Be Debt Free, or is there such thing as "good debt"?

[Newguy99099]

I have a full time job, and have paid off all debts with the exception of my student loans. I make $60k per year and I am 28. I have $50k left in student loan debt at 3.5% interest rate. I rent an apartment. I still have another 26 years left to pay off my loan. I put away the full $5,000 - $5,500 in my Roth IRA each year.

I am wondering if I should be throwing all "extra" money at the student loan to pay it off, or if that interest rate is so low (not only today but also in 10 or 20 years from now, with inflation), that I should be using extra money to invest in a low risk mutual fund, investment real-estate, index funds or put away for other retirements. I am getting married this March and would also like to have money saved to make a good down payment on a home in the next 6-18 months.

I hope I answered the questions needed for you to offer me help but if not, please ask. Thank you.
Mark

[disneysteve]

People always seem to pose these questions as all or nothing deals: either throw every penny at debt or pay the minimum and invest. The answer is to do both. Pay more than the minimum while also putting money in savings. Figure out how much extra you have each month. Figure out how much you need for a 20% house down payment and start saving that. And put the rest toward the debt.

[Augustine]

People always seem to pose these questions as all or nothing deals: either throw every penny at debt or pay the minimum and invest. The answer is to do both.

That is very solid advice.

You can actually pay off debt, save and invest all at the same time. Think of all of these as different buckets that urgently need to be filled with water (your income) and you will find yourself planning your finances better. When you finally get a mortgage, again aim to pay more than the minimum and do not neglect your savings.

[Newguy99099]

Thank you for your answers. May I ask another way - if I have the $50k already saved in a CD which offers a 1-Time withdrawal without penalty, should I take that money and pay off all my student load debt, or still just pay half and invest the other half? My question isn't so much about "all or nothing" as it is about the idea of "good debt".
Is there ever an interest rate percentage where it's better to just make regular monthly payments and use the other money to invest in something that offers a higher interest rate?
I'm not sure if this is as simple as mathematics or if its a philosophy or how to move forward but thank you for your help

[kork13]

Thank you for your answers. May I ask another way - if I have the $50k already saved in a CD which offers a 1-Time withdrawal without penalty, should I take that money and pay off all my student load debt, or still just pay half and invest the other half? My question isn't so much about "all or nothing" as it is about the idea of "good debt".
Is there ever an interest rate percentage where it's better to just make regular monthly payments and use the other money to invest in something that offers a higher interest rate?
I'm not sure if this is as simple as mathematics or if its a philosophy or how to move forward but thank you for your help

What interest rate is the CD earning? If it's less than 3.5%, then yes -- it would make financial sense to pay off the student loan all at once & be done with it.

The "simple math" of it really is simple. Assuming you're in the 25% tax bracket, your 3.5% SL interest is tax deductible, so the real cost is 2.625%. Now in order to validate keeping your cash in the CD, you would want it to give you better after-tax returns than that 2.625%. Interest on your CD is taxed at 25%, so you need to adjust your required earned interest rate upward to compensate... thus, you need to earn at least 3.5% in your CD for it to make financial sense to keep it. Now, that's just the numbers... There's also an emotional side involved here... Are you willing to sacrifice that cash pile in order to be out of debt?

[disneysteve]

if I have the $50k already saved in a CD which offers a 1-Time withdrawal without penalty, should I take that money and pay off all my student load debt, or still just pay half and invest the other half?

You've posted a few different questions, each time giving bits and pieces of the whole story. May I suggest that you make one post where you lay out everything together. How much do you earn? What are your monthly expenses? What debts do you have and at what interest rates?

To answer just question, for example, we need to know what the whole picture is. Do you have an adequate emergency fund above and beyond this 50K? Do you have enough saved for your upcoming wedding? You wrote about buying a house. Will you be able to save enough for a 20% down payment if you use this money to pay off the loans?

[Newguy99099]

Now in order to validate keeping your cash in the CD, you would want it to give you better after-tax returns than that 2.625%. Interest on your CD is taxed at 25%, so you need to adjust your required earned interest rate upward to compensate... thus, you need to earn at least 3.5% in your CD for it to make financial sense to keep it. Now, that's just the numbers... There's also an emotional side involved here... Are you willing to sacrifice that cash pile in order to be out of debt?

So based on these numbers, if I can find a Tax Free muni bond offering more than 2.625% over the same 20-ish year period of time, I would be better served buying $50k worth of that bond rather than being "debt free"? Do I have that right or am I missing some hidden numbers? Thanks!

[Newguy99099]

You've posted a few different questions, each time giving bits and pieces of the whole story. May I suggest that you make one post where you lay out everything together. How much do you earn? What are your monthly expenses? What debts do you have and at what interest rates?

To answer just question, for example, we need to know what the whole picture is. Do you have an adequate emergency fund above and beyond this 50K? Do you have enough saved for your upcoming wedding? You wrote about buying a house. Will you be able to save enough for a 20% down payment if you use this money to pay off the loans?

This 50k is a large portion of an "emergency/house fund". Without this $50 I would have about 6-8 months of emergency funds. The wedding is paid for mostly and the rest has been budgeted for. The 20% house down payment savings would start back close to 0, though would be easier to save for without having monthly loan payments.
I hope I answered all you asked. Thank you!!

[asdf]

You've posted a few different questions, each time giving bits and pieces of the whole story. May I suggest that you make one post where you lay out everything together. How much do you earn? What are your monthly expenses? What debts do you have and at what interest rates?

I agree with this, and since you're getting married, I'd like to know this information for your spouse-to-be, as well.

[snafu]

I'm not able to discern whether you've joined your employer's retirement plan. If the employer contributes to a plan it's smart to take advantage of free money. Retirement funds depend on time and low fees compounding to serve you in the future.

It's very important to understand the 'fine print' for long term debt. You need to know how extra payments are applied to principal of SLs, mortgage, car loans etc. Should you decide to buy a home It's important to wrangle for the lowest possible interest point you might qualify for. It's important to track how the monthly payment sums are distributed to interest, principal, taxes, HOA and fees. Should you feel comfortable sharing financial details with SA, there are very knowledgeable contributors who offer suggestions to help avoid pitfalls and offer facts to help you make the best decisions for your circumstances.

[Newguy99099]

I'm not able to discern whether you've joined your employer's retirement plan. If the employer contributes to a plan it's smart to take advantage of free money. Retirement funds depend on time and low fees compounding to serve you in the future.

It's very important to understand the 'fine print' for long term debt. You need to know how extra payments are applied to principal of SLs, mortgage, car loans etc. Should you decide to buy a home It's important to wrangle for the lowest possible interest point you might qualify for. It's important to track how the monthly payment sums are distributed to interest, principal, taxes, HOA and fees. Should you feel comfortable sharing financial details with SA, there are very knowledgeable contributors who offer suggestions to help avoid pitfalls and offer facts to help you make the best decisions for your circumstances.

My employer doesn't offer a match of any kind.
All I have left is student loan and anything over the monthly minimim reduces directly from the principal. Does that answer your question?

[autoxer]

So based on these numbers, if I can find a Tax Free muni bond offering more than 2.625% over the same 20-ish year period of time, I would be better served buying $50k worth of that bond rather than being "debt free"? Do I have that right or am I missing some hidden numbers? Thanks!

Make sure you look specifically at your tax situation. The loan interest may be deductible, but it only really helps by the amount it is over the standard deduction. If you don't have enough deductions to itemize taxes, then there is no tax benefit to paying loan interest. Now, if you can't find a tax free bond offering 3.5% for 20 years, then you will need a taxable investment that will average 4.67% over 20 years to cover the income tax on it's appreciation. That is getting into more risky investments vs. a guaranteed return of 3.5% by paying on the loan.

But you shouldn't just make the decision based on the numbers. I just paid off a very low interest debt early, because simplifying my cash flow was more valuable to me, then the marginal increase in wealth by carrying the debt to full term. There are other areas where focusing my energy will have a much larger impact on my net worth, than trying to beat the banks at their own game.

I do believe there is 'good debt', if it is used properly. Good debt isn't just a low interest rate, it has to be tied to an asset with potential to appreciate. But it isn't always clear whether it was good or bad until it is sold. Financing a house at 6%, that doubles in value in 10 years would be a good debt, but financing a house at 4% that doubles in value in 20 years would be a bad debt.

[riverwed070707]

Try playing with a calculator like this one http://www.whatsthecost.com/loan.aspx. If you pay the minimums on that loan you're going to pay $26,000 in interest over the next 26 years. Hypothetically if your minimums are currently $250 and you were to bump your payment to $500/month, you would have the loan paid less than 10 years from now and you'd save $17,000 in interest. If you could pay $600/mo they'd be paid in 8 years and you'd have only paid $7,100 in interest. BIG DIFFERENCE. I'd be paying extra if I were you, especially now while you're fixed expenses are low -- gets harder once you throw marriage and kids into the mix.

I agree with Steve it doesn't have to be all or nothing but there is no way I'd finance my college education over the lenth of a career. Personally, unless you have a doctorate or other high-earning potential degree, I don't think student loans should be on a payment plan of more than 10 years.

[Helpmeplease]

Try playing with a calculator like this one whatsthecost. If you pay the minimums on that loan you're going to pay $26,000 in interest over the next 26 years. Hypothetically if your minimums are currently $250 and you were to bump your payment to $500/month, you would have the loan paid less than 10 years from now and you'd save $17,000 in interest.

You forgot to talk about inflation. He is talking about 26 years, not just 2 years or something short term. Doesn't anyone take that into account in this situation?

[cardtrick]

Also, is the rate on your student loan fixed? I'll borrow $50K at 3.5% for 26 years. Actually, I'd feel comfortable borrowing even $10 million at that rate. The reality is that no one would lend me that kind of money...

Don't look at it in terms of the dollar value of the interest paid during the life of the loan. That doesn't tell you anything useful. You have to figure out if you think you can beat 3.5% per year over the next 26 years. 30 year treasuries are yielding about that much currently. I feel very confident that I can. Hence, I'm not paying even a single extra penny towards my mortgage.

Also historically, real estate has been a bad investment during periods of high inflation, so if that's your assumption - that we are going to get lots of inflation, then you might want to research what assets are best to hold.

Or if you're risk averse, then play it safe and pay off all your debts as soon as you can.