It seems fitting that the first guest post on my site is by my first blogger friend! Matt and I met tweeting during the Berkshire Hathaway annual meeting this spring. I’m honored that he used some of the work I’ve shared on my blog to help make an important life decision – saving for a down payment vs. paying down student loan debt!
Matt writes the Distilled Dollar and is a Chicago based CPA. He, and along with his fiancée, is distilling $$$ topics on their path towards financial independence in their 30’s.
Take it away Matt!
We don’t need to have a high IQ to become financially independent, we only need to avoid real stupid mistakes.
It can take years, or even decades, to recover from making poor decisions. In the spirit of smart decision making, I’ve borrowed Vicki’s excellent framework to answer the burning financial question on my mind: Should we save for a down payment or pay down student loan debt?
This question has been troubling me for about six months because 2017 will be the first year we will have extra cash AFTER maxing out pre-tax accounts. Before I dive into the decision making framework, I wanted to say this process was amazing because it offered us clarity and confidence on what the correct course of action is. As you’ll see below, once we broke it all down, the right decision could not be more obvious.
Spoiler alert: This post sheds light on why student loans are delaying home purchases.
As Vicki highlighted, important life decisions involve the head AND the heart. With personal finance, it is extremely tempting to pick the path that yields the highest return for our efforts, and results in our net worth being higher rather than lower. But, bringing it back to reality, monumental decisions like the one I’m facing require more than just those lovely tangible numbers.
The first step is defining the question. In my case, it is relatively straight forward, “Should we use our extra monthly cash flows to save for a down payment on a home or to accelerate our student loan repayments?”
Second step is to define our goal. Our end goal, and I often use “our” because I refer to the collective me-and-my-fiancée, is reaching financial independence in our 30’s.
Now, that’s a big goal that might be 10+ years out relative to where we are today, at the age of 26 and 27. So, we’ve developed smaller milestones along the way to reaching the large goal down the road. Before I dive into these, I want to shed light on a fundamental belief I have and that is:
It is much more critical to focus on our alignment towards our goals than to focus on our goals.
What I mean is, we need to make sure we take the right actions today, and not get distracted by what lies too far ahead. As anyone who’s ever climbed a ladder will tell you — focus on the one rung ahead of you at a time.
Another way to view this belief is the phrase, “our actions speak louder than our words.” If we’re taking all these different steps that are just not putting us closer towards our goals, then we are clearly out of alignment. If this is the case, then I typically spend some time trying to understand why I’m out of alignment in the first place. Then I either change my approach or change my goal.
Especially with long-term goals, life has a funny way of throwing curve balls. In 3 years you might realize that your 5 year plan no longer makes sense. This isn’t a bad thing, it just means you’re growing as person and your circumstances and/or priorities have changed.
From this perspective, our short term goal is to build the right habits today that will reinforce our ability to reach financial independence in our 30’s. This is more of a “means” goal, so I’ll come back to this in step 4.
The third step is to come up with creative options.
The first creative option that came to my mind is that we, a newly engaged couple, could move back in with our parents and do both — save and pay down debt! Hah! Hahahaha!
While it might be the best move we COULD make financially, I’m not sure it would help us in regards to EVERYTHING ELSE (e.g. sanity)…
The fourth step is creating a results table and here is ours:
The fifth step is to compare your options.
One helpful tip right off the bat is you can eliminate an entire row if it produces the same result in each option. For us, our overarching goal is FI in our 30’s is satisfied in every scenario, thus it wasn’t a helpful category when it came down to decision making.
You’ll note every scenario involves using already saved cash each month – which is a prerequisite towards early financial independence. I thought of putting a 5th creative option as “spend the extra cash,” but that might be too creative.
The second row made us eliminate both moving back in with either set of parents AND invest the extra cash into index funds.
Building the right habits of being independent would take a backseat if we were to go back to living under our parent’s roof again. As for index investing, it is tempting, but with after tax dollars and with two other higher ROI options, this option would mean I opted for the less optimal route.
Skipping the middle row for now, I noticed the 5th and 6th rows now were a tie for my only two remaining options so I eliminated them.
Bottom line, here are the key decision making factors:
Based on the remaining rows, it is now clear that we need to accelerate our student loan payments.
Our degree of freedom — including our mobility — will be greatly reduced if we sign a mortgage. My fiancée and I are both rooted in Chicago, and we intend to live in this city for the foreseeable future, but we do not know which specific neighborhood/condo/house we want to live in.
The transaction costs involved with purchasing a house means we should want to live in that home for at least a few years, if not closer to 5+ years. We also know we’re saving a tremendous amount of money today by living in a one bedroom condo, and that our overall financial stress stems from having a mountain of student loan debt.
All of these factors support our decision to continue renting our current place.
I know my fiancée will only feel completely stress-free once that mountain of debt is gone. In this scenario, with our pre tax accounts maxed out, our overall net worth does not matter AS MUCH as reducing this debt.
This goes back to the head AND the heart – don’t forget what matters to you on a personal and emotional level. If you’re not aligned with your goals, then you’ll start taking actions that divert you away from what you want to achieve.
The sixth and final step is to commit and take action.
In order to do that, we decided to take two meaningful steps in our lives.
The first is my going through the process of refinancing my student loans to pay them off quicker and at a lower interest rate.
The second, is my fiancée paying an additional $500/month towards her highest interest rate loan.
Creating a decision framework gave us a powerful tool to arrive at a critical financial decision.
The Chemist O.A. Battista said, “An error doesn’t become a mistake until you refuse to correct it.” I’m sure errors will still happen in our life, but thanks to this framework on making smarter decisions, I’m confident we will avoid those real stupid mistakes.
Have you had to make a similar decision between saving for a down payment or paying down debt? Have student loans delayed your plans to become a homeowner? Have you faced another decision where you could apply Vicki’s framework or do you plan on using it for an upcoming decision you face?
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