Micro.blog

pratik
pratik

I was mulling this in the shower so thought why not let you also chime in. Let me know what would you do (or have a fourth option).

gpittman
gpittman

@pratik In the personal finance courses I’ve taken, it has always been B then A (including what you had been putting toward B) then C.

philipbrewer
philipbrewer

@pratik Option B is going to give you the largest return over time.

Option A makes your household finances less brittle: The lower the sum of all your minimum payments is, the less at-risk you are to every glitch in your income.

Option C could make sense if you're an investing genius who could earn a better return than the interest you're paying on your debts. As a practical matter, people who think they are investing geniuses almost never are. It could still make sense if your debts are at low, fixed rates (like student loans were in the 1970s).

Note that before doing ANY of these things, you should put enough cash in an emergency fund to cover a few weeks' expenses. This will help the "brittle household finances" issue even better than paying down debt, until you reach the point where you can pay off most of your debt.

pratik
pratik

@gpittman Does it matter on the difference in the interest per month between A & B? You can easily guess what type of loans A & B might be.

Miraz
Miraz

@pratik Pay off highest interest rate first, provided you already have some kind of buffer money for emergencies.

mroutley
mroutley

@pratik just another vote for what looks like the consensus: B first. The rate is more important than the amount. Although if A had a small amount of principal left, I might pay it off first, just to get rid of it.

gpittman
gpittman

@pratik The principal would be to pay off the one that will cost you more in the long run. So if A is more expensive in the long run, you would pay that down first. If B, then B. The “pay the higher interest loan” idea is based on the assumption that that’s the one that will cost more. That may not be the case in your situation.

pratik
pratik

@philipbrewer Thanks. Yes, I should have added that having an emergency fund should be the first priority. My rough calculation is 6 months worth of expenses in a cash or easily accessible/non-volatile account. And yes, I'm no investing guru. Far from it actually and doesn't help that I'm very risk-averse.

pratik
pratik

@Miraz @mroutley Option B is what most personal finance sites recommend too but was wondering if the actual interest amounts matter (difference 7-10x)

pratik
pratik

@gpittman Yeah, the long run is what's most fascinating. I've brought down Option B to such a level that the monthly interest amount doesn't seem like much compared to how much I can earn in the long-term given compounding interest.

gpittman
gpittman

@pratik Of course, I would misuse "principal" in a conversation about principal and interest. I should at least pretend I have post graduate degrees. :-)

Cheri
Cheri

@pratik What @philipbrewer said! :) As one data point, our 'order of investments' is: 1) set up emergency fund 2) put 10% of income into retirement investments (Compound interest, yo!) 3) pay down non-mortgage debt 4) accelerate retirement investments 5) pay off remaining mortgage just prior to retirement.

I recommend the Bogleheads Wiki for general investment information. Especially the section on Lazy Portfolios.

mroutley
mroutley

@pratik @miraz yeah, it doesn’t match well with intuition. It seems like paying the bigger principal amount first would save you interest. The trick is that for a fixed payment amount, the proportional reduction in principal is greater if you pay off the smaller amount first.

Maybe an example helps?

Option A is $100 at 20% Option B is $1,000 at 10% Payment is $50

Applying $50 to A saves you $10 ($100x20% - $50x20%)

Applying $50 to B saves you $5 ($1,000x10% - $950x10%)

So, you save more money with Option A

pratik
pratik

@Cheri Thanks for those links. Vanguard's funds have always been in my portfolio so lines up with my investment strategy. BTW why do you put non-mortgage debt ahead of mortgage debt? If you hadn't noticed already, that's basically A & B in my post.

pratik
pratik

@mroutley Agree. Also, the temptation to pay down the debt with a smaller amount is so tempting that you can make less optimal decisions. The desire to see a zero or even one less item in your debts list is strong 😀

jean
jean

@pratik This is a great discussion. Thanks for getting the ball rolling.

I tend to do what you explicitly forbid: hedge my bets between A and C, if B is paid off.

I came to financial competency late in life, in my mid 40s. A perfectionist mindset was part of the problem, until I came to the realization that there is no personal finance strategy that doesn’t include saving money. 😅

Cheri
Cheri

@pratik A few reasons. We believed our investments, compounded over time, would out-earn the benefit of paying off a low, fixed rate mortage early. Housing cost inflation and tax incentives make mortgage interest in the US even 'cheaper' than it appears on paper. Our non-mortgage debt (student loans, basically) had to be repaid, whereas mortgage debt could be eliminated at nearly any point by selling our house or downsizing to a smaller one. Our goals were also a factor. We wanted to retire early and travel, so ramping up our investments was more important to us than paying off the house.

pratik
pratik

@jean Well, it’s less about me forbidding and more about forcing a choice between A & B 😀

pratik
pratik

@Cheri Awesome insight. I agree about the mortgage bit. That’s part of the ready I was vacillating between A & B but this makes it more clear.

In reply to
jean
jean

@pratik Of course! Sorry. Once I got my act together personal finance-wise, and given that my student loans were paid off a long time ago, I don’t have anything in category B. Which would be (and has been) my choice for a windfall payoff.

esjewett
esjewett

@mroutley Pretty sure you reversed options A and B from the example. In the example, A has the lower interest rate but higher monthly payment, meaning it has the lower rate and bigger balance, correct?

ronguest
ronguest

@pratik Chiming in a bit late and the devil is in the details but... High interest short term debt is usually the most clear cut to pay down. Beyond that mortgage rates are below 3% now. As a long term couch potato investor there are only a couple of years out of several decades where I haven’t beaten that type of return by a substantial margin. Also I have always felt debt held in relation to an appreciating asset (like a house) is less disagreeable (that’s just a personal view).

We could pay off our mortgage and every year I analyze doing so because it sure would be nice to be debt free. But the reality is there is no economic reason for us to do so. Instead we take comfort in the large liquid cash pile we have instead. Also, we expect to sell before the mortgage runs it course.

mroutley
mroutley

@esjewett oops, yep, I switched the labels. Hopefully my math is still correct

mroutley
mroutley

@miraz @pratik I got my labels swapped in the example. Option B from the original question is the best option. Sorry about that! Thanks to @esjewett for noticing

esjewett
esjewett

@mroutley I only pointed it out because you had by far the clearest example I had seen. 🤣 Nice work!

mjdescy
mjdescy

@ronguest @pratik Your point is a good one. I actually regret the debts I paid off early because I will never be able to borrow at such low rates ever again.

mroutley
mroutley

@esjewett Thanks! I’m glad it was helpful and I appreciate you pointing out the swapped labels. Saved some confusion 😀

pratik
pratik

@ronguest Not late. I still have my debts 🙂 But yeah, what you said makes sense for home mortgage. It may seem like a lot of interest but unless you pay it off significantly, it doesn’t make economic sense.

rcjackson
rcjackson

@pratik whatever option improves your cash flow better. Positive Cash flow is critical

pratik
pratik

@rcjackson What does that mean?

rcjackson
rcjackson

@pratik Determine minium payments due on each bill. Pay the min on each, then funnel all extra money into your debt with the lowest cash flow index, which is the debt's balance / min payment. Interest rate is irrelevant. This way you improve your cash flow fastest and subsequently can pay off other debts fatster or do someting else with the cash if you like.

See themoneyadvantage.com/cash-flow...

But just search for "cash flow index" a bunch of decent resources should come up.

Good luck.

pratik
pratik

@rcjackson Thanks a ton. That was a very insightful article and I learned something that I didn't know before. CFI is a great way of comparing across loans.