Mint Money Audit: Ken’s Plan to Squash Student Loan Debt

Even when you make six figures and save diligently, your finances can create some anxiety.

Ken [name has been changed to assure privacy], a 36-year-old pilot based out of Pittsburgh earns $100,000 a year. The 36-year-old has various savings buckets for retirement and a rainy day, totaling over $150,000.

He’s a conscious spender, too, according to his Mint profile. He caps his expenses at about $4,000 per month. His top monthly costs include his mortgage ($990), food ($600), auto and gas ($450) and travel and occasional vacations (this month was higher than average last month at: $1,200). “I make an effort to not spend money,” he tells me.

Wow. So what’s the problem?

Dig deeper and we discover that Ken also has $45,000 in student loans and although the interest rate is currently at a very low 2.5%, it is a variable rate, which means it can fluctuate. And given that the markets are highly anticipating a rate hike this December and more over the course of the next year, Ken’s rightfully worried about his student loan becoming more expensive to shoulder down the road.

Should I use my savings to pay off most (or all) of my student loans now? Or just let the loan ride? He asks me.

A little more about Ken’s financials:

• The monthly minimum on his student loans, which he consolidated a few years ago, is $296. He rounds that balance up a tad and pays $300 a month. The pay off date at this rate is 2031.
• He has numerous investment accounts with the following balances:
  • 401(k): $78,000
  • Brokerage Account: $36,000
  • Roth IRA: $20,000
  • Traditional IRA: $10,700
  • Savings Bond: $5,000
• As for rainy day savings he has about $15,750 in a CD, which he can withdraw at any time. He figures this could cover him for four to five months in an emergency. To buy him more time in case things really get bad, Ken says he would also tap his Roth IRA, savings bond and brokerage account ($61,000).
• His checking and savings accounts hold about $22,400, spread across three categories (a virtual “wallet” his bank calls it): everyday spending ($10,000), short-term-savings ($2,400) and long-term savings ($10,000).
• Ken expects to earn a 7% salary increase in 2017.

We spoke by phone and I offered Ken just a few bits of advice, starting with a strategy for his most pressing concern, his variable rate student loan.

Squash your student loans in 5 years or less.

“I have the money to just pay off all my debt now,” Ken told me. While that is technically true, he’d have to deplete more than half of his emergency savings including liquidate some of his investments. I just didn’t think that was worth it. Heading into a new Presidential term and with so much uncertainty about the economy and all else, this isn’t necessarily the best time to heavily compromise your rainy day account to pay off low-interest debt.

And although interest rates will likely increase in the coming year, even if the rate on his student loan doubled to 5% in the next year or two, the payments wouldn’t be out of control.

Instead, I propose the following plan of attack to pay off the debt more aggressively and in far less time than the 15 years left on the term. This keeps more cash in savings over the short-run and saves him a significant amount on interest.

Here’s how:

Liquidate just the savings bond, worth $5,000 and apply it to the student loan principal. Ken agreed that this bond wasn’t really earning much (if anything) any more. Out of all his “investments” this had the weakest return, less than the 2.5% the student loan is charging. This step knocks down the loan balance to $40,000.

The next move is to pay more than the monthly minimum. I calculated that paying $700 a month or a little more than twice the minimum payment on the student loan he can accelerate the pay off to just five years. This shouldn’t be a stretch to do, given his salary and conservative spending. A note: It’s very important that he apply this extra payment to the principal (not a combination of principal + interest) to chop down that balance.

This plan not only reduces his pay off to just 5 years, saves roughly $5,000 in interest.  This calculation assumes his student loan rate stays at 2.5%, though if and when rates go up, I suggest he add an additional $100 a month or more (stemming from that annual raise?) to the principal, which would likely still leave him debt free in 5 years or so.

Take a closer look at investment fees.

Ken’s done an impressive job of saving and investing, but he isn’t sure about fees he’s paying towards the brokerage account worth $36,000. He opened it over a decade ago and never really took a close look under the hood. A traditional, brick and mortar brokerage firm is managing the investment. I suggested he inquire about the fees, both for the account management and for the individual investments. Does the portfolio have mainly low-cost index funds? Or are the investments mainly mutual funds with high expense ratios? If it’s the latter, he could be wasting tens of thousands of dollars (if not more) in fees over the next 30 years.

Instead, I suggest looking into more affordable investment plans that charge very little to manage the portfolio and commit to investing your money in low-cost index funds and exchange-traded funds. Online investment platforms at Betterment, Wealthfront, Charles Schwab Intelligent Portfolio may prove more cost-efficient.

Splurge a little. Or, at least, work towards a 2017 savings goal.

While he admits to making an effort to “not spend,” is he making an effort to save for a tangible goal in the near future? He would like to possibly buy a new home and do some renovations to his current condo, but he hasn’t really saved with that intention, he admits. His short and long term savings accounts amount to over $12,000. That’s a great head start on a down payment on his next home or a renovation project. Pick one goal and start saving more consciously with that in mind. And enjoy the results!

Bottom line: Ken would benefit from paying down his student loans more aggressively to curb rising interest rates, but should do so in a paced manner to buy himself some financially flexibility. By following my gradual five-year pay off plan he can save $5,000 in interest and, along the way, stay more liquid in an uncertain economy.

Have a question for Farnoosh? You can submit your questions via Twitter @Farnoosh, Facebook or email at editor_mint@intuit.com.

Farnoosh Torabi is America’s leading personal finance authority hooked on helping Americans live their richest, happiest lives. From her early days reporting for Money Magazine to now hosting a primetime series on CNBC and writing monthly for O, The Oprah Magazine, she’s become our favorite go-to money expert and friend.