loan repayment options - which terms is better?

[minimm74]

Hi all,

So, of course, I'm paying off our debts as fast as possible, but my mini MM is partially at the whim of my wife and kids. So we can't pay off the student loan debt in the next couple months. But we do have another option. I've tried to figure out which setup is best, but despite the fact that I've got a decent education in math, I'm still getting a little tripped up.

Student loan: $22k ish, at 3.5% interest

option 1: leave it here and pay it back as fast as possible. Looking at past statements, it's working out to be roughly $50-$70/mo in interest (not sure why it's not a straight line decline the way I'd expect, but it jumps around from month to month - I'm paying more than the minimum, so they may be applying it in an unexpected way). This is basically money thrown away, the cost of borrowing money.

vs

option 2: our 403b plan (like a 401k) will allow us to borrow against our savings. Here are the terms: it's probably around 10% but that goes back to us (it increases the balance of our 403b) plus a $75 loan origination fee and $25 annual fee until we pay it off. So it seems like even though the interest rate will be quite a bit higher, it's essentially forcing us to increase our illiquid savings. The one downside is that that money is coming out after taxes, and since it's a 403b, we'll get taxed again when we start taking money out again after 65 or whenever. I don't expect this to be a huge factor though since we're at a low bracket now and expect to be at a pretty low tax bracket through our retirement.

Seems like a no-brainer to go with option 2. Am I missing something? Feel free to punch me in the face, but feeding my kids ramen every day isn't really an option and the minimal thing is a long term negotiation with my wife.


Here's the simplified version I just put together:

$20,000 at 3% vs 10%

3%: ~$600/yr to the bank in interest. Since it's tax deductible, if I'm at a 15% tax bracket, that's $90 I get back at the end of the year, so total estimated cost $510.
10%: ~$2,000/yr in interest that goes to us, $100 in fees the first year to the bank. Taxes on that = $300. So total cost for the first yr is $400, and cheaper after that since the $75 loan origination fee is just in the first yr.

Thanks, Mustachians!

[taekvideo]

The changing interest is partly because of the different number of days in a month, and also whenever you make a payment it might go to whatever interest has accumulated so far that month then does the principal, so the interest for the end of the month normal payment would be less since you paid some of it already.

I would leave it at the 3.5% interest.  That's barely inflation, so you're not really paying anything extra due to interest.  You could make minimum payments and be just as well off.

[MDM]

See thread starting at http://forum.mrmoneymustache.com/investor-alley/calculating-return-on-loan-prepayment/msg281898/#msg281898 for an explanation of why your student loan interest changes each month.

About the 403b loan: don't know the details for sure, just have had the vague notion that "it's a bad idea."  If your numbers work out, however, it would be good to know - always good to learn something different than vague notions indicate.  E.g., see http://www.403bwise.com/participants/getwise_faq.html#faq15.  In particular, there is this statement: "The lender keeps those amounts that you pay in interest, so interest payments will not be a part of your retirement savings."  Of course, don't believe everything you read on the internet but that would concern me if I were you.  Good luck!

[Catbert]

Leave it where it is at 3.5%.  If you borrow from your 401k you'll end up paying taxes twice on the payments:  you'll pay taxes on the money before you make the payment to your 401k and then when you withdraw it you'll pay tax again.  Plus if you change jobs before the loan is paid off you'll either need to pay-off quickly (90 days I think) or it'll count as an early distribution with taxes and penalties due.