, and you should jump out to get the guaranteed 4.4% to 5.5% return on your investment by paying off the debt, or we're not due for the correction, and you should stay the course. 

I can't tell you what I'd do right now, as I definitely feel that we're in for a correction, but I also know that the analysts have correctly predicted 63 of the last 14 corrections. 

If I was in your situation, I'd pay off the student loans.  I hate debt.

mtn said:

Well, I guess I'd be looking at it like this ultimately: 

You have two choices. Either we're due for a market correction, and you should jump out to get the guaranteed 4.4% to 5.5% return on your investment by paying off the debt, or we're not due for the correction, and you should stay the course. 

 

I can't tell you what I'd do right now, as I definitely feel that we're in for a correction, but I also know that the analysts have correctly predicted 63 of the last 14 corrections. 

  You're right there.  Bottom line, average yearly market returns are about 6-7%.  So if we go by the average...it's very close to a wash between keeping money invested vs paying off debt.  I'm unlikely to go wrong long term with either play.  

Coupled with the concern of the longevity of the continued bull market, though, the Fed does seem to be on track to raising interest rates.  And those student loans and HELOCs are _not_ fixed rate loans.  Not too long ago they were all under 4%.  

Add in the concern over trade policy, the effects of the tax cuts, etc... you see where I'm going with all this.  

Oh, I was assuming fixed rate. Yeah, I'd pay them off. Quickly. Student loans first, then the HELOC.

Indy-Guy said:

If I was in your situation, I'd pay off the student loans.  I hate debt.

Can't say I disagree with you.  There's also the little psychological effect that those student loans were for Mrs. VCH's education.  We file jointly, so I consider them _our_ debt...but I know psychologically she'd probably love for them to be dispatched.  And since she stays at home and raises our kids, she's already dealing with a lot on her mind.  

Is there anything specific being saved for? I'd want to keep enough to follow the "3 to 6 months' worth of expenses" rule if you don't have a particular savings goal, and put the rest towards paying off debt.

The fact that you're at least a little concerned about the future tells me that it might be worth buying yourself some peace of mind and eliminating as much of the debt as you can. The fact that some of the debt comes with variable interest rates is another motivator.

From a pure statistical perspective market timing should be avoided. If your goal is to chase the highest possible returns, then a flat or decreasing market is the time when you should be buying and acquiring more assets, not selling. However, having no debt other than a low interest mortgage is a much stronger foundation than what you're currently dealing with, and would give you more disposable income each month. That extra flexibility can allow you to endure more financial strain.

Not entirely sure what I’d do in your situation, but aren’t student loan debts not dischargeable in a bankruptcy?  That alone would make me more inclined to pay them off now, just in case.  

I went through this same mental exercise and chose the pay it all off route. For me it's not an ability to pay but a piece of mind situation. The adjustable rate stuff will be higher by the end of the year. I'd be very surprised if  we don't get 2 rate hikes by the end of year. 

In reply to STM317 :

My concern about the future is more a function of my general "future time orientation".  I was fortunate enough to have a father who, though he's in the "Boomer" generation, has always had more of a "Depression-era" mentality.  And his father?  He saved pennies in an old ammo can until the day he died.  

I'm also fortunate that Mrs. VCH is similarly fiscally conservative.  She stresses over spending $10.  

We don't have anything particular in mind for the savings.  We do have 2 kids, a toddler and a baby.  No (current) car payments, no other debt, and a house that I could pay off with a year's salary.  We have a rental property too that generates a few hundred in profit every month over the mortgage on it.  

Not really concerned about bankruptcy, but yes, student loans are not dischargeable there.

Bottom line, we're talking about ~$52,000 in debt, $625 per month in payments, and about $2300 a year in interest.  I could realistically knock out $29,000 of that, save $325 a month in payments, and save 1300 a year in interest, and still have a ~$10k cushion of money not in retirement savings.  I'd sleep better, Mrs. VCH would be happier, and we'd have more headroom in the HELOC if we need it in the future.  

Although I think getting rid of at least some of the debt is a good idea, if you pull money out of your stocks you may have some capital gains issues at tax time.  Investigate that before doing anything.  Also, even in good economic times I think you may want to consider diversifying your investments a little more, 90% all in stocks seems pretty high risk to me.

stuart in mn said:

Although I think getting rid of at least some of the debt is a good idea, if you pull money out of your stocks you may have some capital gains issues at tax time.  Investigate that before doing anything.  Also, even in good economic times I think you may want to consider diversifying your investments a little more, 90% all in stocks seems pretty high risk to me.

Good point on the capital gains tax, but 90% in stocks seems appropriate for a 41 year old--although I would argue that for an emergency fund you'd want it in something a little safer (even though I don't follow that advice)

stuart in mn said:

Although I think getting rid of at least some of the debt is a good idea, if you pull money out of your stocks you may have some capital gains issues at tax time.

That's never not going to happen, though.  Like my advisor said once,  if you're making money, you're paying taxes on it.  That's why I recommended liquidating enough extra to cover the tax liability.

Those student loans are also not secured by an appreciating asset like a home loan. If it was me I'd definitely look at knocking those off first.

Also, if those are federally backed student loans, then they can't be bankrupted if life goes way off the rails. One more reason to kill the student loans. And while I won't suggest diversifying your portfolio out of stocks, I would say you could choose other stocks. I'm at 5.5 % YTD in a simple blend of index funds - not those fancy new no maintenance fee funds from Fidelity.

On the diversification point, we are almost exclusively in index funds. I have a little ($1000) that I have in a stock I bought awhile back, and about 8k in stock of the company I work for (I can buy it at a discount, so I do). The rest is index funds. 

We've debated on this forum before the pros/cons of having the emergency fund in stocks. We have stupidly high avalable credit, so pretty much any emergency can be paid for now and paid off next month. 

We do own a rental home, and we've talked about using our cash savings to put a down payment on a second one. However, with 2 kids, a full time job, and a desire to have hobbies we enjoy, a second rental isn't in the cards right now. Plus, the market's kindof high. 

Talked it over with Mrs VCH tonight, and she's on board with paying off all the student loans and leaving the HELOCS be- for now. It would also simplify our lives a bit (closing some accounts) which is an added benefit.  We do have some home improvements planned soon, and we may just use the stock market money to pay for at least some of those, too, rather than using the Heloc. 

In reply to volvoclearinghouse :

You have chosen wisely.

Mrs. VCH will enjoy the mental freedom from those loans. 

We are at a point now where finally our safety net in liquid assets is about even with my wife's 6.5% student loan debt.

Unfortunately (fortunately?) I'm too risk averse to pay off the loans and risk our safety net. So it will be another two years. 

In reply to Erich :

Is there more than one loan? For instance in our case there is one loan at 15k and another at 8. So if you pay off one of those loans completely, that eliminates the monthly payment for that one loan. Then you can either save that payment or use it to pay off the other loan faster. 

The inverse of that is why I'm generally opposed to Making extra payments on, say, a mortgage. The extra cash come out of your pockets now, but doesn't reduce the next month's payment. It just shortens the term.