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Debt extinguished. Now what?

Chris Farrell Jul 11, 2011

Question: For the last couple of years, I have been slowly but surely paying off the “bank of dad” in $500 installments for a loan for my first graduate degree. I am nearly done paying my Dad and so am anticipating an extra $500 in my monthly budget. I do not carry any credit card balance, but I am steadily paying off federal student loans from my second graduate degree (law school — current balance around $35K). I contribute monthly to an Roth-IRA as well as to my work 401K. I also set aside money each month into my savings account. How should I best direct my extra monthly $500? Accelerate paying off my law school loans, put more money into my retirement funds (and if so, which one), or increase my personal savings (I am trying to create a pile of money for a potential down payment for a house or just general emergency fund savings)? Thanks for any advice you may provide. Sincerely, Mary Margaret, Jacksonville, FL

Answer: It always feels good to retire a debt, doesn’t it? I like the ideas you have for what to do with the $500 going forward. In an important sense you can’t go wrong with any of your thoughts. Getting rid of school loan faster? Good. Putting more money toward retirement? Smart. Building up emergency savings? Bravo.

The answer is partly practical and partly psychological. In other words, which approach will get you closer to a practical goal and make you feel better.

So, if it were me I would focus on building up emergency savings because over time a healthy margin of financial safety increases freedom of choice. A large savings account would make me fell better. But I have a friend that would put everything toward her student loans. Debt weighs on her even when the financial burden is manageable.

It isn’t a question of I’m right and she’s wrong or vice versa. The issue is which approach will best improve our personal fiscal finess, practically and emotionally.

That said, a critical question is are you maximizing your contributions into your 401(k)? If not, I would do that right away. If you are maximizing retirement savings at work then I would focus more on either the emergency savings or the student loans.

I usually lean toward attacking one financial problem at a time to make a bigger difference faster. However, you’re a good saver. It isn’t a mistake at all to decide on splitting the difference. You could put $200 into savings and $300 toward the student loans; or $300 into savings and $200 into loans; and so on.

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