Rich’s 3 Year Plan for Penny to Repay $173,000 in Student Loans

Dear Penny,

I don’t want to dwell on the past. At some point I want to hear the story of how you amassed $173,000 in student loans, but right now I’m more interested in where you go from here. Still, let me take one moment to process your situation …

Holy Mother of Zeus By The Power of Greyskull Sweet Aunt Jemima that is a CRAPLOAD of bad debt!

Ok, I feel better. And you seem to feel ok, too. Most people would be completely down in the dumps, but you are maintaining good humor. I respect that. Now, what to do?

You probably don’t have HBO, but here’s my analogy. You are in the midst of a very brutal story called Game of Loans, in a fight to the death with The Mountain … of Debt. The question is, are you a Lannister, always paying your debts? Are you a Snow, magically rising from the dead? Or are you every other character, getting the crap beat out of you? Join me, the Father of Dragons, and let’s figure out how to defeat this enemy.

Option 1: Slow and Steady + Increase Your Income. According to your current plan of paying $20,000 per year, it’ll take 13 years and cost you more than $86,000 in interest. Blech. You already practice frugal living, so cutting your expenses won’t work. But what about increasing your income? Obviously this means either Mr. Penny grows his business, or you start working more after your youngest child is in school during the day. Would it be worth it?

Let’s say you could net minimum wage ($7.25 per hour). It’s only $150 per week, but you’d have an extra $7,800 per year to throw at the debt, and you’d be done at least 2.5 years sooner. A tiny increase in income would make a big difference. Savings: $12,000 in interest.

Option 2: Go For Broke! Literally. As you mentioned, if you don’t pay the loans you’d face a hefty tax bill on the amount of debt forgiven. Is there a way to avoid that tax? According to my crack research team, teachers and public servants can sometimes avoid taxation on forgiven debt. Doesn’t apply to you. But, according to several articles including this one, you can also avoid taxes if you’re insolvent by a greater amount than the debt forgiven. Let that mountain grow to $762,000 and make sure you’re really broke in 25 years!

Rather than run the numbers on this option, I’m going to just press the STOP button. It’s very risky to actively try to be dead broke at age 65 and hope for a tax loophole to save you. Nah. I have a better idea.

Option 3: Drastic Action → Debt Free in 2020. Option 1 is nice, but not incredible, especially because the interest is growing faster now than at the end. Option 2 is risky. What if you took drastic action while the interest is at its worst?

You have home equity and Roth IRAs. So let’s say you sell the house and rent for a similar cost of living. Pocket the $100,000 in equity. Let’s further say you cash out your IRAs, freeing up $40,000. [Note: You can withdraw your Roth IRA contributions without penalty, but gains would be taxed and penalized.] If you put $140,000 toward your debt in a big chunk and continue to live frugally, you’re out of debt in 2019 — less than 3 years! Savings: $72,287.43 in interest.

                         Starting Balance Interest Paid Principal Paid Remaining Principal
2017 $172,919.00 $11,023.59 $140,000.00 $32,919.00
2018 $32,919.00 $2,098.59 $17,901.41 $15,017.59
2019 $15,017.59 $957.37 $15,017.59 $0.00
Total Interest Paid $14,079.54
Savings compared to Penny’s current plan $72,287.43


Option 3 is drastic, but I like it for these reasons.

  • $72,000! That’s a crapload, in a good way. Why give $72,000 to a loan company?
  • Yes, you lose your house, but not for long. Just think, in 2020 you’d have no bad debt and you could actually save the $20,000 you’ve spending on loans every year. By 2023, you’d have enough for a down payment on a new house, if you don’t like renting. Mortgage debt is much better than bad student loan debt.
  • Finally, your financial situation would be more robust to handle any shocks. Stuff happens. Your car might not last 13 years. Your kids might need braces. Your furnace might blow up … in your face … on your birthday. $20,000 in savings could be handy.

What do you think, Penny? What’s wrong with this plan, other than completely changing your life? Wouldn’t it feel good to take control of this when you an option to do so?

Bringing the Fire,

Rich

PS — I was always under the impression that “Principal” could only be a person, because a person is your “pal”. So I was typing “Principle” in the context of loans. Nope, wrong. Been wrong about that since elementary school.

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