Advice for paying off student loans and auto loans now that I have my first 'real' job

Question

I'm hoping for some advice on which loans I should focus on paying off first.

I'm 28 and just got my first 'real' job about 2 years ago after 8 years of schooling. I've paid off all my credit card debt and can now focus on these loans.

Debt/Loans:
Unsubsidized Student Loans ($9,000)
US $3100 @ 6.55%
US $2200 @ 6.55%
US $2100 @ 6.55%
US $1600 @ 6.55%

Subsidized Student Loans ($12,300)
US $3000 @ 4.25%
US $4600 @ 3.15%
US $4700 @ 3.15%

Auto Loan
US $24,500 @ 5.99% ($355/mo)

Income information:
Gross: US $4600/mo
Net Income after retirement, insurances etc.: US $2,930/month
Rent: $675/mo

I'm not looking at a big promotion potential, so working with my income, I know I'll be able to pay these off in the next 5-7 years (as long as I don't decide to have kids anytime soon)- I'm just wondering if someone has some advice on the strategy I should take toward paying these off.

Should I focus on the Auto loan since it's "Bad debt"? or should I focus on the smaller more accomplish-able unsub. student loans one at a time since they have a slightly higher interest rate? Should I save and drop a big chunk of money on student loans or auto loan at one time (e.g. at the end of the year)?

To me this feels like A LOT of debt, perspective would be great - is this actually a LOT of debt or have I just been living the grad student life for too long and everyone else has this much debt too? #millennialdebt

Followup: Thank you to everyone for the advice, I really appreciate it. I'm going to take all of your advice and see about coming up with a plan. The car world is hard to navigate as someone who had never bought a car before, mine was gifted to me from a grandparent. It died recently and I absolutely need a new one to commute (hence the lower rent, I live well outside town), with all the problems I've had with an old car I did buy something that I know won't have issues for the next 5-10 years. My old car has been a money pit until it finally died, so the peace of mind of having a car that will get me places for the next 10-20 years, I thought was a good investment? Either way, after all your comments - I'm feeling like I'm not the only one who has made this mistake and I will be able to find my way out of it. Again, thank you for all the advice.

Answer 1

The best approach by the numbers is to pay minimums on everything and put all extra towards the debt with the highest interest rate. So, that would be the unsubsidized loans in any order, then the auto loan, then the subdsidized from high interest rate to low. However, with student loans the interest is deductible. Since the top of your income will likely fall around the 22% bracket (assuming filing single) then your student loans actually cost you less in interest than your car loan. So the car loan should be first to go. There's an income phase-out for this student loan interest deduction but based on the provided details you're currently below the threshold.

What you define as 'all extra' here might also need to change, if you can cut spending you can pay this debt down faster and save a nice chunk of interest. Similarly, retirement investing is great, but with the interest rates you're paying it might make sense to cut back on that for a while. Don't forego an employer 401k match, but any extra you're investing currently might be better spent on debt repayment.

That said, some people prefer to start with the lowest balance debt first. It's not efficient, but for some people it helps psychologically to get something off their books quickly.

One big key to taking this debt repayment and turning it into a healthy financial life in the long-term is to continue to live below your means as your income rises. The temptation many face is increasing spending with every promotion. The car loan is a good example of this, many people buy an expensive new car when they get a job out of school, you might need a car and you might need a car loan to get it, but a less expensive car can save a lot of money in the long-run. As @Pete B. suggests, getting out of that car loan by trading down might be worthwhile.

Edit: Regarding how much debt this really is, it's undoubtedly substantial, but with your income it should be manageable. Learn to love living lean and you'll be out of the woods and piling up money for your future in not much time at all. The best part is that you don't have $25k of credit card debt at 18% interest, your rates and balances are manageable. FWIW I piled up ~$75k in debt from my college years just for a bachelor's due to being wildly irresponsible, it's a distant memory now.

Answer 2

The good news is that your student loans are lowish and you have low interest rates. The bad news is that your car loans is massive compared to your income. Can you get out of the loan and get something more reasonable?

There are two schools of thought when it comes to paying off debt: debt avalanche and debt snowball. I advocate the latter, but in this case both would agree initially. You should focus on the unsub'd student loans first, smallest to largest. Focus on one loan and make minimum payments on the rest.

You should get on a written budget each and every month in order to maximize your debt repayment. I'd advocate working a side hustle as well bringing in an extra 1K per month greatly reduces the time you have these loans.

Its very doable, and the sooner you get this done the more free you will be. No more debt other than a house. If you are married work together with your spouse.

I would also put retirement savings on pause while you were paying these off. My goal, with your income and a side hustle would be to be done in 18 months. $2100/month gets it done in 22 months, but it will go quicker than that once you start finding efficiencies.

Answer 3

Your car is way too big for your finances. But you already made that mistake, and selling it won't fix it, as your car is almost certainly under water.

Student loans cannot be discharged by bankruptcy, but often have hardship based payment reductions. The interest rate on the unsubsidized student loans and on the auto loan are close enough that that isn't an important part of which you pay off first.

I'd bias towards "pay off debts that cannot be discharged in bankruptcy" over the half-point higher rate. Plus the ability to eliminate creditors by paying off loans to one or another can reduce your headaches, and the ability to actually say goodbye to a debt is great motivation.

Now, how should you go about it?

Build 2 spreadsheets. The first is a basic budget spreadsheet, and has an entry for "paying off debt" and "servicing debt". Servicing debt is a hard value (your min payments). Paying off debt is the extra money you plan to spend above and beyond your min payments.

The second spreadsheet contains your debts. Each column has the interest rate and min payment at the top. Down the column is the amount you owe on the debt.

Column 1 contains the debt payments (min and extra summed) from the first spreadsheet.

Column 2 contains the sum of the min payments. (You don't have to do anything fancy with conditions here, because even the min payments you aren't paying end up being added back in)

Column 3 contains the extra money for paying down debt (the difference between column 1 and 2).

Column 4 contains the balance of the first debt. Previous month, plus monthly interest, minus min payment, minus extra money to its left, but min 0.

Column 5 contains the debt-clearing money left over after clearing Column 4 debt. The same calculation as Column 4, but first make it negative, then do a min 0.

Here is an editable spreadsheet with random guesses to the min monthly payment for each debt added. I didn't do the first budget (how much you pay off) and just said "1500$ per month towards debt".

You can visually see how your debts collapse.

If you swap the order of columns you can see what happens if you pick a different debt to clear first.

Column 6 is the balance of the second debt; to its left is the leftover debt clearing money.

With 2 columns per debt, you can simulate what happens when you increase/decrease your debt clearing budget, and work out when you become debt-free.

The process of clearing debt is exponential. More and more of the min payment money ends up going towards clearing debts as some are cleared. The concrete result -- "If I stick to my budget, I'll be debt-free in X months" -- will help you understand exactly how much longer you have to go. It also makes it clear what the impact of skipping a cup of coffee is, or making it at home, as you can tweak the amount of money you spend on clearing debts.

Answer 4

That's a pretty tolerable debt level. My current income (working part-time, doing a part-time PhD), student loan and car loan are about the same if you swap the currency unit without applying for the proper exchange rate, although my interest rates are significantly lower (and I happen to have significant stock holdings and forest ownership, so I could pay off my car & student loans if I wanted to by selling all of my investments; the interest rates are so low I'm not going to, however). And, oh, my income is guaranteed (already agreed) to rise 10% per year for the next two years, so some could say my long-term income is 20% above yours. And oh, I also have >10 years of job experience so I probably won't be first employee to be fired.

I don't agree that the loan amount is huge, or that the car is way too expensive for the finances. I mean, $2255 per month after rent is way larger than $355 per month. If living in a country where gasoline is cheap, 12% of net income for freedom of mobility seems sane, like 23% of net income for housing is. (Ok, the 12% didn't include car insurance but still the freedom of mobility would be way below 20% of net income.)

Yes, a cheaper car could be possible in a country where taxation of cars is low. But, cheaper in cars often means "older", and it's false economy to purchase an old unreliable car unless you intend to repair and maintain it yourself. Furthermore, selling a car has a transaction cost. Buying another car to replace your current car has a transaction cost too. You have chosen your vehicle, now stick with it!

I would say:

• You already paid your credit card debt. That's good. Don't ever again live on your card, i.e. buy only what you will fully pay for in the next credit card bill. I always pay 100% of my card balance monthly, and have always paid 100%. I repeat: credit card debt is bad debt.
• Build up an emergency buffer. How much is it for you? For me, I find two times my monthly gross pay (equivalent to three times my monthly net pay) a tolerable buffer. This should be your first priority. So, before you have $9000 in your bank account, don't pay off any loans. If money market funds yield an interest where you live, you could consider storing part of the $9000 into a true money market fund (not any fund having corporate bonds, not any fund having long bonds, etc.)
• Ensure your insurance coverage is good, i.e. if you wreck your car purely by accident, does the insurance pay more than the car loan owed? As a rule, the car loan owed should in all situations be significantly below the market value of the car; in my case, my car is worth way more than the loan owed. My car is worth 50% more than what I owe for the car; yours should be similarly.
• Pay the car loan according to its schedule. It seems to be calculated such that it will be paid before the car is worthless, at least looking from the perspective of a country where 20 year old cars are still regularly used on the road, and the average disposal age of cars is something around 22 years. Ok, if the car is of a quickly deprecating brand, or if where you live cars are disposed at before 20 years, you may want to slightly increase the monthly amount you pay for the car.
• Focus on the unsubsidized student loans. They have a significant interest rate. I wouldn't borrow money at 6.55% rate at all! Given that high interest rate, it would be foolish to e.g. invest in stocks instead of paying off the unsubsidized student loans. Stocks yield a very uncertain 8%. By paying off the high-interest loans, you get a very certain 6.55% effective yield. And oh, of the 8% yield you need to pay taxes. Depending on where you live, you may not be able to deduct 6.55% interest from your taxes. I repeat: any investment is poor idea given your 6.55% rate. In fact, I would skip on any unsubsidized and not-mandatory retirement savings too before the 6.55% loan is fully paid.
• Don't pay the subsidized student loans away prematurely, if their rate is lower than market rate for typical similar loans, and there's any chance you need e.g. mortgage in the future. Subsidized loans are always loans to keep. Do note there may be the possibility to invest in money market fund, effectively getting the market interest rate minus a small management fee. In some situations, that can even exceed the rates of subsidized loans!
• Don't immediately get a mortgage and purchase a house, either. I would say if you can live for $675 per month for housing, your situation is very good and you shouldn't ruin the situation by buying an expensive house for $300000 and witnessing its value halve to $150000 due to some unforeseen market event / water+mold damage / etc. Purchasing a house is good once you have so much assets that halving of the market value of the house doesn't matter at all to you. I am shocked of the people who think it's good to live in an "own" house rather than renting, not having money to pay the house, and borrowing 90% of the house price as loan from the bank.
• Next time when you purchase a car, do ensure you borrow at most two thirds of its value, paying the one third yourself. Do ensure you pay the loan quickly enough that in all circumstances, you will owe at most two thirds of the resale value of the car.
• Start keeping track of your expenses, loans, investments and other assets. I personally use GNUcash. There may be other alternatives too. It's always refreshing to see my "net worth" value gradually climb up.

A loan is a loan, always. It is always worse to have $100000 in student debt and $5000 owed for a car with $10000 as its value than it's to have no student debt and $20000 owed for a car with $10000 as its value. Really, loans can be roughly characterized by three parameters: how quickly the loan has to be paid, how much you owe and what the interest rate is.

So, in summary: in almost all cases, it's best to start paying the high-interest loans first. You already paid the credit card debt. That's good. Now focus on the high-interest unsubsidized student loans.

Answer 5

My first thought is to reduce your car expense. I would sell the car for whatever you can get and replace it with a cheap used car so you can focus on your student loans. Unsubsidized first, smallest to largest, then subsidized.

Once you're debt-free you can start saving for a nicer like-new car.

If you can't increase your income from your day job, could you take on a second job part-time?

Answer 6

As much as I like HartCo's answer, I also have to disagree with it.

To go off what I mentioned in the various comments I've made, the route I'd pay off the auto loan first, then work on the student loans.

If you wreck the car, you'll still be paying for what the insurance doesn't cover as well as having to borrow for another car. If you pay off the car first, you get the insurance money to roll into the next car. Also, having a car loan affects your credit history more substantially than student loans, which can make a difference if you go to buy a house.

Also, of the amount you are paying on the auto loan, only a small part goes towards the original loan, while the rest goes towards interest. If you have a decent loan, the amount you overpay per month on the car loan will go to the principal (original loan) rather than interest. This cuts your loan down much faster and you'll have to pay less interest on it, continuing to increase the amount per month you pay back on the principal.

Let's take a step back for a moment and do some really raw numbers. If you don't pay anything on the $24,500 loan at 5.99% for 10 years, that will have grown to over $43,000.

If you compare that to the $9,000 of UnSub loans at 6.55% for 10 years, that's around $17,000 for the loans. That total is less than just the interest growth on the auto loan, even though it has a (marginally) lower interest rate.

Normally, I go for the snowball effect, which starts a person paying things off by the smallest loan amount, but I consider student loans an exception. If you have any other debt, student loans need to come 2nd to last and right before a mortgage. Credit card debt and personal loans come first, then auto loans. You've already taken care of the CC debt, so you've already taken care of that first step.

Along with paying off the credit cards, you need to not use them except for emergencies. Have a cash safety net in the bank of at least $1000. The more you have, the less likely you'll have to use credit and the less likely you'll have to pay interest.

Ok, back to next steps. Once you have the car paid off, start with the smallest student loan. It doesn't matter if it's UnSub or not. Use half the money you "were" paying for the car to pay add to what you pay for that loan. Use the other half of the car payment to save up for your next car. This will save you lots of interest later, as not only having a significant down payment can get you better terms on a loan, you might be able to get a car without a loan by, paying for it outright.

FYI: Having the car savings and your safety net saving can also keep you out of financial trouble when the car needs repairs.

Once you start paying off the student loans, every time you pay off a loan, roll that entire amount into paying off the next loan. This is why it's called the snowball effect. The more you roll into the next loan payments, the faster you pay it off.

This is how I paid off my credit cards, previous cars, private loans, and my own student loans. I took part of Dave Ramsey's plan and meshed it with what I learned in the book America's Cheapest Family. I'm not in any way affiliated with Dave or the book, I'm just another happy customer. (Any referral link is added by SE/SO, as has been done on other posts of mine.) One caveat I added to Dave's method is that if you have loans of similar amount, but different interest rates, pay the higher interest rate off. The other caveat is that if you have a loans of similar amount and a much higher monthly payment, pay the higher monthly rate one off first. Both of these caveats will save you time and money.

One thing I didn't mention is retirement savings. Unless you can't afford your bills by doing so, you should be putting in as much as your employer matches on your 401K, etc. Employer matches are free money and the longer you have that retirement money, the more it pays off. This is where interest rates work for you, instead of against.

All of that said, life is going to change. You need to be able to make changes to your plan when it does. The "America's Cheapest Family" book goes into how to do that in a lot of depth, as well as how to pay off and stay out of debt. You don't need to "know everything now", as that "everything" will change. Just learn as you go and make the best guesses you can.

Good luck!

Edit

As contested as my answer appears to be, I'm going to have to add things that I thought might be obvious, not to mention redundant from the references I've mentioned. So here we go:

Student loans are different than any other loan, in that they are regulated differently than any other loan type in the USA. They can't repossess your education, they can't bully you into not paying another bill to pay them, and they do have various deferments, loan repayment recalculations, payment reductions, loan forgiveness, and other ways to ease your monthly burden. They can still garnish your bank accounts, your paycheck, and even your tax refund, but these are their very last options, not their first as with other lines of credit. (Only government loans can go after your tax refund or add to your tax payment to make you current with your loans.)

Using a debit calculator (https://www.creditkarma.com/calculators/debt_repayment/ included for ease of access, not because I'm affiliated with them as anything other than as a customer), you can easily calculate the length of the loans as well as how much interest you'll pay.

Focusing on paying off the highest risk loan first, which in this case is the auto loan, you'll be saving a lot of interest. Continuing to pay at the minimum will take 85 months and cost $5,612 in interest. Continuing to pay your UnSub loans at the minimums will take 37 months and cost less than $1000 in interest.

Higher risk is due to factors outside of a strict mathematical valuation of the numbers. The auto loan, as mentioned previously, is subject to accidents, repossession, potential car repairs, and more. Student loans are much lower risk, due to reasons previously mentioned. Student loans aren't going to disappear during a bankruptcy where a auto loan could (but isn't certain), but your finances have to take such a massive downturn to even think of bankruptcy that I rarely bother to consider it a factor, especially when there's no current indication it's eminent. I find that people who focus their advice solely on bankruptcy decisions are those who are most likely to find themselves filing for it.

A higher interest rate doesn't automatically mean you'll pay more in interest. As I calculated earlier, the $24.5k at 5.99% will cost your more in interest than $9k at 6.55% over the life of the loans. Also, by the time you get done paying off the auto loan, even by increasing your payments, the student loans will have all been paid for naturally, assuming a standard 3% monthly payment rate.

Spreading extra money to all your loans will help, but focusing the increase on a single loan drastically affects the repayment of that one loan, since that extra is being paid towards the principal, instead of the interest. By hitting harder on the principal, that means your interest payment (not rate) goes down on subsequent payments. An old "rule of thumb" to consider from the mortgage people is that by paying a single months payment extra per year shaves off years of payments. This works for more than just mortgages, of course.

http://www.interest.com/refinance/news/3-free-ways-to-pay-your-mortgage-faster/

Instead of living paycheck to paycheck, as one comment suggested I was advocating, I previously suggested having that cash safety net as well as saving money in general. This prevents living paycheck to paycheck.

I advocate the "snowball effect" as a psychological way to "use your weakness as your strength". Most people don't have the will or attention span to take on large projects that don't have obvious positive feedback, such as paying off a large loan. Paying off the smallest debt first gets you a "quick win" as well as one fewer debtor that can come ringing your phone or knocking on your door if your finances go drastically wrong. Because of the different risk factors of the different loan types, I've modified the snowball effect plan to account for it.

Using the snowball effect, or my modified version of it, isn't necessarily the most mathematically best use of your money to pay off the loans, however the difference between the "mathematically best" and the snowball effect is generally counted in months, not years. The "mathematically best" has psychological problems, dealing with the aforementioned willpower and attention span of the person involved. A person with high willpower and laser focus can use the mathematically best approach, but is also the least likely type of person to get into the type of situation where they are drowning in debt.