Smartest Place to Put Tax Refund

Question

Background:

I graduated from university 9 months ago with roughly $30k USD in student loan debt, with interest rates from 3.1% to 6.5%, minimum payments are $300/month. Loan balances are from $2500 to $6500. I have a car loan that has $8700 left on it, minimum payments are $200/month (I've been paying $500/month), interest rate is 3.5%, I have to have full coverage insurance due to the loan which is $120/month. I have $3000 in my savings account right now, making essentially no interest but I'm saving for a house.

I work as a software engineer making $67k USD a year.

My tax return this year was $3000. With this, I can either A) Pay off one of my 6.5% interest student loans (there are two of them, both $2500), B) Put it all towards to my car loan, C) Put it into savings towards a down payment for a house.

• With A), I pay off 10% of my student loan debt in one swoop, reducing my overall cost.

• With B), it drops my car loan down to $5700, getting closer to paying that off, at which point I can reduce my insurance coverage and have ~$400 less per month of bills.

• With C), it puts me closer to owning a house instead of renting, which is a big goal of mine but I don't want to jump into it before I'm financially ready.

My question, financially are any of these options better than the others? I would like to get into a house as soon as possible as I'm frankly just tired of dealing with rentals and land lords, and throwing my money away each month. But I know that will also be easier with less debt.

Answer 1

Congratulations on your graduation and salary. You are in a great career field (I know from experience.) As a background, I would feel pretty confident in your salary as demand for SE is pretty high right now. During my career there were times that demand was pretty to very low. Somehow I survived 2001 & 2002, but 2003 was a pretty rough year for me.

Here is what I would do if I were you.

• Your car insurance is a cost of doing business, even if you could pay off your car, you'd probably want to keep it given the replacement cost of a car and the relatively low cost. So it is not germane to this conversation.
• I'd continue to live like a student until my debt was taken care of. This would mean cheap rent or roommates. Also I'd forget about buying a home (for now).
• I'd reduce my withholding to keep more money coming in each month. You are smart enough to do the math with an online payroll calculator. Aim for zero refund.

Paying off the smallest loans first gives you some great "wind in the sails", and encourages you to keep going. I really like this approach despite being not the most mathematically efficient.

I'd reduce my car loan payment back to $200/mo. and put that as the last one to pay off.

With the tax refund, and any money left over, I pay off the student loans smallest to largest. I would also consider reducing your savings to something around the 1K->2k range, and use that to pay down debt.

If you use your tax refund, and some of the savings you'd have like 34K left to pay off. Could you do that in like 14 months? I think you could depending on your other expenses. No more than 18 months, and if you really worked hard and picked up some work on the side maybe a year.

That is what I would do.

Answer 2

Welcome to Money.SE. Your question is similar to a number of others. The "How do I pay my debt down?" and "How do I invest extra money?" is a bit of a continuum since there's no consensus than one should pay off the last cent of debt before investing.

Oversimplify it for me: the correct order of investing offers a good look at this. You see, Pete's answer on your question is perfectly fine, but, since you make no mention of, say, a matched 401(k), I'd suggest that any answer to a question like yours should first take a step back and evaluate the bigger picture. A dollar for dollar matched 401(k) beats paying off even an 18% credit card.

Absent any tangents, any thought of investing, saving for anything else, etc, my answer is simple, line up the debt, highest interest rate to lowest. Keep in mind the post-tax rate, i.e. a 6% student loan you can deduct, is an effective 4.5% if you are in the 25% bracket.