The debt strategy

The first priority is paying down debt. (We are doing what we can to bring a child into the world, but right now we can't afford an international or private adoption and don't qualify to adopt from foster care. Homestead is obviously not a possibility until we have money.)

Here's the strategy.

Our student loans are in two major categories: federal and private. The federal loans come with the regular choices of plan. We basically only qualify for regular and graduated. The private loan comes with two options: 10 years or 25 years.

The most obvious option, and the one normal sites will recommend, is to take regular for federal and 10 years for private, slash the budget, and put as much money to debt as possible. Then we'll be minimizing interest paid by paying them off as quickly as possible. Right?

Wrong. What we plan to do is sign up for the graduated payments and the 25-year plan, slash the budget, and put as much money to debt as possible. We'll actually wind up paying less interest if we do it right. (The idea that you pay more interest choosing these plans is only true if you don't pay extra money beyond the minimum, or if at any point you let a month go by where you don't pay all your interest and it capitalizes.)

So how much money?
1. 1000/month. This is a line item in our budget. It comes out on payday.
2. The leftovers. This is whatever we don't spend. It goes in the day before payday. My short-term goal is to have this be at least $500/month. My long-term goal? ...Well, we'll see.

And how does it get allocated?
1. Minimum payment to each lender.
2. Check: Is all the interest paid off? Has the principle of each loan gone down, even if only by a dollar or a penny? If not, make the additional payment so that each loan's principal is down. (I am not sure whether the first graduated loan payments eat away at the principal. I think they do.)
3. Put all the rest of the money to the loan with the highest interest rate.

Why does this work? I can't whip out the formula to prove it, so here is a very simplified and exaggerated situation to see how it works. You have a $500 balance on your credit card at 19%. You also have a $500 student loan at 2%. Your minimum payment to the student loan is $200. You have $600 in cash. Should you call the student loan company and negotiate to pay only $100 to your student loan? Obviously the answer is yes, because moving the money from the 2% loan to the 19% loan makes a big difference in the additional interest you would pay if you carried the balance to the next month. The picture with the student loans is the same idea, just more complicated and with less drastically different interest rates.

The big warning: This depends on being able to sustain making extra payments. If at any point we slip below what the payment on the regular repayment plan would be, we start to lose money.

(What about consolidation? I don't know. I haven't really looked into it. My instinct is that averaging out the interest rates is a bad idea if you are pursuing this strategy.)

Once our loans enter repayment, I will post again with more specific numbers. By that point, I should also know what a reasonable goal for the "leftovers" money is based on our usage. (Reasonable is defined as a little less than last month. :p)