Occasionally I answer reader questions and give them a public financial checkup. The lucky reader gets free advice; you get a peek at somebody else’s money. If you want to be considered for a future checkup and are willing to share your finances with me, learn more here.
Today’s checkup is for Erik, a 24 year-old corporate trainer from Phoenix, AZ who is hoping to balance repaying over $100k of student loan debt with saving for emergencies, his wedding, and—hopefully—a house.
Here’s Erik’s situation in his own words:
My fiance and I are going to get married in the fall of 2012. Combined, we have $110,000 in student loan debt [and] our gross annual income is about $75,000…We’re saving for the wedding and are also trying to save for a house, but do not have enough money for both… We are also conscious of retirement, and I contribute 6% to my 401(k) and have approximately $2,500 in that. I read a lot about finances, but I am just not sure if I am doing everything right.
Our short term goals are to save up for the wedding and also start saving enough so that we can put a down payment on a house within three years. (We anticipate needing $20,000 for the wedding. We have $5,000 saved for it so far.) Longer term, we’d like to reduce the student loan debt considerably in five years, and make smaller monthly payments. I want to be putting more into our retirement as well, with a goal of approximately $50k combined in retirement at the age of 30.
Here’s a breakdown of Erik’s income, expenses, assets, and debts:
Erik’s Net Worth
- Free rent is a benefit of Erik’s fiancee’s job, although they don’t expect that job to last for more than three years.
- Erik’s monthly car payment is $138, but he’s opted to pay down the loan faster at a rate of $110 every two weeks.
- Not included in the above picture is Erik’s $240 monthly pre-tax 401(k) contribution.
Erik and his fiancee have a lot of education debt for their income. (A crude rule of thumb I use is that you don’t want to owe more in non-mortgage debt than you earn annually before taxes.) Erik mentioned in the emails we traded that he’s exploring a second income stream that could bring in up to $15,000 a year, which I think is a great move. He also recently earned an MBA and his current job doesn’t reflect that yet. As tough as the market is, I would make it a priority to begin searching for a higher-paying job for which the new degree qualifies him for. The best time to look for a job is when you already have a good job.
Erik also noted his fiancees income isn’t totally secure, which to me means that they should probably focus on saving cash before repaying debt. This also means they should definitely hold off on buying a home until he knows that he and the future Mrs. can earn at a consistent level for the foreseeable future.
On the upside, Erik and his fiancee have a safety net in their emergency savings. Also, they live rent- and utility-free. This allows them to deal with their $1,200 student loan payments, other expenses, and have enough left over to save every month.
What I don’t like about Erik’s situation is that it’s precarious. If they lose an income, the free housing, or both, they may not be able to cover both their debt payments and minimum monthly expenses.
1. Earn More Money: For the above reason, I think Erik’s doing the right thing in looking to earn more. I also think that saving cash should be a priority over paying down debt. If he can save $1,000 a month, I would continue to do so until they get married, and even a little bit beyond. Erik says his monthly expenses are about $3,100, meaning he needs $18,000 in savings to cover six months’ expenses. Although they have that now, they’re designating some of their wedding and, at their current rate of savings, they won’t be able to cover their $20,000 wedding and have a six-month emergency fund leftover.
2. Reevaluate Savings Priorities: Trimming the wedding budget is an idea, but at the very least, I would have six months of expenses saved in cash even after they pay for the wedding. Then, it’s time to look at debt, upping the retirement contributions, and, when all else is in order, a house.
3. Pay Off Some Debt: After the wedding, I would pay off some debt by funneling extra cash to the car loan and high interest student loan. Although one student loan has a higher interest rate, the car loan has a higher monthly payment that you’re responsible for. Plus, it’s always better to have a lien-free car if, for no other reason, it’s easier to sell if needed. Personally, I would then pay off the 8.75% student loan before starting to think about a home. (The reality is that it probably makes sense to rent until they earn a bit more and/or have reduced a bit of debt.)
4. Up Retirement Savings and Then Save for a House: After repaying those two debts, I recommend Erik up his retirement savings to 15% of gross income, Then, he can start saving money to put 20% down on a house. With that amount saved, no consumer debt, and regular 15% retirement contributions, Erik will be in as good a position as possible to buy a home.
ERIK’S MONEY REPORT CARD
Here’s how I think Erik’s situation stacks up, right now.
Despite Erik’s large education loans, he’s headed in the right direction…especially for being 24. He and his fiancee are smart to have taken advantage of free housing, but as life’s big expenses (a wedding and a home) creep closer, they’re going to have to hustle to stay ahead. That means:
- Ensuring they still have enough emergency cash on hand after the wedding.
- When possible, paying off the car loan and highest interest student loan.
- Increasing their income.
- Increasing retirement contributions when possible.
What do you think? What advice would you give Erik and his fiancee? Share your thoughts in a comment.