Student Loan Payoff Indecision Waking Nightmare

[Lackland]

Hey there, Mustachians. Long-time reader, first-time poster.

This is merely a variant on the very-popular "should I pay off my student loans or start saving" question, but with some slight twists. I suppose I'm one of those many Millennials who was overly-optimistic and financially uneducated, and I am currently playing the Game of Loans (You either pay, or you die). I'm armed with a prestigious degree that apparently has some sort of amazing value that I've never found out how to access, and currently gross $3500/month, although that will go up as I climb the civil servant ladder. Until recently, I was fatalistically resigned to ten years of repayment and made the minimums while kicking in extra whenever I could. Then a couple of things happened: I remembered that I had some money invested (due to a member of the hard-working, hard-saving Greatest Generation from whom I am descended), the markets came back, and I FINALLY started learning about how compounding interest, retirement savings, and tax law work. So I suddenly have both the loans and a small pot of cash ($37,000) sitting in a money market, screaming "DO SOMETHING!!!" every time I check my balance.

What I think I should do, and what I WANT to do, is to drop some cash bombs on the four loans that total $26,000 at 6.8%, at a total mandatory minimum payment of $470/month, to both give me the relief I crave and to deny future interest to the rentier banks who are given free income by the government. But I'm also screwed for retirement, with literally nothing invested under the aegis of 401k/IRA/457b. I keep on thinking that there might be some way to jumpstart those savings with my sack full of cash, and that stops me from putting out the long-burning fires of my debt emergency.

And by "Keep on thinking," I mean "obsess." No decision has been made, and I really do not feel as though I have any friends or family members who understand both personal finance and the concept of not buying useless crap. (I've heard a lot of "You just need to enjoy life, man" when I've broached the subject of these windfalls.) So, wise Internet strangers: Any opinions?

[Catbert]

Personally, I'd pay off the student loans.  Instead of earning .1% or so of interest from the money market you'd be getting 6.8% from the pay-off.  Then I'd take at least the $470 a month you've been paying on the loans and put it into your 401k or Roth IRA.  If you can get a match go the 401k (or equivalent) route.  If no match then use a Roth first. 

[arebelspy]

Pay them off at 6.8%, then aggressively start saving.

[capital]

6.8% is pretty close to the average long-term return of the markets, so financially it's pretty much a wash if you want to pay of your loans or make investments, except for the potential tax deductibility of your student loan interest. You can always run the math on how much the deduction is worth to you-- maybe a couple hundred. Since the debt causes you anxiety, I'd just pay it off. Moreover, there's a big temptation factor where having $37,000 sitting around in cash might tempt you to spend.

With $3500 a month gross (plus a pension, possibly, if you're a civil servant), you have plenty of income to build up your savings while living without dependents, even in the most expensive areas. Step one is to make sure to max out any matching funds for retirement accounts.

If you're planning on buying real estate within the next couple years, you might want to save this money as a down payment, however.

[Grigory]

6.8% student loan interest?! Ye gods! Did you get unsubsidized loans? Because my subsidized Sallie Mae loans only charge 2.9%. Unless you find a surefire way to invest your money with >6.8% annual return, the smartest thing to do would be to pay them off. That way, you'll get a 6.8% return and you won't even have to pay taxes! :))

[StarryC]

Many recent grads had 6.8% loans, which was the standard rate for Stafford loans begining in 2006 I think. 

It sounds like you can pay off all of your loans, and still have some money left.  DO IT! 

You can only deduct $2,500 of student loan interest, so you probably won't save THAT much on the tax side, and your tax rate is probably not that high at your current salary.   (Let's say you pay 15% income tax, you'd save $375 a year in taxes while paying/ accruing $1,768 in interest per year.)

Then, put your current monthly loan payments into retirement savings.  This provides flexibility- if you have an actual, expensive emergency you can just not save that month.  You'll still have about $11,000, which is a pretty good start to a retirement account.

Also, with a civil service job, is your employer saving for you in some capacity?  You might not be as far behind as you think. 
 

[ScubaAZ]

6.8% student loan interest?! Ye gods! Did you get unsubsidized loans? Because my subsidized Sallie Mae loans only charge 2.9%. Unless you find a surefire way to invest your money with >6.8% annual return, the smartest thing to do would be to pay them off. That way, you'll get a 6.8% return and you won't even have to pay taxes! :))

This is a common misconception of those who went to college in the late 90's- early 2000's.  Student loan interest is dirt cheap, right?  Wrong.  Grad school loans run 6.8% for federal loans, and higher for private loans.  Undergraduate loans are the same, though the government has bought down their rate for the last several years (set to expire and currently being debated in Congress again).

The fact that it can never be discharged (well, there are a few exceptions) should mean that the rate would be fairly low, but the banks also know that many students don't have an option if they want to go get through school.  I couldn't have done law school without them.  One should also be able to get a rate based on your own credit score, rather than lending to anyone who applies, and people like me, who have excellent credit paying 3x more in interest to subsidize those who take out huge loans without ever planning how they will be paid back, and defaulting on them.  Makes me angry.  If I'm earning .8% on my savings, it should be criminal for them to earn 6.8% on my loans.

Sorry, done with soap box.

[Rebecca Stapler]

6.8% student loan interest?! Ye gods! Did you get unsubsidized loans? Because my subsidized Sallie Mae loans only charge 2.9%. Unless you find a surefire way to invest your money with >6.8% annual return, the smartest thing to do would be to pay them off. That way, you'll get a 6.8% return and you won't even have to pay taxes! :))

LOL! What rock do you live under? Also, whether the loan is subsidized or not doesn't affect the interest rate when you pay them off; just whether you're charged interest while you're in school.

Lackland, I agree with others -- pay those suckers off. (1) your moneymarket is losing money due to inflation, so it's not like you're actually earning money in lieu of paying off the SLs, (2) Although you would probably earn more than 6.8% in the market right now, you won't in the long term, (3) you have until April 2014 to make your 2013 Roth IRA contribution. You could *almost* max out your contribution ($5500) just by saving the $470/mo payment, but regardless, (4) you have enough in the bank to both pay off your loans in total and make your 2013 contribution.

Go for it! Lose those chains!!

Do you have access to a 401k / 403b through your employer? Do they match your contribution?

[.22guy]

I say pay it off, just make sure that you use the $470 a month on something productive financially and not a new car payment.

[Grigory]

6.8% student loan interest?! Ye gods! Did you get unsubsidized loans? Because my subsidized Sallie Mae loans only charge 2.9%. Unless you find a surefire way to invest your money with >6.8% annual return, the smartest thing to do would be to pay them off. That way, you'll get a 6.8% return and you won't even have to pay taxes! :))

This is a common misconception of those who went to college in the late 90's- early 2000's.  Student loan interest is dirt cheap, right?  Wrong.  Grad school loans run 6.8% for federal loans, and higher for private loans.  Undergraduate loans are the same, though the government has bought down their rate for the last several years (set to expire and currently being debated in Congress again).

Class of 2008 here, aka the first college graduates to get hit by the economic implosion. :( I borrowed for the first 3 years and got enough grants (with a bit of my own money) to pay for the 4th year, which means my last loan was taken out in 2006, for the 06-07 school year. All of my loans were subsidized and the interest rate was only 2.8%. The reason I was asking is because I'm pretty sure banks charge higher for unsubsidized loans since the Feds can't back them up (subsidize), right?.. Still shocking, though - 6.8% interest in this economy! O_o

LOL! What rock do you live under? Also, whether the loan is subsidized or not doesn't affect the interest rate when you pay them off; just whether you're charged interest while you're in school.

It's a pretty nice rock - large and flat and with plenty of shade. You should try it too someday. ;)

[Joet]

if there's a 401k match at work thats (almost) always the 1st priority ,beyond that, paying down the student loans makes sense to me AFTER you have set aside a 6 month emergency fund. This may save you money in the long run as you wont have to pull money out of 401ks due/sell as the market tanks the next time WTSHTF

Im also rather conservative. Completely paying off your student loans AND contributing ~10% or so to your 401ks with the rest as your emergency fund makes sense to me

[arebelspy]

6.8% student loan interest?! Ye gods! Did you get unsubsidized loans? Because my subsidized Sallie Mae loans only charge 2.9%. Unless you find a surefire way to invest your money with >6.8% annual return, the smartest thing to do would be to pay them off. That way, you'll get a 6.8% return and you won't even have to pay taxes! :))

This is a common misconception of those who went to college in the late 90's- early 2000's.  Student loan interest is dirt cheap, right?  Wrong.  Grad school loans run 6.8% for federal loans, and higher for private loans.  Undergraduate loans are the same, though the government has bought down their rate for the last several years (set to expire and currently being debated in Congress again).

Class of 2008 here, aka the first college graduates to get hit by the economic implosion. :( I borrowed for the first 3 years and got enough grants (with a bit of my own money) to pay for the 4th year, which means my last loan was taken out in 2006, for the 06-07 school year. All of my loans were subsidized and the interest rate was only 2.8%. The reason I was asking is because I'm pretty sure banks charge higher for unsubsidized loans since the Feds can't back them up (subsidize), right?.. Still shocking, though - 6.8% interest in this economy! O_o

LOL! What rock do you live under? Also, whether the loan is subsidized or not doesn't affect the interest rate when you pay them off; just whether you're charged interest while you're in school.

It's a pretty nice rock - large and flat and with plenty of shade. You should try it too someday. ;)

Subsidized just means the feds pay the interest during the subsidized period (while in school), it doesn't mean a lower rate from what I understand.

Yes, I was also recently surprised to find out student loan rates went to 6.8% as standard (in 2008, I think?).. yikes.  Mine are at various rates but average to 3.xx

[kevin78]

Im also rather conservative. Completely paying off your student loans AND contributing ~10% or so to your 401ks with the rest as your emergency fund makes sense to me

I have a similar dilemma and this is exactly what I am doing.  I guess its the thing that seems to make the most sense, get the student loan debt out of the way which requires as big a payment as possible, but still contribute enough to  get the employer match at work plus a little more and then you obviously have to have an emergency fund in this situation.

[davisgang90]

Remember, paying off your school loans is a guaranteed 6.8% return.  Once you are debt free you can really start saving larger parts of your income.

[aj_yooper]

Seems like you have more than enough to:

1)  Max out a Roth IRA for this year (you can dollar cost average into it if you are worried about buying in at the peak)
2)  Pay off your loans
3)  Start contributing at least the amount you were paying on the loans into retirement accounts at work.

That's what I'd do if I were you.

Post your budget if you dare and we can probably find additional places where you can cut and up the amount you have available for long-term savings/investment.

Congratulations on figuring it out! 

+1 with a minor modification.  Since you are currently paying $470 per month after taxes, contribute $587.50 pre-tax to any sheltered investment, like a 403b, and added caveats: 1. Use a low cost provider for your Roth IRA, like Vanguard.  2.Keep the rest of your stash as an emergency fund.

[katieboo]

You said something about the civil servant ladder. Are you saying you work for a government agency? I work for the state government and I plan on applying for the public service loan forgiveness program, where if I make 10 years worth of payments under the federal direct consolidation program and while I'm employed in public service, gov will forgive the remaining balance.

And I can make income based payments lower than the standard repayment plan. And Ive applied and I'm hoping to qualify for the new pay as you earn payment plan which will lower my payments even more.

I have a high interest rate so the loan forgiveness program should help me, since I have a six figure outstanding balance. Its not for everyone, but if you work in any government agency and plan to stay there, I'd definitely recommend looking into this.

[anastrophe]

You said something about the civil servant ladder. Are you saying you work for a government agency? I work for the state government and I plan on applying for the public service loan forgiveness program, where if I make 10 years worth of payments under the federal direct consolidation program and while I'm employed in public service, gov will forgive the remaining balance.

Highlighted the relevant portions. This is a good plan only if you cannot pay them off in the same time period easily, have federal loans (not private), and are working full-time in public service. You have to hit all the criteria, but if you do it's great.

[katieboo]

Yes, anastrophe, I agree. Graduates with a low outstanding balance are an example. And your income has to be low enough to qualify for reduced payments or you won't save a lot of money in the end. And some graduates may not want to consolidate their loans in the federal direct program for other reasons. I had this talk with my sister and cautioned her to really weigh the pros and cons of consolidating.

[Rebecca Stapler]

You said something about the civil servant ladder. Are you saying you work for a government agency? I work for the state government and I plan on applying for the public service loan forgiveness program, where if I make 10 years worth of payments under the federal direct consolidation program and while I'm employed in public service, gov will forgive the remaining balance.

Highlighted the relevant portions. This is a good plan only if you cannot pay them off in the same time period easily, have federal loans (not private), and are working full-time in public service. You have to hit all the criteria, but if you do it's great.

I don't think lackland would qualify, based on income : debt. Even so, I doubt the forgiven amount would be less than the interest over 10 years.

[TrulyStashin]

I'm also fairly certain that when the principal balance is forgiven after 10 years of public service, the amount forgiven is taxed as if it were income in that year.    That's a fine howdy-do.......

Also, FWIW, the debt ceiling faux-crisis of 2011 resulted in a deal that killed all subsidized loans for graduate students. So, the interest begins accruing the day you take out the loan even if you're in a 3 or 4 year professional / graduate program.  This will shift about $18 billion in costs onto students over the next decade.

We're doing a fine job of making higher education completely unafforadable to all but the wealthy.

[dismount soapbox]

[rubybeth]

6.8% student loan interest?! Ye gods! Did you get unsubsidized loans? Because my subsidized Sallie Mae loans only charge 2.9%. Unless you find a surefire way to invest your money with >6.8% annual return, the smartest thing to do would be to pay them off. That way, you'll get a 6.8% return and you won't even have to pay taxes! :))

I went to school from 2006-2009 and consolidated in 2009, and my rate is 6.2%. My sister went from 2009-2011 and hers are at 7+%.

[Rural]

I'm also fairly certain that when the principal balance is forgiven after 10 years of public service, the amount forgiven is taxed as if it were income in that year.    That's a fine howdy-do.......

That's true for the basic IBR that is forgiven at 25 years, but not for the Public Service plan that's forgiven in ten; the forgiven amount is not taxed.

[Rural]

I don't think lackland would qualify, based on income : debt. Even so, I doubt the forgiven amount would be less than the interest over 10 years.

Not qualifying is a major stumbling block, of course, but you have to be on an income-based plan in the first place. The payments under the plan may be less than the interest charge. Also, if you're saving 50% of income in pretax retirement funds (some of us can pull that off, especially combined with an HSA), then that income is excluded from the payment calculation.

Editing to say I mean that anything that goes into pretax accounts is excluded. It doesn't have to be 50% or more, though of course that has all sorts of advantages aside from the payment calculation.

[Rebecca Stapler]

I don't think lackland would qualify, based on income : debt. Even so, I doubt the forgiven amount would be less than the interest over 10 years.

Not qualifying is a major stumbling block, of course, but you have to be on an income-based plan in the first place. The payments under the plan may be less than the interest charge. Also, if you're saving 50% of income in pretax retirement funds (some of us can pull that off, especially combined with an HSA), then that income is excluded from the payment calculation.

Editing to say I mean that anything that goes into pretax accounts is excluded. It doesn't have to be 50% or more, though of course that has all sorts of advantages aside from the payment calculation.

That is a great point about reducing AGI to qualify -- with a 401(k) or HSA. (Personally, you pointed out another reason we need to open an HSA. I didn't think about it that way -- but we're on an IBR payment plan, so it has the benefit of lowering our payments)