Now, back to today’s post, which is about Emergency Funds (and, why you should NOT have one) …
To me emergency funds are dead money …
This is a controversial idea, so I get a lot of flack every time that I share my thoughts on this … but, I also get some agreement from readers like Milton:
A number of responses to your guest post seemed to misunderstand what you were saying about emergency funds. Your standard PF emergency fund is cash that is sitting in a bank account and earning a microscopic return that is being outpaced by inflation.
Some people … are sinking in debt, paying 18-25% on debt while their emergency fund earns less than 1%. It’s as if they don’t understand that those high-interest debts ARE THE EMERGENCY.
It seems idiotic, as Milton points out, to pay 18% on a $2,000 (say) credit card balance when you may have $10k cash ’emergency fund’ sitting in a CD (earning just 1.05%).
And, if you agree with that …
… then, why is it such a leap to realize that instead of even trying to build up an emergency fund of $10k (so that you can earn 1%) you should be trying to build up an investment fund (so that you can earn 8%+)?
But, that’s not the only ‘dead money’ that you need to mop up:
If you agree that earning 8% is better than earning 1%, why would you try and pay off your 1% student loan instead of investing that money at 8%?
Thanks for the great – and, well thought out – responses to Bristol’s shout out for help with his debts:
I was stuck in an internal conflict about paying off debt or investing for years until now. I would like to apply your debt cascade to my financial situation and need your help.
You’ll have to take a quick look at my original post for the details, but the jury was pretty much split over whether Bristol could (or should) pay off his debts now or later (for the purposes of investing instead).
Marie summarized the ‘FOR paying off the debt fast’ case quite succinctly:
Seems like he can pay off his loans in 19 months
But, many were on the AGAINST side, including traineeinvestor who offered some great advice:
I would invest it all and not make any early debt repayments. Five percent (the most expensive debt – assuming it is not tax deductable) is a pretty low threshold rate of return to beat and mortgages and student loans are unlikely to be called early unless you miss a payment.
I’m right on the fence with this one … for two reasons:
The first is that, while average returns are much better than the interest rates being earned (actually saved … but a dollar saved is a dollar earned right?), if Bristol also applies his $10k cash stash to the debt, it may take him <2 years to pay off all of the loans … over that short period who knows what investment returns will be?
And, there is something to be said for being debt free … especially when it can happen so quickly!
[AJC: on the proviso that the debt repayments are immediately rolled into an aggressive – and, maintained – investment program]
On the other hand, if Bristol has a plan to make an immediate investment (found a great business to buy or invest in; found a great real-estate investment; has a brilliant idea for anew business; and so on) then why hold off on ‘the big payoff’ to pay down circa 5% debt, instead?
But, Bristol has none of those plans right now, and that brings me to my second – much more important – point, foreshadowed by Luis:
Who cares about your debt at this time! What do you want to do with your life?
Bristol’s current life plan – not what to do with his debt – is the problem … because his current life plan is impossible!
Here’s what Bristol shared:
I do have a stable job where I invest in the 401k up to the match% only. I have $10000 in a savings [account] and $10000 in a few blue chip stocks. I would be willing to invest the majority of my savings. I am currently 23years old and would like to retire at least by age 55. So that would be 2066 and per cnn retirement calculator i would need 5.9million dollars (2.2million in todays dollars) to spend retirement happily. I think i could reasonably get 8% return. I think I would mostly like to invest in the stock market.
I think the expectation of working hard, living sensibly, saving hard, and starting young to retire on $2.2 million dollars (today’s dollars) in 30+ years would seem reasonable, wouldn’t it? In fact, this seems to be the mantra of much personal finance advice right now …
Yet, this is what happened when I sent Bristol off to play with an online calculator for a while:
I have been plugging my numbers into a similar calculator one that takes into consideration additional monthy contributions and have realized that if I want to reach my goal I will have to be much more aggresive. Although it is possible for me to get there, its just not happening on 8%. So I have alot of thinking to do about how to get there and how much risk Im willing to take. One thing is for sure, time is money and I will not be putting extra money onto the school loans anymore!
Inflation forces very large Numbers for even relatively modest retirements: <$90k p.a. in today’s dollars (Bristol’s approx. target, based on a 4% ‘safe’ withdrawal rate on his $2.2 mill. pre-inflation target) may be considered luxurious by many, but – be honest – would you be happy working hard and being financially disciplined for 30 years and retiring on less?
So, inflated (at a relatively modest 3% inflation rate) an ‘easy’ target like $90k a year (today’s dollars) requires you to save nearly $6 million over your working life; simple logic tells you that this is impossible for a normal working person … Bristol included.
Bristol’s problem isn’t how to pay his debt; it’s how to amass at least $6 million in 30 years!
And, Bristol’s not the only one …
Personal finance in America is broken; the advice is small picture (pay debt, live frugally).
Who’s there to give the Bristol’s of this world the big picture?
I’m publishing a whole series of posts targeting Debt … it has very little to do with conventional financial wisdom on this critical subject. Here is the second post (I have another one coming up, soon) …
If you have both debt and a need to save money, how do you prioritize? Some people will pay off debt at all costs before saving a penny. Others will be fine getting by with minimum payments while dumping as much money into savings or investments as possible. While others try to do a little bit of both. That’s why the poll today asks how you view this subject.
You should go ahead and answer the poll.
Now, this is such an important decision – perhaps one of the MOST important mindset changes that you need to make if you want to follow in my $7 million in 7years footsteps – that, for my new readers, I will point you again to my trademark Cash Cascade™ system (don’t worry, it’s simple and free) that replaces the Debt Snowball, the Debt Avalanche and most of the other other debt repayment systems that you may have previously tried.
Here’s why it works:
People make the mistake of thinking that there is GOOD DEBT (typically, investment debt) and BAD DEBT (typically, consumer debt) … but, this is only true BEFORE YOU TAKE ON THE DEBT.
Once you are in debt, then there is only CHEAP DEBT and EXPENSIVE DEBT. Put simply, pay down your expensive debt, until only the single digit ones (on an after tax basis) are left, THEN start investing.
This goes against the ‘pay down all debt’ theories, but works both logically and practically. Try it … and, let me know how it’s working for you?
Well, in this post I’m going to try and do exactly that but, first MoneyMonkasks the question that all people have at the back of their minds:
As a woman, I just want to say that “to each it’s own” Women love security.
If you are not a person that love investing, and you have the cash to pay off your mortgage (considering that you plan to live their forever)
Adrian- not everyone is business oriented. Some just don’t have the business acumen to run a business. Therefore, that group SHOULD pay off the mortgage
This is the dream of home ownership: own your home outright and you have nothing to worry about.
But, do you?
Let’s say that you own a $150,000 home today … what will it be worth in 30 year’s time?
About the same as a $150,000 home today, but in future dollars!
So, let me ask you; when your kids grow up, move out, and you retire, what are you going to move into?
Probably the same, or another $150,000 home … a smaller condo or newer townhouse that will probably not give you too much change, if any, from $150,000, a retirement home that (with fees) will cost you far more than $150,000.
Your home is not your financial security; your realizable net worth is. Put it another way: you can’t live off your home, but you can live off your cash and investments.
True security comes from knowing that you can pay your monthly bills for the rest of your life, without needing to work or get handouts from friends, relatives, or the government, through up markets and down (war, pestilence, and other Acts of God aside).
I hope that you see my point …
So, let’s look at two scenarios for a $150,000 house that you just bought and locked in a 30 year fixed rate loan at 6% (a bit higher than today’s actual rates, which are still between 5% and 5.5%):
1. You pay off your mortgage early
Note: We will assume that you are allowed to pay off as little / much as you like on your loan (not the case with some fixed rate loans in the USA, and certainly not the case with most fixed rate loans in most other countries!) because it makes the math simpler.
This is great, because you ‘earn’ 6% on your money [AJC: remember, a dollar saved – in interest – is the same as a dollar earned], better yet:
– The amount you ‘earn’ is guaranteed; every year that you are no longer paying that 6% loan, you are in effect earning 6% … simple and guaranteed!
– Unlike an investment that pays you 6%, there is no tax to be paid on the 6% mortgage that you save (although, there can be a negative benefit of losing the tax deduction on your home loan interest … but, I’m trying to keep this simple), so it’s more like earning 7.5% – 8.5% (depending on your tax rate) in any other investment.
– Let’s say that you plonk the entire $150k down in one hit, you save the entire $175k INTEREST (yes, a house that you buy for $150k in 2010 will have cost you $325k, just in principal and interest, by the time you have paid off the 30 year loan in 2040).
2. You do not pay off your mortgage early
Note: Paying the loan off slower will, naturally, save you something greater than $0 and less than $175,000 … but, is too hard to calculate, here, so we will continue to use the assumption that somehow, you were able to pay that entire $150k loan off in one hit.
Well, it’s a fairly simple calculation then, isn’t it: what can you invest $150,000 in that will return more than $175,000? Let’s run some numbers and see:
Business: If Michael Masterson is right, and we gain 50% (or more) from our own business, then after 30 years you would have earned $29 Billion on your $150k ‘seed capital’.
But, MoneyMonk is right: there is extreme risk and skill involved in being successful in business … just a shame the potential reward is so low 😉
[AJC: just a tad more than the $175k interest that you would have saved if you used the money to pay off your mortgage instead of starting a business]
Real-Estate and Stocks: Again, if Michael Masterson is right, and we gain 30% by investing in a mixture of buy/hold real-estate and stocks (naturally, continually reinvesting the rents and dividends), then after 30 years you would have $392 million …
… if that sounds a lot, remember that Warren Buffett built up a $40 Billion+ fortune over 40 years at not much more than 21% compounded.
Stocks: I agree with Michael Masterson, that if you buy stock in just a few good businesses when they are are going cheap (as the market does from time to time) and wait 30 years, you should have no trouble getting a 15% compounded (pre-tax) return so, after 30 years you would have nearly 10 million.
But, all of this has some risk / skill associated with it … so, maybe paying off the mortgage and snaffling that $175k is still the way to go for all of those risk averse people [AJC: Like me. True!] out there?
But, wait, what if we just do the ‘no brainer’ thing and plonk that entire $150k in a set-and-forget-low-cost-Index-Fund?
Here’s the good news: paying off your mortgage is a 30 year investment (you have forgone 30 years of being locked in to a loan and paying 6% interest year in, year out), so it’s only fair that we buy $150k of Index Fund units and don’t even look at our portfolio for 30 years, right?
Well, that’s an ideal strategy – THE ideal strategy – for Boglehead set-and-forget investors! So …
Index Funds: Over 30 years, the markets (hence the lowest cost Index Funds) have averaged something more than 12% – set and forget (!) – so, after 30 years you would still gain close to $3.5 million!
But, wait … we’re all about security here: you can’t live off averages, right? What happens if there’s another crash like 1929 and 2008 the day after I plonk my entire $150k into an Index Fund?
Well, you lose half your money immediately 🙁
But, we don’t care what happens immediately, this is a 30 year set-and-forget plan … and, there has been NO 30 year period where the stock market hasn’t returned AT LEAST 8%.
Now, isn’t 8% (since we have to pay tax on it) exactly the same as the equivalent after-tax 6% mortgage (give or take 0.5%)?
The lowest possible return that we can get with any reasonable investment strategy that we can come up with is exactly the same as the best possible return that we can get by paying off our mortgage early.
Dave Ramsey says to use Gazelle Intensity to pay down all debt, before even thinking about investing. Yet, would he consider running his (rather large) business without an overdraft, or leased cars, equipment, and/or furniture?
I doubt it … he needs to preserve his capital, and put it to better use by growing his business investment (more stock; better marketing; more staff; more training; etc.; etc.)
So, why should personal finance be any different?!
But, Dave Ramsey would argue to pay off all debt, whether it is ‘good’ (e.g. produces income) or ‘bad’ (e.g. credit card loans for consumer goods, like that LCD TV that you just bought).
If you are a regular reader of this blog, by now you will know that my view differs markedly; I say:
Once the debt is incurred, it is no longer ‘good’ or ‘bad’ … it becomes either ‘cheap’ or ‘expensive’.
What makes a debt ‘cheap’ or ‘expensive’? What is the yardstick interest rate? 2%? 5%? 11%? 19%?
Any, all, or none of the above. You see, it’s relative:
– Debt only becomes ‘cheap’ when you have something that produces a better after-tax return [AJC: probably, a MUCH better return to account for the fact that paying off the debt is a GUARANTEED return].
– Otherwise, by default, all debt becomes ‘expensive’ and you should do as Dave Ramsey suggests.
Fortunately, finding suitable investments to offset the need to pay off relatively low-cost debts such as student loans and home mortgages is as easy as finding some great value stocks, a cashflow positive real-estate investment or three, or a small business to buy or begin …
I recommend that – if you are pursuing a Large Number / Soon Date – you must pursue your investments with Cheetah Focus … a great example is provided by Eric [AJC: emphasis added]:
I graduated college 2008 from the University of Texas. worked at an oil and gas company in Houston named Flour Daniels. they had massive lay offs in 2009. I worked for a year and managed to save well over 50% of my pay. I reinvested it all into the stock market. I set up a regular investment account and a Roth IRA.
To date my Reg. Stock account is up 30%+ and my Roth IRA is up over 60%. and I still have another month to increase my yearly gains for it
I have had no prior experience with investing/trading. I played safer stocks/ETFs .. Bought on dips and sold when it would pop.
Oh and I also took out a loan from Citi bank.. who sent me a 10,000 loan offer in the mail with a 2% interest for the life of the loan. LOL.. I had to take it. I threw that into stocks also.
Any how my point is. If i had focused on paying off my $28,000 college debt I would have missed all of last year gains. I just made it a goal to beat my debt interest. and I did!
Currently I have enough money to pay off all my debt. but of course i’m not going to do it. I took out 2K from my portfolio to invest in an online woman’s clothing site. We have great style at affordable prices. we are not making huge profits.. but we are selling and that is encouraging.
Did you notice in the image (above) why the gazelle has such intensity?
It’s because the cheetah is coming up fast and furious on his tail 😉
Adam (a staff writer at Get Rich Slowly) wants you to “challenge yourself” by replacing the the standard ‘pay yourself first’ advice with:
Only pay yourself first if you deserve it.
Now, Adam isn’t suggesting that you stop saving that 10% to 15% of your gross income that the bulk of the personal finance blogosphere recommends …
… what Adam is really asking is:
Should You Stop Funding Retirement to Focus on Debt?
[This] is one of the most heavily debated dilemmas in personal finance. Unlike “spend less than you earn” or “track every penny you spend”, there’s no cookie-cutter answer to this question. Variables such as age, career, risk tolerance, and even personality type make each individual situation unique.
This is a good line of questioning – and I encourage you to read his article – but, unlike Adam, I think there is a “cookie-cutter answer to this question”:
You should always ‘pay yourself first’ …
… but, where you place that money depends on where you earn the greatest after-tax return.
Keeping in mind that a “dollar saved is a dollar earned”, it could be in:
– Your 401k, potentially earning 8% plus the value of any employer matches (in an earlier post, we calculated this as providing another % point or two to your long term return),
– Your debts, potentially saving 10% to 30% interest on high-interest car, credit card, and consumer loans,
– Your real-estate investment strategy, potentially earning 15% to 25% in long-term rental increases and capital appreciation,
– Your seed capital for your new business, potentially earning 50%+ in future profits and windfall gains on the sale of the business,
But, is unlikely to be found in paying off low interest student loans (saving 0% to 5%) or mortgages (saving 4% to 6%) or in investing in low interest savings such as bank accounts, bonds, or CD’s (earning 1% – 5%).
Blindly plonking your money into your 401k, or paying off debt, or paying down your mortgage is not the way to get rich(er) quick(er) … 7m7y readers always look at their options in terms of greatest contribution to reaching their Number.
… which seems like I am flipping, when I should be flopping, about debt. Until you realize that I can just as equally claim that there’s nothing wrong with being in debt, either.
You see, it depends.
In fact, what I contend is that the majority of my readers NEED to be in debt … but, that’s not the same as advocating debt for debt’s sake.
Let me explain by introducing you to a new reader, Lee, who asks:
I’ve been reading about this 20% rule and it does make sense, but after what happened with real estate over the past 18 months do you still think this is a good approach? Right now, I have about 55% equity in my home. To get my home to only be 20% of my networth I would need to refinance it to 80% LTV. I have a pretty low rate (4.625%) and only have 9 years 8 months left on my mortgage. Would you still recommend someone in my situation refinancing?
After a lot of confusing to’ing and fro’ing [AJC: you can go pack to that post and read all of the comments … in fact. I would encourage it, because this is one of my Top 3 most widely read posts], I asked Lee what I think are the critical questions:
1. Do you have a Date in mind, when you REALLY want (nay, NEED) to stop working so that you finally have time to live your Life’s Purpose?
2. Do you have a Number in mind, that represents how much you need in your nest egg (be that the bank, ‘passive’ investments, your house – although, you may need to think how you plan to access those funds to live from – etc.)?
If not, I suggest that’s your first task: think about your Number and Date. Already (or just) got them?! Good … now;
3. Will your current financial plans and strategies get you to your Number by your Date?
To which Lee responded:
As far as retiring by no later than 55, yes my current path will easily provide for that. If I choose to the pursue the passion I mentioned earlier, then that would impact the amount of money I would need in the short term, but would not affect my long term retirement goals.
If your current financial strategy is working for you – i.e. in that you are happy with your current work and financial arrangement, and believe that you can achieve your Number by your Date – why would you even think about changing anything, Lee?!
So, let me go back and clear up the confusion about debt for my other readers:
– If you can achieve your Number by your Date WITHOUT the use of debt then PLEASE do so,
– Otherwise, what choice do you have but the wise application of debt?
… I just happen to believe that for the vast majority of my readers, Door # 2 (‘wise application of debt’) is the one that holds their prize 🙂
If you needed any evidence that the ‘global financial crisis’ – on a global macro level – and problems with the US real-estate market – on a global micro level – are still affecting people in the their day to day lives, you need read no further than Rischa in Seattle’s comment [AJC: I’ve added punctuation for your reading pleasure]:
From what I’ve read I think we’re screwed, but I’m not even sure what we can do. Here is the scenario: my husband and I bought this house about 10 years ago in the boom here; with both of us working we could afford the mortgage and our lifestyle easily. I’ve [since] been laid off and we’ve been living on my savings, which is now gone and I’m on unemployment, which is fast running out.
We’re about $100K upside down, we got a trad. loan 30 yr fixed, but without 2 incomes we’re sinking fast. We don’t necessarily want to stay in this house, in fact we want to move to a part of the country where the cost of living is less.
Any clues? What should we do? How do we get out of this when getting out would cost more than we have, even if we spent our retirement to get out? We would have less than nothing left!
Of course, it’s difficult to give Rischa personal advice – and, I wouldn’t do it – but, I could suggest that she go back to that post and reread the bit where I said:
Ask yourself the following TWO questions:
i) Can I afford the payments? If so,
ii) If I were to invest in a house right now, given my current net worth, is this the house that I would invest in ?
If the answer to both questions is YES, then stay. If the answer to either question is NO, then sell/move … be it into a rental or to purchase another (provided that the changeover costs/hassles are worth it).
In Rischa’s case, the answer to the first question appears to be NO … and, she would prefer to be moving to a cheaper part of the country (and, cheaper house?), anyway …
So, it’s obvious that she can’t afford her existing house, but what would you do? Hang on to a losing proposition? Or, cut your losses?
One of Dave Ramsey’s most popular ideas is that of a debt snowball. The idea is that you pay off your smallest debts first, then roll that debt’s monthly payment into the next smallest. When the next smallest is paid off, you roll the two former payments into the next smallest debt.The snowball grows and grow with each debt that’s repaid.
Here’s a real life example; here are your three debts and minimum payments:
$10,000 @ 20% APY, $500 minimum monthly payment
$4,000 @ 10%, $200 minimum monthly payment
$1,500 @ 12.5%, $75 minimum monthly payment + EXTRA PAYMENT
The debt snowball method states that you should put all extra debt payments towards the $1,500 balance. When you finally pay off that debt, your new payment schedule should look like this:
I have only added the words “EXTRA PAYMENT” to both examples, because I want to clarify – then expand upon – BFFP’s example.
First, though, what Dave Ramsey is saying – and, what BFFP is trying to illustrate – is the concept that you take one of your debts (the highest interest rate in the traditional ‘Debt Avalanche’ or the smallest balance owing in Dave Ramsey’s more psychologically-friendly ‘Debt Snowball’ method) and pay that down completely … merely making the required minimum payments on any other loans (but no more!) to stop them from going into default.
The credit card companies will love you for this!
Then when that loan is paid off in full you apply the payment that you USED to make on the first loan that you tackled to the next remaining debt, and so on …
… it ‘snowballs’ because you are applying more and more to each remaining debt, while never having to commit more (or less) to debt servicing than when you first started budgeting.
So, in both examples we are paying $775 (i.e. $500 + $200 + $75) towards debt repayment until all debts are paid off … THEN – conventional financial wisdom will tell you – you get to start INVESTING that $775 a month and you are FINALLY debt free and on your way to … what?
Well, let’s go back and make the small correction: if you only make the minimum payments, you will never pay off any of the debts (or, way too slowly), so you need to find some extra money and make some extra payments to the first loan that you decide to tackle; let’s use an example of $225 a month as an extra payment …
… and, from now on you commit to that monthly $1,000 i.e. $500 + $200 + $75 + $225 EXTRA PAYMENT + C.P.I. + 50% of any ‘found money’ (second jobs, part-time business income, loose change, IRS refund checks, etc., etc.) for your entire working life!
So, we are on the road to success! Or, are we?
The problem is that we have to decide where we’re heading: if our aim is to become a Ramseyesque Debt-Free=Happy clone, then well and good. Your financial plan is set.
[sign off now]
But, if we intend to get rich(er) quick(er)™ we have two huge limitations, neither of which the Debt Snowball or Debt Avalanche address:
If we lose just 10 years to our investing plan by delaying investing while we pay down ALL of our debt and/or pay down our mortgage we can halve our potential return.
Do you think that might be significant?
So, we don’t want our debt-repayment strategy to unnecessarily delay our investment strategy.
Where are we going to get the money to invest?
Sure we can accumulate $1,000 a month (after paying off debt) – and, grow that amount through C.P.I. and ‘found money’ strategies -but, will that really set us off on the path to financial riches?
The same graph shows that for every $1,000 A YEAR we invest, we can expect $100,000 after 20 years … so, our $1,000 A MONTH strategy should yield $1.2 Million over the same time period … unfortunately, that won’t be enough for a DEPOSIT on the Number that you really need …
… and, inflation will take at least a 50% chunk of that (not to mention taxes)!
So, the solution for most people – who don’t want to lower their expectations to match this depressing, but debt-free (!) scenario – is to move INTO debt … to invest!
This is so-called ‘good debt’ and I’m not sure what Dave Ramsey and Suze Orman’s take on this is, but most financial pundits call it ‘good debt’ for a reason. Assuming that you agree, read on [AJC: if not, I’m guessing that you hit <delete> about 4 or 5 paragraphs ago]
So, here’s what we need …. a different mind-set:
Since we already know that we will more than likely need to incur SOME ‘good debt’ as part of our investment strategy (i.e. some safe level of leverage for investment purposes e.g. a loan on a rental property) …
… why pay off OLD debt now in order to accumulate NEW debt later?
It doesn’t make sense, does it?
We merely waste time and money … instead, we should resolve the following:
1. To treat all Consumer Debt as ‘bad’ and incur no further such debt, unless it’s not really Consumer Debt at all (e.g. we need to buy a car to run our catering business, and public transport or a bike really won’t cut it)
2. To apply the minimum required payments + extra payment(s) + c.p.i. + ‘found money’ not merely to the lesser goal of paying down debt, but to the greater goal of helping us get to our Number (i.e. the financial representation of our Life’s Purpose [AJC: if you don’t buy into that philosophy, then simply insert the words “helping us become financially free”])
3. To, from this day forth, look at all debt as an INVESTMENT in your financial future: and, simply ‘invest’ where you get the greatest returns: is that in paying off an old debt? Or, is it in acquiring a new debt?
In the example above, we have three debts of 20%, 12.5% and 10% (are they tax deductible? If so, look at the after tax cost which will be 25% to 35% lower than the nominal interest rates circa 14%, 8.5%, and 7% respectively) …
Compare these interest rates to the cost of money for the types of investments that you want to make …
… in this example, all three are higher than current mortgage rates so you will probably want to keep paying them off (although a good argument can be made for paying off the 20% loan first, then buying an investment property BEFORE paying off the others).
Let’s make two changes to our example:
Let’s assume that one of the loans is a 2.5% Student Loan, and swap the amounts owing (so that the Student loan is now the ‘biggie’) and, let’s assume that we have at least 5 more years before it HAS to be paid back (so we have time to make an investment work for us); here’s our starting position:
Once we have paid off our two HIGH INTEREST loans, instead of paying down the low interest student loan, we continue to make its minimum monthly payment, and instead apply all of the previous / extra loan payments (from our OLD loans) to building up a ‘reserve’ in a bank account (it pays us a – low – rate of interest!) …
… at this rate, we will have a deposit on a small rental (or our own first studio apartment) in less than a year, then our financial picture will look something like this:
Keep in mind that if you used Reserve # 1 to build up a deposit on a small apartment to live in, then you will have no rent to pay, so you can apply part to home ownership expenses (rates/utilities/taxes) and part towards your next Reserve!
And, if you bought a rental, then you may be in an excess rent situation and have more to apply to building your next Reserve, as well … if not, then you will need to decrease the amount going towards your next reserve to cover any rental shortfalls (e.g. mortgage payment deficits, vacancies, repairs & maintenance fund, etc.).
Now, you know why this is not a Debt Snowball, a Debt Avalanche, or even a Debt Meltdown:
It’s the Cash Cascade …
… the new way to look at paying down debt!
In the two years that it would have taken you to pay off your Student Loan and buy your first property, you now own two properties and are well on your way to financial freedom!