[Adrienne]

Originally Posted by Pat P.

Congrats on your graduation. I have a different take on this deal.

First, you are not taking into account taxes. If you are taxed in the 25% bracket (which is likely), a 5% CD will return effectively around 4%, which will barely keep up with inflation. So in order to beat taxes and inflation you need to invest into a vehicle that has returned over 10% over a long period of time (at least 5 years). Therefore, it would be wiser to pay off part of your debt in the first year instead of saving for a house.

Second, you are assuming you will have your income (wages) for as long as you keep your debt (15 or 30 years on the two scenarios your are contemplating). But statistics tell us that the average time in a job is about 4 years (From "48 days to the work you love", by Dan Miller), so in the period of time you are considering you would change jobs/be laid-off at least two or three times, adding much more stress to your finances.

I'll suggest a different approach. If your total debt right now are the 55K of students loans you have mentioned, pay them as soon as you can. I don't know what are the entry salaries for law graduates (I am an engineer ) but assuming a 65K a year take-home salary, if you get intense you could be clear on two years or less. This means living with 35K and paying off around $2400 a month.

Now, say that you are debt free at the start of the third year. Now you can take those same 2400 you were paying on your students loans, and in six months have an emergency fund of about 15K.

After that, you can start thinking about a house. If you are planning to buy a 135K house, you could buy it for 25% down in a year, or if you really don't like debt, do a 100% down payment in 4. Notice that if you lose your job or have any other kind of emergency, your emergency fund could help you pass them, without disrupting your long term plans. Remember that after the emergency you have to restock the fund.

This may sound an extremely crazy approach, but you could be debt free, have an emergency fund and a house in less than 7 years. Also, I have not considered you can increase your income (which is likely) substantially on this period, which can make the plan easier to bear or accelerate the goal achievement.

If you are more interested in this approach, look up for one of Dave Ramseys "Total Money Makeover", or catch a one hour of his daily radio show on iTunes.

Finally, I have done part of this stuff. My wife and I payed off 28K of debts in 10 months following Dave's plan. Now we are building our emergency fund. If you are not convinced, look for one of his shows on iTunes (its free and the podcast is only 40 minutes long).

Good luck,
Pat

PD: One more thing about taxes deductions and mortgages. Say that you have a 200K mortgage with a 5% rate. Then the interest will be 10K a year which you can write of your taxes. On the other hand, if you don't have a mortgage, you would have to pay taxes on that 10K. In a 25% bracket that is $2500. So if you keep your mortgage you are "saving" to send 2.5K to the IRS by giving 10K to the bank. IMHO that is bad math .

You are discounting far too many factors for example, the equity you would make in those 7 years (usually at least 3 percent a year). If you buy a house for 100K in 7 years that is almost 25 grand in equity you have made that you aren’t paying taxes on.

You are also assuming a very low interest rate. Every CD right now is about 5.25 percent. And only someone who had not done any research on investing or is terrified of any risk would plan to invest in a CD over long term.

I personally get around 18-25 percent a year on my stock, mutual funds, 401K, etc. So when I say, 10 percent when I did the initial math, that is actually very conservative. I was using 10 percent because the US stock market goes up about 10 percent a year as an average for the past 100 years.

Also if some of your investments are paper money or tax sheltered or in real-estate then you aren’t paying 25 percent tax on that yet.

For example, all my stocks I have never had to pay tax on with the exception of dividends. Why? Because as they go up in value, I don’t pay taxes on them until I cash them out.

As to student loans, why would you pay those off? If they are at 3 percent and 6 percent and if you invest that money instead and earn back over 10 percent, you still end up on the winning side of things if you don’t pay it off right away. Even 10 percent – 6 percent you are making – you end up with 4 percent more. You don’t pay taxes on that 4 percent until you cash it out so the 4 percent continues to make money on itself.

Also, if you don’t buy a house, then you are paying rent and that is money you are just throwing away anyway, might as well build equity.

Adrienne