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Student loans: Pay them down or start an emergency fund?

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Butch Dill/AP/File

(Read caption) In this file picture from August, students attend graduation ceremonies at the University of Alabama in Tuscaloosa, Ala. With more than $50,000 in student loans, should a couple pay them down aggressively, build an emergency fund, or both?

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What’s inside? Here are the questions answered in today’s reader mailbag, boiled down to five word summaries. 
1. Investing in light of default
2. Debt eradication
3. Loans or emergency fund?
4. Repetitive questions
5. What’s next on my path?
6. Time for a financial advisor?
7. Polite hygiene advice
8. Wedding and financial planning
9. What are readers like?
10. 2012 predictions

How long does it take for you to stop dating checks and other documents with the previous year after the calendar flips?

I’ll admit that it will probably take me most of January to get used to writing 2012.

Q1: Investing in light of default
I have a small IRA, with half in a mutual fund, which has topped out, and the other half in two stocks which are near to bottoming out, from a lag factor associated with recession and reinvestment.

I anticipate a currency devaluation as an effect of renegotiation or default on national debt limits. Would overseas money markets be a safe place to stash funds from the sale of the mutual while I wait for it to drop so I can repurchase it? If you believe that our debt problems will negatively impact overseas money markets, what is an alternate spot, exclusive of index funds, which will drop as the market does?
- Monica

I don’t think I would trust overseas money markets more than domestic ones, as I think a lot of economies are facing some sort of currency devaluation due to the ongoing economic conditions.

I also wouldn’t bank my entire plan on market timing, particularly when you’re making moves based on a sense of a fund having “topped out” or “bottoming out.” If I were you and I moved forward with this plan, I’d set some thresholds on when to buy back in. For example, you might want to say that you’ll buy back in after three months if either the value of the fund is down, say, 15% or it matches the value you sold it at.

Don’t worry about what the absolute top of the market is or what the bottom is – worry about making money for yourself.

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Q2: Debt eradication
I’m a 22-year old student who will graduate with a B.A. in December. I took out some federal and private loans to pay for school. I saved for the past year and paid off the private loans while in school. I’ll be left with $16,000 at 6.8% when I graduate. I have no other debt and a 3-month emergency fund ($6,000). I plan to make payments well over the minimum to pay this balance off in 2 years or less.

Is this a good thing? The more I research credit and credit scores, it seems that a relatively low-balance loan isn’t a bad thing to keep around for ten, even fifteen years. However, having a positive net worth is my #1 priority. Should I be making aggressive payments or simply using that money to pad my retirement and savings while keeping the loan around? While paying the loan aggressively I’ll still be contributing 15% of my net income to an IRA. I have one credit card with a $500 limit; never carried a balance. I pay bills on time every month. I currently rent. A house isn’t on my to-do list, and I’ll buy a car outright if I get one in the future. Is it enough to build my credit without a credit card balance, mortgage, car payment, and (soon) no student loan?
- Belinda

I don’t think the value of having a 6.8% student loan (in terms of your credit score) is worth the financial cost of having to pay 6.8% interest on the balance every year. If it’s within your means without causing other financial troubles, I would pay it off sooner rather than later.

Given that you do have a continuing line of credit in the form of your credit card, your credit report won’t go completely empty after you pay off the student loan. I would consider using the card regularly (and paying off the balance) and being open to moderate raises in your credit limit.

You’re doing very well. Keep along your current path and you’ll continue to do very well.

Q3: Loans or emergency fund?
I’ll graduate from grad school this May with $25,500 in federal subsidized loans (spouse and I also still have $27k combined undergrad debt at 5.3%). I haven’t technically needed these loans for the last year of school but because they’re subsidized I’ve been storing the money in a rewards checking account earning about 3%. It will be around 12,000 total in November when the subsidization ends and 6.8% interest kicks in. This is the extent of our short-term savings/emergency fund right now (my spouse and I are also saving for retirement). So, since we are looking to save for life’s big things in the next few years (car, family, and house, probably in that order), and we don’t have a defined emergency fund amount, I wonder how much of that 12k should we pay back immediately? We’re currently steadily employed though I’m seeking new full-time work in my desired field instead of my current part-time job. We have roughly $1000 extra/month to put to good use on student loan repayment and savings (we’re a pretty frugal couple), but I’m not sure what the best combination would be. We have to pay minimum $400/mo on our student loans. Is it best to pay more on student loans and postpone more emergency/car/baby/home savings? Is it best to pay back the entire $12k “savings” (which is really borrowed money) and start our “real” savings from scratch? I’m lost and confused and would be interested in your and your readers’ opinions. 
- Danika

If I were you, I would establish a new emergency fund and fund it with enough money to provide three months or so of living expenses for you and your partner. I would then use the remainder to pay off your highest loan and then use the subsequent $1,000 per month toward minimum payments and whatever loan has the highest interest rate.

I would count that 6.8% loan as already having that rate and make “payments” on that debt to a savings account. Then, when the subsidization ends, I’d pay the entire balance of that savings account to that 6.8% loan.

In terms of balancing emergency protection and a path toward debt freedom, I think this is a very good plan.

Q4: Repetitive questions
I’ve noticed that there are a lot of consistent shall we say themes in your reader mailbag questions. Student loans come up a lot for example and so does retirement. Why repeat so much?
- Shaun

The reason these stories show up so often is because they’re the type of concerns that cause people to really start thinking about their finances and because they are so common among people. A lot of people leave college with student loans and they worry about paying them off.

I use a lot of these types of questions because there are a lot of variations in the story and because it’s a genuine concern that a lot of people out there have.

I try to choose questions that reflect the whole of the questions that I receive. I do often pick out specific interesting ones, but I also see from my email inbox that I get a LOT of questions about student loans, so I cover those questions.

Q5: What’s next on my path?
I’m now fortunate to be in a position where I’m (finally) earning a great wage at a company I have no intention of leaving anytime soon, living in a city (NYC) that I love, and living well below my means.

It’s been drilled into me for years that paying off your credit card(s) and building a healthy emergency fund are the first foundation steps to a healthy financial life. I’ve accomplished both (finally!), and have $0 credit card debt (only one credit card), and $11,000 in savings. I still have outstanding student loans, which I’m paying back and contributing more than the minimum on each month – these are at a very low interest rate, and the total repayment each month comes to $350. Paying off one would save me about half of that amount as the payments are pretty much equal between the loans.

I’m also putting $12,000/year into a 401(k), and am planning on continuing to contribute $1,000/mo into my savings account for the next 9 months – until it reaches $20,000. Since I live in NYC, I plan on renting for quite a few more years and I’m planning ahead for when I’ll want to move (moving into a new apartment here typically costs $4-5,000 upfront in costs for my price range – first month’s rent, last month’s rent, possibly a broker’s fee and a security deposit). 6 months of my bills (if I were laid off) comes to about $15,000, and that’s my emergency fund savings goal since I don’t have close family in the area and wouldn’t want to have to move due to prolonged unemployment. The $20,000 goal for this year assumes that I’ll want to move within the next year, which is a possibility (but not set in stone).

I’m not in a hurry to change my plans right now as I still have a bit of time left to contribute to my savings account, but I’d like to have some solid steps in place when I get there.

So – what comes next? It seems like after the savings account, credit card and retirement account are all healthy (or being contributed to healthily), that any number of options open up. I don’t get an employer match on my 401(k), so it’s 100% my own money in there, and I’d like to max it out for a few years, due to not being able to contribute anything in my younger 20′s (4 years of working w/o the spare $$ to contribute). But, I’ll still have a good amount of money that I’m now putting into savings left over after maxing out my 401(k), and I want to make sure I’m investing it wisely, if that’s even the right first step after this.

Are there any recommended steps after this point, or does it depend on the individual and their goals?
- Jill

It really comes down to goal-setting more than anything else.

Simply put, there is no general right way to invest. There are only good ways to invest to help you reach a specific goal. If you don’t know what you’re saving for, you’re probably going to save in an inopportune manner.

Let’s say, for example, that you decide to start investing in stocks because you heard they have a great return, not because you had any goals in mind. Let’s say you make this decision in January 2008. In December 2008, you decide to buy a house because you got pregnant and you decided you needed a house for that child. Your money has now lost 40% of its value.

You would have been far better off in a savings account had you incorporated the idea of buying a house in the next one or two years into your plan.

Spend some time thinking about where you want your life to be in five years or ten years. Where are you headed? Your investment choices should really follow that.

Jill also had a follow-up question.

Q6: Time for a financial advisor?
At what point does a financial advisor become wise? I’ve never had the need of one before, but is there a certain point that someone should start thinking about consulting with one, if only to make sure they’re on the right track and not missing anything they should be doing?
- Jill

I’m of the belief that given all of the amazing tools available to individuals online, most people don’t need a financial advisor. You would have to have a lot of money in the bank in order for the benefits that an advisor can provide to make up for the amount you’d be paying this person for advice.

For most people, particularly those without a ton of money in the bank, doing it yourself is a much better option.

What’s the dividing line? I think some of it comes down to your gut, but if you’ve got enough money that a percent or two of it is a significant amount of money itself, that’s when I’d get an advisor.

Q7: Polite hygiene advice
How do I politely tell a coworker that they have really bad breath? It’s bad enough that it’s distracting in the workplace. I don’t know how to properly approach it.
- Anna

Unless the relationship with that person is poisonous, I’d quietly bring it up with that person directly. There’s a very good chance that the person does not know this and the vast majority of the time that person will be very glad to have that advice as it helps their career chances.

If you have a bad relationship with this person, then you might want to consider going to their supervisor. I wouldn’t register it as a complaint, but instead encourage that supervisor to have a chat with the employee about it.

The purpose of all of this is to improve the office environment on the whole. Candor without negativity or snark is almost always a good way to go.

Q8: Wedding and financial planning
I am 28 and currently in the process of saving for a house with my fiance who is 25. We both currently work at the same company where I am a full time employee, and he started this year as an intern working 30 hours a week. We are looking to buy a house next year after we come up with the necessary 20% down payment for up to a $200k house. So our goal is to have $40k + closing costs saved by early next year.

When it comes time to purchase, unfortunately the mortgage will be in my name alone since he has bad credit; whereas mine should be immaculate by the time next year rolls around. I have no debt, and pay off my credit card balance every month. He has about $5.2k in subsidized student loans that are currently in deferment until he graduates at the end of 2012. All his other delinquent accounts have been more or less settled.

Right now we have $11k saved in our emergency fund and have $9.7k in the down payment fund. I’ve set the ambitious, but attainable goal to set aside at least $2.5k a month. We would be projected to have saved just about $30k by the end of the year. My mother has offered to additionally gift me $10k which I can use as my “new” emergency fund if I have to dip into my current one.

I earn just under $50k a year, and he is set to make $25-$27k depending on if he works the full 30 hours a week. So our net income is about $4.5k-$5k a month depending how many business days there are in a month. My company matches 75% of my 401k contribution up to 7% of my annual salary which I am currently taking full advantage of, but since he’s not a full time employee, he does not get the same benefit.

Right now all his income (lesser $200/month into another account that will be for when the student loan comes due) goes straight into the down payment fund, and we live off about half of my gross salary. We have a few things in the pipeline that would be advantageous for us to have a house by first quarter of next year. Our wedding is slated for the end of May 2012, and our goal is to have the wedding reception at home with just family and a few friends. This would be about 30 people at most, and the total wedding costing less than $2000 (I hope).

Should I set up a Roth IRA for him and myself now? I had planned on waiting until we purchased the house. But the best contribution for retirement is time, right? Starting a Roth IRA would set back the time frame of when we would purchase our house.

We likely will have additional expenses such as furnishing and/or appliances for the house. Should I use my emergency fund to buy appliances? Should I save for longer, so that when we close, we can pay for furnishings in full? Or should I live using our existing, aged pieces until we save up enough to buy those new furnishings later? My mattress is over 10 years old and is due for replacing.
- Jean

You’re currently contributing about 12% of your salary to your 401(k) including match, which is a very good number given your age. I don’t think you need additional retirement savings when you have other such pressing financial goals. It might be worthwhile for your husband to have one, which could just be routed from the money he’s contributing to the down payment fund. $500 a month would get him past the annual Roth cap. Given his salary, I would probably shoot for about $200 a month, giving him about 10% of his salary toward retirement.

When we bought a house, we used a lot of the furnishings we had at our apartment at first. Supplement that with whatever low-end furniture you need to fill out, then slowly begin replacing it as you need to. This is exactly what we did and we were quite happy about it.

If your mattress needs replacing, replace it, particularly if it’s interfering with your sleep in any way.

Q9: What are readers like?
Do you ever get visual images of your readers or add in more details in your mind than what they give you in their emails?
- Connie

I imagine details about readers all the time.

I usually do that so that I can see them as a person rather than as a dry question. I try to imagine the best picture I can of the person asking the question so that I want to help them.

Sometimes, that can backfire because I’ll put more positive details with the person than there really should be. Most of the time, though, I find that if you make an effort to look at a person’s best side, they’ll step up the plate.

Q10: 2012 predictions
What do you think 2012 holds in store for our world? Got any big 2012 predictions?
- Kenny

I think Barack Obama will win re-election, not because he’s done a stellar job, but because he’s done a “good enough” job compared to what the competition is. I think we will see a significant third party impact in this election, too, because the Republican party’s coalition of social conservatives and fiscal conservatives is becoming more and more frayed.

I think the American economy will show continued signs of rebounding and will look comparatively stronger (economically) than Europe throughout the year.

I think that December 21, 2012 will pass without any significance other than perhaps a few reactionary people overreacting to a quirk in the Mayan calendar.

Got any questions? Email them to me or leave them in the comments and I’ll attempt to answer them in a future mailbag (which, by way of full disclosure, may also get re-posted on other websites that pick up my blog). However, I do receive hundreds of questions per week, so I may not necessarily be able to answer yours.

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