Should I pay off my subsidized loans now, or later?

[NoraTheGradStudent]

Baby Mustachian here, in need of advice.

I'm a graduate student with 2, possibly 3, academic years left including the current one.  I have 10K in subsidized loans that I have been happily ignoring because I thought to myself "they won't accrue interest until I graduate, so I'll just worry about them later." The loans will have a rate of about 5.5% once they go into repayment, 6 months after I graduate.

Over the summer, I started reading MMM and it has completely changed the way I think about my spending and my future. I really want to have the freedom to do research in my field, but I also have interests in meditation and yoga that I wish I could spend more time on, and possibly even teach others. It seems like the best way to be able to pursue both my passions is to be FI.

My take home pay is about 1,900 a month and my expenses have been about 1,400 a month, but I am still spending more than I would like. I plan to move to a less expensive apartment next summer when my lease is up. In the mean time, I'm working on reducing my food expenses and my "lady temptations" and I'm getting better, but I still have a long way to go. I plan to get my spending down to 1,200 a month, but let's be pessimistic and say 1,300. So, that leaves me with $600 a month. My question is, what should I do with it?

I have about 6k in the bank and a measly 1,200 in a Roth IRA, not much of a cushion, but I also have excellent job security for the next two years (assuming I make adequate progress on my degree). If I start putting $500 a month into my student loans, I'll pay them off just before graduation, so I'll never pay any interest. On the other hand, isn't this sort of an investment with rate of 0% return? Does it make more sense to put my money into something else and pay off the loans later? If so, where should I invest it?

Thanks,
Nora

[Numbers Man]

Nora - Pay off the student loans with the extra $500 a month. Being debt free from student loans by graduation would be awesome.

[Psychstache]

Congrats on seeing the value of FI and using it to build the life you want.

Mathematically, it would be in your best interest to keep the $500 for yourself and earn something on it while the interest is being covered and then use the money to pay it off in a lump sum once the subsidization period ends. For a short window like 2-3 years, I would just try and find a high yeild checking or savings account that you can take advantage (I have a local CU that pays 2.5% that I use for short term cash).

That said, if you are worried that you have not yet developed the discipline to resist the temptations to spend the money, then you may be better off just putting the money straight into the loan to avoid flittering it away while you are in school.

[Rebecca Stapler]

Paying off the loans before they start accruing interest is a 0% return, unless you consider how long it would take you to pay them off after they're earning interest. So, if your 3 year delay means that they won't be paid until 3 years after they start accruing interest, then your ROI is 5.5% for 3 years. It is wonderful not to have student loan payments, but also wonderful to have retirement savings growing in a low-cost index fund.

Because you have some time to think about it and it won't cost you anything to wait a little bit, I would max out your IRA contributions over the next 3 years and stash away the rest as savings. When the grace period is about to end on those subsidized loans, you will have a better idea of whether you need the savings (maybe you don't have a job lined up) or whether you could pay off the entire loan. You can use your savings and dip into the IRA principal as much as you want to pay it off. (But I suspect you will find that you would prefer to use non-retirement savings and that might make you work extra hard to pay it off ASAP.) But you won't regret putting the $$ into your IRA for the tax-defered growth and not losing out on those years of contributions.

[lackofstache]

I'm w/ ksaleh on this one, put the $500/mo into an account that will accrue interest. At the end of your schooling, you can use the principal to pay off the loans & keep the interest it has made, if that makes sense to you then or pay off the loans more slowly depending on your financial options at that point. This will give you more options when you graduate than paying them off early will. You can still avoid the interest if things look good financially upon graduation. Good Luck.

[MakingSenseofCents]

I'm w/ ksaleh on this one, put the $500/mo into an account that will accrue interest. At the end of your schooling, you can use the principal to pay off the loans & keep the interest it has made, if that makes sense to you then or pay off the loans more slowly depending on your financial options at that point. This will give you more options when you graduate than paying them off early will. You can still avoid the interest if things look good financially upon graduation. Good Luck.

This is pretty much what I did. I also made a post on it  http://www.makingsenseofcents.com/2012/11/student-loan-plan.html

I made really large lump payments this past summer once the 0% was done.

[snshijuptr]

I just finished grad school and my loans are coming due this month. We have enough saved to pay off the 6.8% interest loans which I will do if I don't get an unemployment deferment. Having this cash cushion has been awesome for our family. We have cash emergency fund, student loans funds, and home down payment funds built up and they are all giving us options right now as I find a job and we move around.

TLDR: Life after graduate school can be really crazy. Save a huge cash cushion.

[chicagomeg]

Plus, after you graduate, you can probably put them on Income Based Repayment for one year, and maybe even two. If your payments are $0, the govt. will cover the interest for up to 3 years. I applied for IBR in Nov. 2011 (6 months after graduation). They requested my 2010 tax return. In Nov. 2012, my $0 payments were renewed through Feb. 2014 based on my 2011 return. Almost 3 full years after graduating, I will finally lose $0 IBR payments this winter, just in time to start graduate school and put them into in-school deferment, and then I'll pay them in full the day I graduate from grad. school. Sometimes I want to pay them off just to get them off my back, but I try to remember how much interest I'm earning on the money by holding onto it for now. Since my subsidized loans are just under $20k and the money is in Ally earning .85%, it's almost $200/year.

[NoraTheGradStudent]

Thank you all for the advice! I'm going to put the payments I would have made into my roth IRA and then withdraw what I need to pay off the loans just before they go into repayment.