Investing vs Student Loan?

[realityinabox]

Hi all,

I am wondering what my priority on paying off my student loan vs. investing in retirement funds should be.  I'm 27, just recently graduated with a bachelors degree in engineering and  landed a good job straight out of school.  I have roughly $10k in federally subsidized student loans at around 4% (no un-subsidized loans), so if I really attacked it, I could pay it off within the 6 month grace period.  Being and Dave Ramsey-ite in a former life, that was my initial plan of attack, but the more I think about it, the more I wonder whether it is worth it to delay investing in order to pay off a debt at 4% interest. 

For reference, my company doesn't do a 401k match (they contribute 3% regardless), and I am under the cut-off for traditional IRA contributions. 

[ShoulderThingThatGoesUp]

So depending on your major you're making somewhere between $50k and $70k, I'm guessing? Try drawing up a budget where you shoot the moon - max 401k, max tIRA, and pay off the $10k.

[MDM]

Hi all,

I am wondering what my priority on paying off my student loan vs. investing in retirement funds should be.  I'm 27, just recently graduated with a bachelors degree in engineering and  landed a good job straight out of school.  I have roughly $10k in federally subsidized student loans at around 4% (no un-subsidized loans), so if I really attacked it, I could pay it off within the 6 month grace period.  Being and Dave Ramsey-ite in a former life, that was my initial plan of attack, but the more I think about it, the more I wonder whether it is worth it to delay investing in order to pay off a debt at 4% interest. 

For reference, my company doesn't do a 401k match (they contribute 3% regardless), and I am under the cut-off for traditional IRA contributions.

If you earn more than 4% on investments, then investing instead of prepaying the loan will be better.

If you earn less than 4% on investments, then prepaying the loan instead of investing will be better.

So, gaze into your crystal ball.... ;)

[ingrownstudentloans]

Hi all,

I am wondering what my priority on paying off my student loan vs. investing in retirement funds should be.  I'm 27, just recently graduated with a bachelors degree in engineering and  landed a good job straight out of school.  I have roughly $10k in federally subsidized student loans at around 4% (no un-subsidized loans), so if I really attacked it, I could pay it off within the 6 month grace period.  Being and Dave Ramsey-ite in a former life, that was my initial plan of attack, but the more I think about it, the more I wonder whether it is worth it to delay investing in order to pay off a debt at 4% interest. 

For reference, my company doesn't do a 401k match (they contribute 3% regardless), and I am under the cut-off for traditional IRA contributions.

If you earn more than 4% on investments, then investing instead of prepaying the loan will be better.

If you earn less than 4% on investments, then prepaying the loan instead of investing will be better.

So, gaze into your crystal ball.... ;)

Unless he puts the investments into a pre-tax 401k and tIRA, in which case he will have to earn less than the 4% after adjusting for tax savings to justify paying the loans first. 

Max 401k and tIRA and pay as much towards the loans as you can to knock them out as fast as you can.

[MDM]

Unless he puts the investments into a pre-tax 401k and tIRA, in which case he will have to earn less than the 4% after adjusting for tax savings to justify paying the loans first. 

Max 401k and tIRA and pay as much towards the loans as you can to knock them out as fast as you can.

Did you mean "...to justify investing"?

And if taxable investments are good enough, why pay the loan faster than needed?  Of course one can choose to do what one wants....

[ShoulderThingThatGoesUp]

I'm assuming the 6 month grace period has meaning outside the 4% that incentivizes paying it off.

[MDM]

I'm assuming the 6 month grace period has meaning outside the 4% that incentivizes paying it off.

From http://www.direct.ed.gov/leaving.html:
"Once you are no longer enrolled at least half time in an eligible program, you'll receive a 6-month grace period (see below) on your Direct Subsidized and Unsubsidized Loans during which you are not required to make loan payments. You must begin repayment at the end of your grace period."

Not sure, but that is likely what the OP meant.

[realityinabox]

I'm assuming the 6 month grace period has meaning outside the 4% that incentivizes paying it off.

From http://www.direct.ed.gov/leaving.html:
"Once you are no longer enrolled at least half time in an eligible program, you'll receive a 6-month grace period (see below) on your Direct Subsidized and Unsubsidized Loans during which you are not required to make loan payments. You must begin repayment at the end of your grace period."

Not sure, but that is likely what the OP meant.

Correct, and if I'm not mistake, the 4% interest doesn't kick in until the grace period ends.  This is only true of subsidized loans, but those are the only type that I took out.

So it has essentially been free money for the last couple of years, and will continue to be until around November, at which point it will start costing me 4% in interest. 

[cripzychiken]

This is the whole "math vs heart" discussion.

Math-wise: investing is likely best.  More money in tax deferred accounts is always better.  Less taxes, longer time to compound.

Heart-wise: How important is having no debt to you?  Does having no investments and no loans 'make you feel better' than having 10k investments and 10k loans?

A lot of people have this same discussion talking about prepaying the mortgage.  There is no 'right' answers b/c both paths put you in a great financial situation. It's just which one you care about more, but neither is 'wrong'.

[ingrownstudentloans]

Did you mean "...to justify investing"?

I said what I meant.  He would have to earn less than 4% return on his hypothetical investment, after adjusting for the effect of the tax savings if it was a pre-tax vehicle, to justify paying the loans first.  Because if he was going to earn less than 4% then it would make sense to pay the loans first.

And if taxable investments are good enough, why pay the loan faster than needed?  Of course one can choose to do what one wants....

If his hypothetical taxable investment are good enough, I agree.  My point was that your simple 4% assumption did not take into account the tax implications of the investment vehicles that he was asking about.

[MDM]

He would have to earn less than 4% return on his hypothetical investment, after adjusting for the effect of the tax savings if it was a pre-tax vehicle, to justify paying the loans first.  Because if he was going to earn less than 4% then it would make sense to pay the loans first.

If his hypothetical taxable investment are good enough, I agree.  My point was that your simple 4% assumption did not take into account the tax implications of the investment vehicles that he was asking about.

The word "earn" is indeed imprecise.  To do a full blown analysis one would have to look at all tax nuances, including traditional or Roth options, the amount of tax (if any) paid on taxable earnings, whether student loan interest is deductible or not, etc.   Some of those things (e.g., tax bracket at traditional account withdrawal; market return) are uncertain, and as cripzychiken noted, some will ignore any calculations and go with gut feel anyway.

For a generic rule of thumb, doing a simple comparison of expected return rate vs. interest rate is a reasonable approximation.

Depends on whether one subscribes to "Entities must not be multiplied beyond necessity" or "For every complex problem there is an answer that is clear, simple, and wrong" in this case. ;)