Author Topic: Better to save/invest or pay off student loan faster?  (Read 7699 times)

israele

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Better to save/invest or pay off student loan faster?
« on: July 16, 2014, 04:57:22 PM »
I posed this question to my parents' financial adviser who recommended I save for a down payment on a home rather than plug my invested savings into loan debt. I found that advice to be odd, but she's the professional, right?

I live in Brooklyn, NY (probably anti-Mustachian, I'm realize) and have no imminent plan to move for the time being. Buying property isn't really in the cards at the moment, and certainly not in the NYC area where real estate is prohibitively expensive for someone like me.

I'd love to take a nice bite out of that student loan debt but worry about depleting my savings. I would be grateful for any sound recommendations from this lovely community. Thank you!

Snapshot:

Age: 29 (single)
Invested savings: ~$23K
ROTH IRA: ~$40K
401K: ~$8K (contributing 6% which my company matches)

Loan amount: $42.5K
Interest: 6.55%
Automatic monthly payment: $562.41
Full disclosure, I'm lucky enough to get help on the loans from my folks. $300/month - for now. (I don't count on this and don't factor it into my thought process here)

If you're curious:
Monthly expenses: ~$1,300
Bi-weekly income: ~$1,250 (varies slightly with overtime)

allergic2average

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Re: Better to save/invest or pay off student loan faster?
« Reply #1 on: July 16, 2014, 06:14:45 PM »
I say knock out the loan first, simply because it follows you even after you die.  If you were to die tomorrow, the government or whoever its from will pin that loan on your parents or whoever you're related to.  Also if you're already in debt, why would you add another huge debt to your name?  I just think the smartest route to go is for you to put 12k into the student loan so at least the interest you have leftover to pay will go down.

laufen

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Re: Better to save/invest or pay off student loan faster?
« Reply #2 on: July 17, 2014, 02:45:14 AM »
I say knock out the loan first, simply because it follows you even after you die.  If you were to die tomorrow, the government or whoever its from will pin that loan on your parents or whoever you're related to.

I thought this depended on whether one lives in a community property state (if you're married) and whether the loan is federal (loan cancelled upon death) or private (they chase your relatives).

https://studentaid.ed.gov/repay-loans/forgiveness-cancellation

ambimammular

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Re: Better to save/invest or pay off student loan faster?
« Reply #3 on: July 17, 2014, 04:43:59 PM »
I would throw the extra to the student loan, otherwise it will haunt you to the end. Plus, those dollars will make you a guaranteed 6.55%. Then when you're interested in permanent housing (hopefully in a cheaper part of the country) start saving. Home loans will be easier too with that 42.5K off your back.
 

KayakMom

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Re: Better to save/invest or pay off student loan faster?
« Reply #4 on: July 17, 2014, 04:48:47 PM »
I recently decided to pay off my last student loan instead of invest.  I toyed with the idea, because it was a low rate.  Besides the guaranteed "rate of return" it's just one less bill to remember, etc.  Mentally it will be nice to have it gone- and that's worth something.

solon

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Re: Better to save/invest or pay off student loan faster?
« Reply #5 on: July 17, 2014, 04:59:14 PM »
I'm with MMM on this one. Get rid of the debt as fast a possible. Especially student loan debt.

Advantages of paying it off:
 - guaranteed 6.55% tax free return
 - student loans can't be discharged in bankruptcy (I know, you're not planning BK. But even if you wanted to BK, you couldn't lose the student loans)
 - student debt follows you in death, as someone already mentioned
 - you get peace-of-mind when you send that last payment. This is far more satisfying than you know!

norabird

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Re: Better to save/invest or pay off student loan faster?
« Reply #6 on: July 17, 2014, 05:03:44 PM »
I have CC debt at only about a 1% above your student loan rate, so it's not *that* low a rate. I would totally throw extra money I had at it though obviously I also have some spending issues to figure out, which adds to the sense of urgency of getting rid of this reminder of my over-consumption (not an issue for the student loan debt).

You already have pretty good investments, I'd up your debt payments for now. You could increase your 401k even though it's not being matched above 6% too--reduces your taxable income and lets you increase your overall savings rate despite losing some of that investment money.

If you aren't planning to save for a home, then saving for a home is pretty unnecessary, no?

Also, shoutout to BK! I think we need more mustachians here and don't think COL is so bad if you have roommates. No cars FTW!

mginwa

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Re: Better to save/invest or pay off student loan faster?
« Reply #7 on: July 18, 2014, 12:03:51 PM »
I think you should pay off the student loans first. But here's a more detailed way to think about it.

I can think of 3 big factors in making a decision like this: 1) your comfort level with debt payments, 2) cash flow, and 3) a financial analysis of the costs and benefits of each approach.

First, your comfort level. How would you feel about your life and your job if you had another required payment each month? Would it be too stressful, or would it not matter?

Second, cash flow. A 30-year mortgage on a $300k loan at 5% is $1,610.46. You can plug whatever numbers you think are appropriate into Excel, but that's more than half your current income. I suspect it would be very tough to find something for much less in Brooklyn. I assume your rent is rolled into your current cost of living of $1300, which mean you pay almost nothing for Brooklyn. Good job! I think you'll have a hard time making that cash flow work, and an impossible time if you still have student loans. What's the rush?

Third, financial analysis. It's hard to do without more information, but basically you can build a spreadsheet that tells you exactly what is going to be financially optimal. You know your student loan interest rate. You know that you get a tax deduction for the interest you're currently paying, so you can calculate exactly what the loan is costing you each year and how that will change over time as you pay less interest and more principal. You can do the same analysis for saving for a down payment, fees, and then mortgage on a property. Can you earn interest in excess of what you're paying on your student loans while you save? Don't forget the taxes on the growth of your savings. In general I think this kind of analysis will show that it's better to pay off loans first, then save for a house. However, there's one case where it might change: are your parents going to help you with a down payment? If you are very close to having enough money for a down payment on a property you can afford right now, you may find that the equation changes. However, given the rough outline you provided about your situation, I think that is highly unlikely.

Anyway, Mustachianism is all about financial freedom and independence, and it seems like piling on more debt wouldn't feel very free. You can't eat your house, and you can't get out of paying your student loans, so it would be a tough situation to be in if anything went wrong. You have a ton of savings already given how much debt you have. I'd suggest you focus hard on your student loans. Don't cut back on the 401k, though--the upside on the tax benefit plus the employer match is huge, as much 70% or more on that first 6% with a 50% employer match. That's way more than a -6.55% interest rate (which is probably more like -4.5% after tax benefits are incorporated.)

Cheddar Stacker

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Re: Better to save/invest or pay off student loan faster?
« Reply #8 on: July 18, 2014, 01:38:08 PM »
Pay it off. That rate is too high. Good luck.

AssetGrinder

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Re: Better to save/invest or pay off student loan faster?
« Reply #9 on: July 18, 2014, 02:36:07 PM »
If it were me I would pay off the loan asap especially at 6.55% That was some real bad advice from the adviser. there solution for you to take on more debt is ridiculous. Now I wonder what kind of nonsense they have your parents invested in.

TexasAnnie

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Re: Better to save/invest or pay off student loan faster?
« Reply #10 on: September 07, 2014, 08:32:02 AM »
Doesn't it depend on what kind of student loan it is, that is private or Federal?  I thought that some student loans you always paid the total amount of interest, even if the loan was paid off early? 

It seems like that would affect the calculations.

RyeWhiskey

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Re: Better to save/invest or pay off student loan faster?
« Reply #11 on: September 07, 2014, 11:41:19 AM »
FWIW, I'm 28 and just took out 20.5k in student loans for grad school at ~6% interest rate. I have 15 months until the grace period ends and in that time I will be saving and tossing chunks of money at the loan to get it down as far as I can before I have to make monthly payments (I'm hoping to pay it all off for monthly kicks in). 6%+ is just too high to sit on debt. I'm not sure I would sit on it at 3% either but I would definitely think about it.

Consider that - real return (i.e. after inflation) - the stock market has delivered ~5% historically. Why would you sit on debt that you'll have a hard time outperforming with the invested cash? If you underperform, say the market only delivers a 2% return, you didn't make 2%, you lost 4%. You have to make at least 6% in order to come out ahead which is too much of a gamble in my opinion.

Pay off the loans. Then save.