DFA Weekly Link Rally: Saving Money to Repay Debt in Lump Sums

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2nd mortgage, student loan, or save

If you didn’t already know, I am a staff writer with FiveCentNickel.com (see this link for my FCN article archives) and have articles published there every Thursday morning.  This past Thursday I asked the FCN readership to help me decide whether to repay my 2nd mortgage or my student loan debt first.  I received a lot of great advice but ended up deciding to save money while simultaneously accelerating debt repayment.

Let me explain…

If I had to decide to contribute all available funds toward a debt snowball one of these debts ahead of the other, I would choose the 2nd mortgage.  However, rather than lock up all available monies into debt repayment, we are choosing to save a majority of available monthly money in a Debt Repayment Fund (click to contribute,) then repay the debt in lump sum payments.  Yes, this strategy will cost a little more in interest, but the amounts are negligible compared to the incredible flexibility this approach affords us.

The economy and housing market are worse in Michigan than in most any other state.  The Debt Repayment Fund will accumulate for the purpose of lump sum debt repayments, but will also act as a hedge emergency fund against job loss.  How probable is job loss for us?  Very probable.  In fact, my wife’s employer has already warned that her position is likely to be eliminated for next school year.  Coupling this information with the tumultuous Michigan housing market, we are choosing to save most of our extra cash flow, then decide what to do with it as time passes.

We may use the Debt Repayment Fund to pay lump sum debt payments quarterly, bi-yearly, or yearly… we’re not sure yet.  What we do know is that a combination of increased principal payments and a hedge of savings is the best decision for us at this point in time.

Extra principal payments on two loans

To keep accelerated payment momentum going on our debt snowball we will still make extra principal payments on the two loans in question.  In my FCN article I asked for advice on whether to repay our 2nd mortgage or my student loan first.  We have an estimated excess of $1,500 each month and will disperse it like this:

  • Debt Repayment Fund = $1,000 (this is an interest bearing SmartyPig Savings account)
  • 2nd mortgage extra = $300 (this amount is added to our regularly scheduled monthly payments)
  • Matt’s student loan = $200 (this amount is added to our regularly scheduled monthly payments)

Any extra income over and above the $1,500 will also be saved in the Debt Repayment Fund.

In summary

We will pay extra principal payments on our two highest rate loans and save all excess in our Debt Repayment Fund for future lump sum debt payments.  We are doing this as a hedge against unemployment and a devastated Michigan housing market.

What do you think of this plan?

Link rally for this week



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1 Craig/FFB

I think these days you have to make sure you are secure against unemployment first. Lose your job and every payment is difficult. Sounds like what you are doing is reasonable. So long as you are saving the money and not spending it, the money will be there when things have gotten better economically and then you can put more into your mortgage.

2 Matt Jabs

The only chance the Debt Repayment Fund is tapped into is in the event of necessity brought on by job loss. To guard against even this we are working to diversity income through entrepreneurship.

3 BG

Is the debt repayment fund through ING or SmartyPig? SmartyPig has a 2.01% yield right now, whereas ING seems to be at 1.1% — you mention both in the writeup.

All, in all, a very reasonable and well thought out plan!

4 Matt Jabs

Ahhh… thanks for pointing that out. I was going to create a new ING Savings account, but decided to go with SmartyPig because of the higher rate – I just missed changing it when editing the article. Thanks for pointing it out, updated now.

5 Dave Ozment

Thanks Matt… I appreciate the link.

Dave

6 Kelly

I like the way you are using the extra income, Matt.
I think it’s a smart decision. Sorry to hear about the possibility of a layoff for your wife’s position, but I’m sure that brings you even more fire to make smart choices.

7 Matt Jabs

Thanks Kelly. We don’t mind the layoff as much because she may be ready for a change. This summer we have a few entrepreneurial ideas for her to get started on.

8 MyFinancialObjectives

Your plan sounds like something you would find in a finance book. Really that is pretty ingenious, the only hole I could see is if the interest that would otherwise accumulate on your loans turns out to not be so negligible. Really, great idea!

9 Matt Jabs

Thank you. The interest is calculable, so can know exactly how much based on the amount of time we save for the lump sum payments. After doing some test calculations, we have weighted the extra interest costs to be a few hundred dollars and deem it worth our while to save for security purposes.

10 BibleDebt

Good explanation on why you are holding money back. At least your ultimate goal is to pay the debt off. I assume you have the willpower to not spend the money somewhere else if the opportunity presents itself?

11 Matt Jabs

You better believe we do! 🙂

12 Ronnie

Your explanation makes perfect sense to me :D. Even hard core DR followers would acknowledge that he says that when there’s an imminent possibility that you’re going to need a stash of funds, that it’s okay to hold off on accelerating debt repayment. And the truth is, you’re still accelerating repayment on both loans, but you’re putting yourself and your family in a more secure position, should the need arise to use those funds. Best of luck to you!

13 Matt Jabs

Yeah, that’s the way we view it Ronnie. While I would love to knock down the maximum amount of debt every month, security is very important at this point… so we are doing a little bit of both! 🙂

14 TheDebtHawk.com

Matt, I like your plan a lot. I have been doing something similar this year. I have been saving all of my extra income in my emergency fund with the intent of paying off debt with that money, provided that I don’t lose my job. When I feel comfortable with my job stability, I will use the fund to pay down my student loan debt.

15 Matt Jabs

You hit the nail on the head! Good to know I’m not the only one following this path.

16 Money Funk

I LOVE paying my debts in lump sum! There is such an exhilarating feeling. So, I like your plan naturally. And I didn’t know you were a writer for FCN. Great job!

17 Matt Jabs

Yep, ever since 4/30/2009. 🙂

18 Steve in W MA

Disburse.

19 Budgeting in the Fun Stuff

I think you’re making the right decision…job instability sucks. Good luck on your Smarty Pig goal! That’s where we keep the majority of our emergency savings money right now…

20 Matt Jabs

Yeah, the SmartyPig account is paying us almost double what ING is, so it just makes sense. Although I’m not normally a rate chaser… double paying rates are tempting – I may move all our savings to SmartyPig!

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