As you know, we started off our professional lives with over $200,000 in student loan debt. After almost 8 years of paying those down — sometimes with minimum payments and sometimes aggressively — we are down to about $177,000.
Last month, we added a $517,500 mortgage to our debt profile. Because we borrowed just under 88% of the value of our house, we have to pay PMI. PMI, or mortgage insurance, is tacked on to mortgages for more than 80% of the appraised value of the house. Once the mortgage falls to 80% of the appraised value, PMI will drop off of the loan. PMI is to protect the bank, not the borrower, in the event of a foreclosure. We have 8% to go.
With a constellation of student loans and a mortgage, how should we prioritize our debt payoff?
In order to answer this question, it’s important to understand how much we owe, the interest rates, and the monthly payments. With that information, I can prioritize our debt payoff.
1. Determine our Debt Profile.
Here is a snapshot of our student loans:
|Loan Type||Current Balance||Current Payment||Interest Rate|
|My Bar Study||(see above)||(above)||3.19%|
Here is a snapshot of our mortgage, with PMI:
|Mortgage||Current Balance||Current Payment||Interest Rate|
|Principal & interest||$517,500.00||$2,470.62||4%|
* The “Current Balance” for PMI is the amount we have to pay to get rid of PMI, it’s not an additional amount.
** The PMI amount accrues 4% interest and demands a $237 payment each month. Effectively, it adds 0.55% to the interest rate. When I compare the PMI balance to other balances, I think of it as accruing 4.55% interest.
2. Understand our Debt Payoff Strategy.
Now that I know where we stand with our debts, I can prioritize them. Everyone’s priorities differ. You can try to get rid of the loan with the largest interest rate and cost (known as the debt avalanche), or pay off the loan with the lowest balance (known as the snowball method), or you can aim for getting rid of a monthly payment — whether that means the lowest balance or the highest interest rate.
I prefer the third option. Whenever we cut out a monthly payment, I feel more financially stable.
Unlike credit cards, minimum monthly payments for student loans and mortgages are amortized, and do not go down when the principal goes down. Because of this, I approach debt payoffs via Dave Ramsey’s snowball method — I target the smallest payment first.
3. List the Debts in Order of Priority.
Our priority is to eliminate a monthly payment, which means that we need to target our lowest-balance debt first. Here they are, from lowest balance to highest:
|Debt||Current Balance||Current Payment||Interest Rate|
|My Bar Study||3.19%|
|Principal & interest||$517,500.00||$2,470.62||4%|
It looks like our first priority should be that $5,000 student loan at the top of the list. Getting rid of that payment will give us $92 a month more, to sink in to the next loan on the list. If we pay off $16,000 in student loans, we’ll save just under $200 per month. Compare that to the $43,000 we would need to pay to get rid of $240 per month in PMI — we will get a lot more bang for the buck if we target those two student loans.
Finally if you are interested about getting a good strategy to help you pay off debt, I suggest you get a copy of Dave Ramsey’s The Total Money Makeover. The book has sold millions of copies and helped hundreds of thousands of people with their debt. Its also got something like 4,200 reviews on Amazon with an average of 5 stars, so its really, really popular. Get a copy if you get a chance.
It seems to me there are some cases where it’s very clear what’s called for, snowball or avalanche — if there are a slew of really tiny debts (I see people with less than $1000 each on a variety of credit cards) then snowball is definitely the way to go, whereas if there are interest rate differences of more than 2 or 3% (say, the choice is a student loan at 8% vs a car loan at 2.5% — a real example I’ve seen on a blog!) then it’s pretty clear you ought to do the higher interest rate one. But in your case, the interest rates are close enough to each other that I feel like you might as well do the thing you want to do. I guess I would run some numbers to see if you’d save enough money by prioritizing the 5.4% one to make it worth it, but other than that….
Ms Stapler, Highest interest rate first and fully paid off. Afterwards, any extra payment towards the mortgage reduces the interest on that amount for the long term life of the mortgage and, as a result, produces a small additional (extra)mortgage payment for the remaining life of the mortgage. So it functionally reduces the length of the period for mortgage payoff. Since it is a tradeoff of short versus long term payoff, consider splitting the payment at some % between mortgage and your next highest interest loan.
With warm affection,
John E Meyn, Friendship, ME
That is definitely food for thought.
I haven’t been thinking much about getting rid of my consolidated student loan, because it has some “what if?” safety net benefits — of being able to put it in forbearance or lower the repayments if our income for some reason plummeted.
But that 5+% interest is pretty awful in comparison to the rest of the loans, and we can’t write it all off on our taxes (unlike PMI and mortgage interest, we can only write off $2,000 / year of student loan interest). Getting rid of a $448/month expense would be really wonderful, and make our financial situation less tenuous.
I think I need to go back to the drawing board and plug in the “benefit” of keeping the mortgage and PMI in lieu of that high interest student loan.
We were in a similar boat to you with PMI. We put 10% down since there wasn’t a difference between 10 and 15% interest rate wise.
We have been PILING money at the mortgage to get out of this state and we are planning on continuing the extra $81 per month towards principal once we’re done with PMI.
Just be careful though “Once the mortgage falls to 80% of the appraised value, PMI will drop off of the loan.” This isn’t necessarily true. The bank will not automatically remove PMI until 78% (where they are required to by law). Between 80 and 78%, you need to contact them (usually hand written letter) to petition the removal.
We are about $6,000 away from getting the PMI to go away and I CAN’T WAIT!
We have paid an extra ~$15,000 towards the mortgage principal since last June when we purchased the house and have shaved off 5 years and 10 months from the original 30 year schedule.
That stinks that the PMI is so high for you! I guess it all has to do with the size of the loan.
Either way, you guys are looking at this objectively and it will allow you to tackle it in the best way! Snowball is a great method even if you do the Ramsey style.
Yes, the PMI amount is locked in at the time of the loan, so putting down a higher down payment not only got us a better interest rate — it reduced the amount of PMI. But, it won’t budge until we get to that sweet spot in our equity.