confused about my student loan

[deca]

I have a student loan with a current pay-off amount of 22,011.95. The original balance upon graduation was 24,828.90. I consolidated on a 20-year payment schedule at 3.25% interest within a couple months of graduating. I also went through one deferment period of about six months while DH was unemployed. By my calculations I have been making payments on this loan for at least 40 months. I think more than that actually, but let's say 40.

If you divide the amount I've paid down so far (2,816.95) by the number of months (40) you get about $70/month. But I pay way more than that! My payment is $148.

Everyone keeps telling us not to pay this loan down early because we're coming out ahead after you consider inflation and the taxable income deduction, and the return we could get on our money elsewhere. I'm not so sure. I don't have a statement in front of me but it seems like most of my payment goes to interest up front. What am I not understanding?

[disneysteve]

Originally Posted by deca

20-year payment schedule at 3.25% interest

Everyone keeps telling us not to pay this loan down early because we're coming out ahead after you consider inflation and the taxable income deduction, and the return we could get on our money elsewhere.

What am I not understanding?

What you aren't understanding is that you can invest your money elsewhere and earn way more than 3.25%. Making extra principal payments on your loan is equivalent to earning 3.25% on your money (and that doesn't even account for the tax deduction). Does that sound like a good deal to you? It sure doesn't to me.

Let's say you are very conservative. Rather than making extra payments, you put your money into an FDIC-insured high yield money market account paying 5.36% (the current high). Even if you are in the 25% bracket, your after tax return will be 4.02% meaning you will outperform the loan prepayment by 0.77%.

If, on the other hand, you are not so conservative, you could put that extra money in a low cost mutual fund - let's pick Vanguard's Total Stock Market Index. During the past year, you would have racked up a return of 14.29%, outperforming those extra loan payments by over 11%!!

This is the same reason why many of us, myself included, argue against pre-paying one's mortgage. My mortgage is at 5.875% before the deduction and more like 4.4% after the deduction. Why would I want to prepay a loan that is only costing me 4.4% when I could be investing my money and earning 8 or 10 or 14%? I understand the feeling of security from having a paid off house, but financially, it just isn't a good decision in most cases.

[deca]

I understand the math on investing my money being a better bet than paying down the student loan.

What I don't understand is how 40 months of payments of $148 each only amounts to 2,816.95. I've paid so much more than that. By my math I've paid over $5000. It just seems like a lot of my payments are going to interest. Since the interest rate is allegedly only 3.25%, I'm very confused.

[safari]

Your original loan amount was $24,828. If you calculate the interest you pay every year (at 3.25%), it comes out to $807, or $67 a month. So if your payment is $148, it means that $67 goes toward interest and $81 goes toward the principal. In 40 months, you've paid $2,680 interest and $3,240 principal (these are rough numbers, in reality the interest will be lower and the principal higher because your balance is decreasing every month). As you continue making your monthly payments, the balance will be getting smaller, so more money will be going toward the principal. You're saying that so far you've only paid down $2,816, which doesn't sound right. If you've been paying $148 for at least 40 month, you should have paid down over $3,240.

[kv968]

Originally Posted by deca

I understand the math on investing my money being a better bet than paying down the student loan.

What I don't understand is how 40 months of payments of $148 each only amounts to 2,816.95. I've paid so much more than that. By my math I've paid over $5000. It just seems like a lot of my payments are going to interest. Since the interest rate is allegedly only 3.25%, I'm very confused.

When paying a loan, you pay the most interest and least amount of principal in the beginning. As you go along the interest portion starts to drop and your principal goes up because they're applying the 3.25% to the total amount of your loan as you go along.

For example, in the first year they were charging you 3.25% on $24829 which is $807/year. Say you were paying $100/month in interest just to keep it simple. In the second year they'd charge you 3.25% on $23629 ($24829 - $1200 principal payments) which would be $768/yr and so on. Granted they apply it monthly but that's the jist of it.

Maybe this amortization schedule will help you understand:

amortization schedule

[bigsaver]

Pay that loan down as slowly as possible. Even if you just put your money now in a cash account, you would get 6.00% at FNBODIRECT and even after tax you would be beating taht 3.25%. Just my 2 cents.

[PharmacistRealtor]

I personally believe you should save at the same time that you pay down your debt. Everytime you have extra money to put down on your loans I would put 1/2 in savings and 1/2 towards your debt. You are about evening out interest rate wise but if you don't have savings then when a payment can't be made you're in trouble...I think a both/and approach would be the best....just my 2 cents...