order of allocation

[El Chupacabra]

Would love to pick some of your brains about the state of our finances. I am a 1st year med student, and will in whole, owe $160K in loans at 6.8%. My wife makes $160K/year. We owe $14K on our credit cards at 11%. We purchased a home last year with 138K down and owe $417K on it. Our 30yr mortgage is $3K/month.

Anyway, I'd like to get some idea of whether I should be paying down the med school loans first, maximize her 401K, get the cards down, etc... Furthermore, would anyone out there recommend a financial planner to deal with these issues? Thanks in advance for your help.

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[Bobblehead]

If either of you has time I wouldn't go to a financial planner. I would get a book like Personal Finance for Dummies or spend some quality time reading the www.diehards.org or www.fool.com boards.

The short version is always pay the highest interest rate first which is your credit cards. You shouldn't be carrying any revolving consumer debt period. Ever. So get that paid down ASAP. You also need an emergency fund (efund) which you should try to start while paying down the credit card debt. That will allow you to not put something on the card when it comes up (car's timing belt, new furnace, emergency root canal, etc.).

If you wife has a 401k match she should contribute to the maximum match at all costs. That's free money you're throwing away otherwise. If the 401k is not matched and you are eligible for a Roth IRA that's probably the first place to go to.

I'm just doing very simple math here with many assumptions but you're borrowing $40,000 a year for med school. Your wife is making $160,000 a year. Let's assume that you're roughly seeing about 55% of that in post-tax income which comes out to $88,000 per year. You spend $36,000 on mortgage payments which leaves $52,000. If you can cut your monthly expenses to $2000 or less in total that still gives you $28,000 to spend on med school. If you add that to your loan amount you're paying $68,000 in tuition and fees for school? That seems a little high to me.

If you can cut your monthly expenses to $1000 a month, which would be hard unless you're very frugal you could conceivably have $40,000 of your wife's income left per year which would be equivalent to the loan amount that you're taking out.

Now if you're saying that you're investing the $40,000 you're loaning at a post-tax return higher than 6.8% then I say go for it but I get the feeling that you're spending it which means that any money you end up not borrowing will give you a return of 6.8% which isn't bad.

So I'd summarize it as:

1. You shouldn't have $14,000 of credit card debt that you're revolving. You are living far above your means if a $160,000 salary plus $40,000 in student loans annually is still causing you to need to revolve consumer debt.

2. You should try to negotiate lower interest rates with all of your credit card lenders, try to balance transfer to 0% APR or lower APRs as able and then pay down those cards before the 0% expires. You get 11% real return as a result. That's better than the historic stock market returns.

 

[WealthPlanner]

I agree with the earlier post: I didn't go to a Financial Planner either...

Summary of Current Situation
Revolving Credit: $14,000 in revolving credit @ 11% APR
401K: Max contribution
Income Tax: $160,000/year income
Student Loan: $40,000 per year for five years at 6.8%
Mortgage: $417,000 Mortgage (7.75%, maybe)
Mortgage Payment: $3,000/mo Mortgage
Equity: $138,000

Summary of Recommendation:
Take advantage of FICO algorithm and position revolving credit to your advantage. Contribute in 401K but only up to the matching threshold. Income Tax and Student Loan situation could be improved using government incentives. Income Tax lowered and fix student loan by "throwing money at it."

Recommendation:
Revolving Credit:
Transfer $14,000 to zero APR plans and pay down. New card must have a limit of four times the amount ($14,000*4=56,000) to be considered a good revolving credit by the Fair Isaac & Company algorithm.

401K:
Adjust 401K contributions only up to matching amount (more on this later); I personally do not like IRA because there is no matching.

Income and Tax:
The GO Zone investments in Mississippi offer ½ land improvement tax deductibles. For instance, an $180,000 property, with land improvements of $80,000, $40,000 of that is tax deductable. Your wife's taxable income goes from $160,000 to $120,000, but it gets better... If she purchase five (the maximum per individual), that's $200,000 ($40,000 x 5) of deductions which she could use in the next years to lower her tax bracket. Also, these investments are structured for no down payment, 15% equity, break even with mortgage and rental, $38,000 of forgivable loans from the Mississippi and Federal governments when held for five years (but prorated so when sold after 2.5 years, $19,000 must be returned). Yup, they are giving out money. These incentives are for investors to revitalize the ravaged states of Louisiana, Arkansas, Texas, and Mississippi (Mississippi has the best programs.).
Back to using the tax breaks, you wife should file for "Married filing jointly" and lower her income to $128,500 at 25% bracket (using 2007 tax schedule). The $200,000 should last for six years. Her effective tax rate is 20%.
Regarding the 401K, in the next "GO Zone" program, roll out the 401K and use for retirement (see Mortgage). The tax deductions washes the income tax and you get the 401K and matchings free of tax (with a 10% penalty for early .withdrawal.).

Student Loan:
With $38,000 X 5 = $190.000 of forgivable loans, for Christ sake do not buy that convertible Ferrari. Yes, you could have the M3. And yes, loans are tax free.

Mortgage:
Cash out and invest in other properties, and cash out again to invest on retiring early as ten years, on your terms, as safe as possible, and TAX FREE. That topic is in the next lesson.

Now you know some parts of the plan my wife and I are on…

 

[etf]

I personally do not like IRA because there is no matching.

if you go with a roth ira, uncle sam is essentially offering a matching contribution proportional to your tax rate. how much more of a match could you possibly want? although with the income of at least $160k, i'm not sure they still qualify for roth...one option would be to do the standard IRA and do a roth conversion in 2010.

 

[The White Coat Investor]

Here is what I would do if I were you:

1) Pay off the 11% loan.
2) Direct money next to your 401K and any other retirement account available to you. Max them out. Invest them only in equities. You might be able to qualify for Roth IRAs if you can get your AGI low enough (contributing to the 401K will probably do it for you.) That allows you to put $25,500 into retirement accounts per year. If you do it before April 15th you can even put in $8K for last year.

3) Take what is left and direct it to the 6.8% student loan. When you finally have that paid off, begin diversifying your retirement account holdings by adding bonds and begin investing in a taxable account.

4) Take your time paying off the mortgage (I assume you have a rate under 6%)

The problem with planners is by the time you know enough to pick a good one you know enough to do it yourself.

 

[Stroganoff]

The fact that the OP bought a $555K house leads me to believe that frugality isn't a high priority. In The Millionaire Next Door, it is emphasized that physicians lead the pack in top-income earners who are either 1) financially clueless, and/or 2) financially spendthrift (cars, houses, boats, vacations, bling). Heck, even on a resident's salary of $45K, I'd still max out a $15.5K 401K and live like a student off <$30K gross.

 

[WealthPlanner]

The fact that the OP bought a $555K house leads me to believe that frugality isn't a high priority. In The Millionaire Next Door, it is emphasized that physicians lead the pack in top-income earners who are either 1) financially clueless, and/or 2) financially spendthrift (cars, houses, boats, vacations, bling). Heck, even on a resident's salary of $45K, I'd still max out a $15.5K 401K and live like a student off <$30K gross.

Let's not judge until we find out where they live...
Hey El, LMU is Loyola Marymount U in West L.A., CA.?

 

[Stroganoff]

Let's not judge until we find out where they live...
Hey El, LMU is Loyola Marymount U in West L.A., CA.?

I wasn't judging. I was being objective. That fact that you're making $160K and still have $14K in credit card debt that isn't PIF monthly indicates a "living-beyond-your-means" scenario. And the fact that a simple thing like a 401k not being maxed out (it's only $15.5k) on that income shows carelessness.

 

[The White Coat Investor]

I wasn't judging. I was being objective. That fact that you're making $160K and still have $14K in credit card debt that isn't PIF monthly indicates a "living-beyond-your-means" scenario. And the fact that a simple thing like a 401k not being maxed out (it's only $15.5k) on that income shows carelessness.

For the most part I agree with you but assuming they are a two physician family, living expenses of $200K/year are probably doable. They won't have trouble paying those loans off with their combined income and saving adequately for retirement, assuming they want a 30 year career. Of course if their expenses go up when he starts making the big bucks too, then you're spot on with your assessment.

 

[El Chupacabra]

First of all, I am consistently amazed by the generosity of sdn members, particularly in giving me a hand; it means a great deal to me. Admittedly, I am learning, but some of your responses are comical.

$550K for a house in California is not unreasonable, but you're right, we're far from frugal, however careless is a stretch. Albeit we're possibly at the upper end of our means, one could argue it beats paying rent for 4 years; furthermore, I'm personally an advocate for investing in real estate, and I feel strongly we made a good decision in the property we purchased.

No, we're not a two physican family, as my wife is much smarter than I; she went to law school. The reason we have a $14K credit card debt is due to the fact she's a first year attorney, and we put a large sum down on the house from money we've saved. Therefore, we wanted to keep our remaining cash liquid "in case sh**" Despite advice to the contrary, we managed this transitional period unscathed and frankly I'm quite happy about our current standing. That being said, you guys clearly know more in terms of finance, and I'm eager to learn, and per your suggestion, I'm going to attack that $14K debt like a jaguar on a gazelle.

And for the individual who asked, LMU is Loyola Marymount. Go Lions!

 

[etf]

550k for a house in northern california is unreasonable, unless you're looking at foreclosure properties in stockton/modesto...

 

[El Chupacabra]

Then I'll take that as a complement.

 

[WealthPlanner]

First of all, I am consistently amazed by the generosity of sdn members, particularly in giving me a hand; it means a great deal to me. Admittedly, I am learning, but some of your responses are comical.

$550K for a house in California is not unreasonable, but you're right, we're far from frugal, however careless is a stretch. Albeit we're possibly at the upper end of our means, one could argue it beats paying rent for 4 years; furthermore, I'm personally an advocate for investing in real estate, and I feel strongly we made a good decision in the property we purchased.

No, we're not a two physican family, as my wife is much smarter than I; she went to law school. The reason we have a $14K credit card debt is due to the fact she's a first year attorney, and we put a large sum down on the house from money we've saved. Therefore, we wanted to keep our remaining cash liquid "in case sh**" Despite advice to the contrary, we managed this transitional period unscathed and frankly I'm quite happy about our current standing. That being said, you guys clearly know more in terms of finance, and I'm eager to learn, and per your suggestion, I'm going to attack that $14K debt like a jaguar on a gazelle.

And for the individual who asked, LMU is Loyola Marymount. Go Lions!

Don't close that credit card once it is paid off (either offloaded to a zero APR or paid with sweat). Closing it will lower your credit score. And do use your credit cards one a quarter to give the crediting company something to report to the credit bureaus. And if you off load to another credit card, make sure the balance is below 30% of the limit (to be considered good and managed revolving credit).

Good Luck and stay dry in LA in the next few days!

 

[Finally M3]

Here is what I would do if I were you:

1) Pay off the 11% loan.
2) Direct money next to your 401K and any other retirement account available to you. Max them out. Invest them only in equities. You might be able to qualify for Roth IRAs if you can get your AGI low enough (contributing to the 401K will probably do it for you.) That allows you to put $25,500 into retirement accounts per year. If you do it before April 15th you can even put in $8K for last year.

3) Take what is left and direct it to the 6.8% student loan. When you finally have that paid off, begin diversifying your retirement account holdings by adding bonds and begin investing in a taxable account.

4) Take your time paying off the mortgage (I assume you have a rate under 6%)

The problem with planners is by the time you know enough to pick a good one you know enough to do it yourself.

Great advice. If you can get under the AGI, max out your roth. Can't beat tax-free retirement money (IF, of course, you have capital gains).