Author Topic: interesting idea for a financial product for student loan borrowers  (Read 1421 times)

Fuzz

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Hi Gang,

Like lots of folks on the forum, I am faced with the save for retirement vs pay down student debt dilemma.

I was in a meeting with a local bank and the loan officer said that they would loan at 2 percent against cash equivalents.

Here is my idea: you put $1000 with local bank in a bond fund for retirement. The bank then loans you $900 at 2 percent against that $1000 to pay back student debt and the money goes directly from the bank to your servicer. All of a sudden you have $1000 in the bank for retirement (sort of) and have refinanced a 7.9 or 6.8 percent loan to 2 percent. Your debt service burden goes down, your assets go up, and the local bank gets a great relationship.

Why doesn't this work? Why doesn't this already exist?

Pitfalls: (1) That $1000 you put in the bond fund goes down and the bank is upside down on it's asset to loan. (But that's why it's bonds--maybe muni bonds or US Treasuries).  (2) Transaction costs are too high.  (3) Some sort of regulation prohibits this.

Gin1984

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Re: interesting idea for a financial product for student loan borrowers
« Reply #1 on: June 08, 2014, 11:25:14 AM »
I assume this is variable?  Though I like it as an idea.  However, it can't be money in retirement fund because those are protected from creditors, I believe. 

TreeTired

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Re: interesting idea for a financial product for student loan borrowers
« Reply #2 on: June 08, 2014, 11:29:39 AM »
Sounds great except for this:

Quote
I was in a meeting with a local bank and the loan officer said that they would loan at 2 percent against cash equivalents.

A bond fund (if maturity is greater than 1 day)  is not a cash equivalent.   But even if they are only willing to lend 50% sounds like a good idea.  Sounds  a lot like the repo market.

warfreak2

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Re: interesting idea for a financial product for student loan borrowers
« Reply #3 on: June 08, 2014, 11:48:47 AM »
If your student loan is at 7.9% or 6.8% then you probably ought to just pay it off directly before you think about buying bonds.

What you're proposing is equivalent to investing on margin, aka leverage. Some brokers offer margin accounts at interest rates of about 2% or so, using the assets you buy as collateral. Generally, leverage is a way to increase your returns by accepting higher risks, it may make sense for some people depending on their risk tolerance, but it seems odd to lever low-risk/low-return bonds rather than investing in stock or real estate.

Also, most bonds aren't "cash-equivalent". One-year US Treasury bonds are probably most acceptable -  but the return on this kind of "cash-equivalent" investment is so low that, even if you are making more than the 2% you're borrowing at, it just doesn't make sense to pay only $900 on your high-interest loan, instead of the full $1000.

Think about it - the bank is offering you a rate as low as 2% because your collateral makes it super-safe - if you don't pay back on time, they'll definitely be able to get their money by seizing your collateral. In this sense, the bank's investment in its loan to you is itself cash-equivalent. Hence, a reasonable return to expect on your cash-equivalent investment would be pretty much the same interest rate that you're borrowing at, so it's probably a wash.