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Student Loan low rate debt: Accelerated payoff plan vs investing

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    Student Loan low rate debt: Accelerated payoff plan vs investing

    Hello friends,

    I have four private student loans including:

    $14,600 @ 5.25% min payment $100 (20yr), starting April 14
    $5,500 @ 4.00% min payment $40 (20yr), starting Dec 14
    $31,600 @ 3.75% min payment $278 (12yr), starting Aug 7
    $14,000 @ 2.75% min payment $77 (20yr), starting April 14

    I make $54,000 a yr and if I live frugally here is my monthly budget:


    net bi-weekly income: 2984.58

    expenses

    rent 550
    loans 490 (min)
    grocery 400
    utilities 100
    phone 80
    auto insurance 100
    I Pass 20
    gym 30
    gas 100
    going out 0
    eating out 0

    remainder = $1112.58

    which means if I never eat out and never go out I'd have $1110 extra each month, which more realistically is something like a remainder of $800, bc I'm 24 and live near dt Chicago and am working my first full-time position.


    Eventually, when I can get the match in August, I'll be contributing $250 of my salary each month to utilize the max 401k match, so in 6months from now this number will be $250 less each month (traded for a 3% 401k contribution). Also, I'll probably get something like a 5% raise in August, so the lose will be almost equalized.

    Finallyyyy now to my question. What do I do with this leftover $$$ each month? I know to start attacking the loans from the highest interest rate down, from the 5.25% then on the the 4% and so on, until they are gone. But, with such low interest rates, is that truly the most optimal thing to do with your $$?? Are there investments that can beat the low rates? Particularly once the only remaining low is 2.75%, surely there are better things that I can be doing with my $$ than quickly paying off the 2.75% loan. The longer I draw it out the more inflation helps me anyway. But, the never ending fear is that these rates will not stay this low forever, especially now that the economy is bouncing back, they will rise. The 2.75% could easily turn higher than the 5.25% loan or worse.

    Let me know what all you smart people think. Thanks!

    #2
    Student Loan Debt

    It sounds to me like you are doing well for a 24 year old at this point. Many will say to pay off the SL balance with the lowest overall balance in order to achieve success quickly. If you are smart with your money, and it sounds like you are, I would pay the SL with the highest interest rate and then work your way down from there.
    Regarding your main question, you will get many different opinions on the ďrightĒ thing to do in this situation. Personally, I hate having debt and am all for freeing up as much monthly cash flow as possible. You are correct that you could probably receive a higher rate of return by investing this money conservatively, but you will also be paying more in interest charges by dragging the loans out. IMO though, for peace of mind, I would pay off the SLís as quickly as possible and not worry about investing at this point. You will be contributing to your 401k and at the age of 24 I would focus more on monthly cash flow as opposed to retirement. Also, you will be wanting to buy a house at some point and by paying off your SLís you will be decreasing your debt-to-income ratio which is an important factor when applying for a mortgage. In summary, you sound like you are doing well and I would focus on paying down the SLís early and saving money that would otherwise go to interest payments and continue to contribute to your 401k.

    Comment


      #3
      It's great that you told us your income/expenses, but you didn't really talk about your balance sheet. Your budget is solid. How's your balance sheet?

      What investing have you done?
      IRAs? Roth IRA? Brokerage account? CDs?
      Do you use your 401k? What's the company match?
      What amount do you have in your checking? Emergency fund?

      What (if any) other debts do you have? Rates?
      Saw no car payment listed, so can we assume car is paid off?


      I'd love to help see where you should invest, or how it compares to your debts, but before seeing your situation it's kinda hard to know the better use of the funds.
      Last edited by jpg7n16; 02-22-2012, 10:15 PM.

      Comment


        #4
        Since student loans have tax advantage, I would focus on the smallest loan first. It will take you about 5-6 months to pay off that loan if you snowball it. This will free up 40 dollars a month and more importantly you will feel good and feel that that you are making progress. The other loans will take too long to get to that feeling. Pyaing off that samllest loan will free up extra 40 dollars a month, which could be applied to your second smallest loan. This is just my 2 cents.

        As for investing, the sooner the better. However, you are young and you have plenty of time to start investing. Just remember, your student loan is a debt, but it is more of an investment as it helps you get better paying jobs.

        Comment


          #5
          Originally posted by emanon1501 View Post
          Since student loans have tax advantage, I would focus on the smallest loan first.
          Sorry, how are those two related?

          I believe you're just following the DR approach of small balance to large, with a debt snowball. That has nothing to do with the tax advantage, and doesn't consider it at all. Interest rate is no concern for the low to high balance method.

          How do I know this? Say for instance, OPs income was too high to qualify for the tax advantage. Would your advice change at all?

          --------------------------------------------------

          Looking at the interest rates, the tax advantage weighs heavily in the decision. Since SLs have a tax advantage, I'm leaning heavily towards not paying off any of them 1st, but rather choosing to invest.

          Without that advantage, I'd lean towards paying off the 5.25% one, but then still turn to investing.

          As for investing, the sooner the better. However, you are young and you have plenty of time to start investing.
          These sound contradictory. Are you saying that the sooner he starts, the better it is - so don't start right away?

          Just remember, your student loan is a debt, but it is more of an investment as it helps you get better paying jobs.
          So you're saying that employers will pay you more if you have student loans? Or that they only hire people with SLs to higher paying jobs?

          Your education/degree was the investment. The loans are the aftermath.

          Comment


            #6
            Originally posted by jpg7n16 View Post
            Sorry, how are those two related?

            I believe you're just following the DR approach of small balance to large, with a debt snowball. That has nothing to do with the tax advantage, and doesn't consider it at all. Interest rate is no concern for the low to high balance method.

            How do I know this? Say for instance, OPs income was too high to qualify for the tax advantage. Would your advice change at all?

            --------------------------------------------------
            umm.. OP told us his income.

            Who is DR? DR Pepper? You believed wrong! Please do not make assumptions.

            Student loans interest can be written off for tax. So, by focusing on smaller loan will allow larger loans to be used for tax advantage. Based on the income, this is possible.

            So to answer your question (Would your advice change at all?), no, this does not change it at all. Why?! I went through this process before, SO I KNOW BASED ON EXPERIENCE!

            As for your comments about (Just remember, your student loan is a debt, but it is more of an investment as it helps you get better paying jobs.) People who have college degree are generally paid better than those who do not; hence, it is a investment as it will have better return over lifetime.

            Comment


              #7
              OP Income is 54K, which is below 70K for single. If OP is married, even better.

              Can You Deduct Student Loan Payments From Your Taxes? | eHow.com

              Comment


                #8
                Originally posted by emanon1501 View Post
                Student loans interest can be written off for tax. So, by focusing on smaller loan will allow larger loans to be used for tax advantage. Based on the income, this is possible.
                Student Loan Interest Deduction

                I think what JPG was saying, is that you CANNOT write off student loan debt interest if your MAGI is $70K or more for filing single. Maybe he didn't see where OP gave his income.
                Brian

                Comment


                  #9
                  Consolidate your student loans into one, low interest loan and go from there. This will simplify the whole process.

                  Comment


                    #10
                    Originally posted by jpg7n16 View Post
                    It's great that you told us your income/expenses, but you didn't really talk about your balance sheet. Your budget is solid. How's your balance sheet?

                    What investing have you done?
                    IRAs? Roth IRA? Brokerage account? CDs?
                    Do you use your 401k? What's the company match?
                    What amount do you have in your checking? Emergency fund?

                    What (if any) other debts do you have? Rates?
                    Saw no car payment listed, so can we assume car is paid off?
                    By balance sheet you mean the amount of money I have in savings to date? Basically none. I am just now to the point where I am receiving my regular $1500 / 2week net checks, and I just graduated in Dec. Being a student before I have no savings really. I am establishing an emergency fund asap then deciding what to do with the rest of my $.

                    0 investing to date
                    no IRA yet :/
                    Use my 401k? why would I do that? lol and take the taxes and 10% deduction.
                    I get $0.50 company match for every $1.00 invested into my 401k up to 6% salary so 3% salary invested free + my 6%.
                    Emergency fund will be established in the next 30-45 days ($2-3k)
                    no other debt
                    car is paid off
                    im not married

                    I do not know much about using SLs for tax deductions bc until this yr they were not due.

                    Consolidation of private loans is not advantageous. It is better to keep the low SL rates bc the best consolidation rates are like 7.9%.
                    Last edited by J.Apple902; 02-23-2012, 08:19 AM.

                    Comment


                      #11
                      Originally posted by J.Apple902 View Post
                      By balance sheet you mean the amount of money I have in savings to date? Basically none. I am just now to the point where I am receiving my regular $1500 / 2week net checks, and I just graduated in Dec. Being a student before I have no savings really. I am establishing an emergency fund asap then deciding what to do with the rest of my $.
                      Yes that's what I meant And I like your plan so far. Given that you don't have an EF, you're absolutely right in setting one up first.

                      0 investing to date
                      no IRA yet :/
                      Use my 401k? why would I do that? lol and take the taxes and 10% deduction.
                      I didn't recommend cashing out your 401k, I was seeing if you are currently saving in one - or have one through your employer that you could be using for investing.
                      I get $0.50 company match for every $1.00 invested into my 401k up to 6% salary so 3% salary invested free + my 6%.
                      Emergency fund will be established in the next 30-45 days ($2-3k)
                      no other debt
                      car is paid off
                      im not married
                      Based on what you said here, I would recommend contributing 6% to your 401k (no more, no less). And I would make that change today. Then get your EF funded. Then depending your risk level - either open a Roth and start saving there. Or pay down the 5.25% SL.

                      After tax, your SL is likely charging an effective 3.9% (likely 25% bracket for single filer). As the market is expected to return 7-11% long term, you stand to make more on your investments than you are paying on interest.

                      I'd start up a Roth, using a Target Date fund of some kind to save for retirement.

                      I do not know much about using SLs for tax deductions bc until this yr they were not due.

                      Consolidation of private loans is not advantageous. It is better to keep the low SL rates bc the best consolidation rates are like 7.9%.
                      Any interest you pay on the loans (up to $2500 interest) is deductible - whether you itemize or not. Make sure you claim yours. Will likely save you about $550-600. That effectively reduces the interest rate you are paying, because you get some of it back at tax time. If I charge you $5 and rebate $2, it's like you just paid $3.

                      I wouldn't recommend consolidation either. Your loans are just fine. Rates aren't too high, and the new rates would be. So I agree - stay away from consolidation.

                      Comment


                        #12
                        Originally posted by bjl584 View Post
                        I think what JPG was saying, is that you CANNOT write off student loan debt interest if your MAGI is $70K or more for filing single. Maybe he didn't see where OP gave his income.
                        Wow. I wasn't clear at all was I. Questions were primarily to get emanon to think through just what he was saying. I saw the income. OP qualifies for the deduction. I get that.

                        My point was, the tax deduction in no way makes paying off the smallest balance any better of an option.

                        Even if the tax deduction didn't exist, emanon would likely have said to pay the small balance first.
                        .................................................. ...............................
                        Originally posted by emanon1501 View Post
                        umm.. OP told us his income.
                        I'm aware. Have you ever heard of a hypothetical question?

                        Who is DR? DR Pepper? You believed wrong! Please do not make assumptions.
                        Dave Ramsey. The man who's widely known for paying off a small balance ahead of a large interest rate. (ie The same thing you are recommending)

                        And I will continue to make assumptions. I don't care what the adage says, they are actually very useful in every day life.

                        And in my experience, when people say "pay the small balance first" it's because they listen to Dave Ramsey.
                        Student loans interest can be written off for tax. So, by focusing on smaller loan will allow larger loans to be used for tax advantage. Based on the income, this is possible.
                        I'm aware it's possible. But continuing to pay interest solely for a tax deduction is stupid.

                        Would you like to save $1 on your taxes? Great! Just pay me $4, and I'll knock $1 off your taxes.

                        (By the way, you assumed that client was not married filing separately, which would have precluded him from taking the deduction regardless of income. Just pointing out that people assume all the time)
                        So to answer your question (Would your advice change at all?), no, this does not change it at all. Why?! I went through this process before, SO I KNOW BASED ON EXPERIENCE!
                        Really? What experience? I too have SLs, and paid off the largest rate ones first. Based on my experience, I've benefited more by having less interest to pay.

                        In fact, I've saved MUCH more on interest than I would have on taxes. So will the OP if paying the debts off, but there may be better uses of his money that allow OP to make even more.

                        As for your comments about (Just remember, your student loan is a debt, but it is more of an investment as it helps you get better paying jobs.) People who have college degree are generally paid better than those who do not; hence, it is a investment as it will have better return over lifetime.
                        (You're assuming that because he has SL debt, that he actually got a degree and didn't drop out to work full time - see how common they are??)

                        I'm aware that people with degrees generally make higher salaries. That would make going to school worthwhile. Is OP considering whether he should get a degree??

                        OP isn't deciding whether he should get an education. He's deciding what to do with the loans he already has.

                        Your post read like you were saying that OP should keep the loan because it was like an investment (seeing as how you said "your student loan is a debt, but it is more of an investment"). Which it's not. It's debt. Short of the tax break, it doesn't matter what it was used for. What matters is "what do I do with this debt now that I have it?"

                        Comment


                          #13
                          I would do this:
                          1. start putting minimum in 401k to get maximum match.
                          2. have enough EF that I am comfortable with
                          3. pay off loan with 5.25 interest rate before start funding retirement and investment accounts.
                          If you feel like you have to have more in investment/retirement accounts, middle in the road is not a bad idea (putting some money into retirement account and applying rest towards student debt)

                          Comment


                            #14
                            No right or wrong answer on the payoff debt vs. investing question. I struggled with the same thing and I have interest rate of 3% on my loan. But I want to be out of the debt so I'm attacking it with extra money instead of investing (I still save about 20% of my income between savings and retirement.) Not being in debt is a good feeling.

                            Comment


                              #15
                              Emergency Fund

                              Am I the only one who thinks that before considering the whole invest vs. pay off SL issue, it might be worth taking another look at the EF? $2-3k really isn't that much when you think about it. I think it's a great start, don't get me wrong... but maybe after you focus heavily on getting that $2-3k EF set up, whatever you want to do with the balance of your money should be divided between slowly adding a little more to that fund, and whatever other option you choose (SL or invest). Obviously you're just starting a new job, so hopefully the chances of becoming unemployed are not high... but a real emergency fund should be able to cover several months of living expenses. Sometimes you just never know when some expense that you didn't think about in your budget is gonna pop up.

                              Comment

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