Student loan payoff thoughts

[superathlete]

My wife and I each have student loans.  She is a physician and is part of a program which pays them off without incurring income taxes. Both our loans cease to exist if we expire.  Her loan details follow:

$72,000 balance @ 4.75% interest.  My loan is $8200 at 2.625% (no way am I paying this off early).

She just got another $10,000 applied this week towards principle.  Again, tax free.  We started out near $135,000 a few years ago, so I'm happy about the progress we've made. The monthly payment is about $520 (I call it our Mercedes payment).

We have a high savings rate and have been plowing them into the stock market with both pre and post tax accounts.  We've not prepaid any mortgage and are not in a particular hurry to retire, as we enjoy our work. We do earn enough money, however, that student loan interest is not tax deductible. Outside of a house mortgage, we have no other debt.

I would like to be free of student debt, but it is not a burden on us.  I have operated in the past on paying the minimum necessary on her loan. Please tell me if you believe this is a good path to continue on.

Thanks!

[nereo]

My thoughts:  With a 4.75% interest rate you are 'in between' where it makes sense to pay the minimum and where it makes sense to pay it off ASAP.  Using history as our investing guide, you will be better off paying the minimum and investing the difference.

The one major caveat here is that you must invest the difference, not spend it.  Where people get into trouble is when they have $500 extra/month they can put towards a loan and they choose to invest it instead.  But then one month there's an extra expense and another month there's a sale and another month they go on vacation and 10 months later they've only 'saved' $3,000 of their planned $5,000, and spent the rest.  If this sounds like you, then just push everything you can into the loan.  If you are dedicated savers, I'd pay the minimum and keep padding your 'stach.

just my opinion.

[ken]

You didn't say if the 'program' she is part of is simply withholding salary from your wife and then applying it income tax free or if the program is actually paying toward the loans (like additional pay). Either way, continuing on this road is probably the best path. YOu also don't say how often an amount like $10,000 us applied to the principle. Even if it is only annually, the balance will be coming down quickly.

[skunkfunk]

On the near 5% loan, technically stocks outperform and keeping it is a somewhat hedge against inflation. On the other hand, you increase risk exponentially when you leverage an investment like that. Personally I'd pay that one off, no question.

The low rate one - I'm kinda wrestling with that myself. I have a bit under $6k at under 1%, but it's variable. I'd like to be able to say I'm debt free, but shit, that rate is so damn low.

[nereo]

On the near 5% loan, technically stocks outperform and keeping it is a somewhat hedge against inflation. On the other hand, you increase risk exponentially when you leverage an investment like that.

I am confused - how does the risk go up exponentially and how is that leveraging an investment? I can't see how either are true.  explain please?

[Dezrah]

The math can be pretty complicated sometimes, so I found it easiest to just make a spreadsheet showing how the interest accrued (but not compounded) daily and how much each payment reduced the principal.  It was very illuminating to see that our loans cost us $10 every single day just in interest.  Then I set up various accelerated payment scenarios and compared them.  Ultimately it just felt better to pay it all off quickly and "save" $8k in interest over 7 years.

Think of it this way also, have you ever heard someone say "I regret paying off my debt so early" more often than "I regret that I didn't do more to pay off this debt sooner"?  Probably not. 

Also keep in mind that your freedom to move and/or find new jobs is severely limited while you're relying on this employer for debt repayment.  If you're 100% sure you'll stay with this job until it's paid off on a standard schedule, then obviously it's not a problem.

[skunkfunk]

On the near 5% loan, technically stocks outperform and keeping it is a somewhat hedge against inflation. On the other hand, you increase risk exponentially when you leverage an investment like that.

I am confused - how does the risk go up exponentially and how is that leveraging an investment? I can't see how either are true.  explain please?

Just my thoughts, I'm no investing expert. For example, essentially you have say $10k out on loan at 5% (-3% for inflation, so 2%), and  you invest in stocks at an expected return of 10% (-3% inflation for 7%.) So you stand to make a lot of money right? Except take out your 2% you're paying in interest on that money invested so you're down to 5%. Now factor in that the stock market is plus or minus 18%, and you've increased your risk and lowered your reward. So pseudo-leveraged by my understanding. Not sure what else to call it.

I don't know for a fact how the math works out, but I'm pretty sure it's an increase in risk. You stand to lose more money than you started with, with a bad return, rather than up to the money you started with.

[nereo]

Just my thoughts, I'm no investing expert. For example, essentially you have say $10k out on loan at 5% (-3% for inflation, so 2%), and  you invest in stocks at an expected return of 10% (-3% inflation for 7%.) So you stand to make a lot of money right? Except take out your 2% you're paying in interest on that money invested so you're down to 5%. Now factor in that the stock market is plus or minus 18%, and you've increased your risk and lowered your reward. So pseudo-leveraged by my understanding. Not sure what else to call it.

I don't know for a fact how the math works out, but I'm pretty sure it's an increase in risk. You stand to lose more money than you started with, with a bad return, rather than up to the money you started with.

Ok - I might not agree with what you've said but at least I can understand it for now.
Yes, investing the money vs. paying off the loan early carries the risk that the market will go down and you will have less than what you started with.  It was more the phrase "increase risk exponentially" that I was questioning (empahsis added). 

Also, if you pay off the loan early, you loose the inflation hedge.  So you gain that by saving vs. paying down the debt. 
Finally, while it is true that the markets can go down (typically only for 1-3 years), I disagree that you would "increase your risk and lowered your reward".  It is actually more common for stocks to increase in value than it is for them to decrease in value.  So you are actually increasing your (potential) reward, not decreasing it.

in sum:  paying only the minimum on the debt allows you to reap the benefits of inflation, and reap any gains in the market.
Since the loan is at 4.75% and the OP has several years for normal repayment, history favors investing over debt-reduction.

[skunkfunk]

history favors investing over debt-reduction.

I think we're on the same page here, but what are your thoughts on asset allocation? On the one hand, the market is the highest average return for a lazy investor. On the other hand, you should put some money in safer investments, hedge your bets so to speak. Allocation and all.

Where's a safer, higher-interest allocation than a guaranteed debt pay-down? Bonds? Maybe, but the bond market scares me right now. No good reason for me to say that except that I don't like it. Seems like interest rates have been due to go up for a while.

(go ahead, chastize me for market timing bonds.)

I'm not saying he should throw everything at a 4.75% debt, but I do question whether it should get only the minimum. Asking not just for OP, as I have a similar situation.

[superathlete]

Excellent thoughts and input.  Some clarifications.

The money is being paid by a third party (National Health Service Corps). It is not coming out of her check and I'm not convinced she took the job she did because of this loan repayment. One would be hard pressed to argue that compensation is decreased by her employer as a result of the eligibility to repay loans. There are strings attached in that you must complete a year of service or you owe the money back plus some penalties.  I don't feel limited by the repayment agreement as there are ways to transfer if the employment situation would become untenable (or wait it out, it can't be worse than residency).

The payments are annual, as are the contractual agreements. 
Daily interest savings on the recent $10,000 payment is about $1.30.  Not nothing, but not much either.

One of the things I have wrestled with that no one has brought up is the hedge inherent in most student loans, including our own.  Only one party owes the debt, unlike something like a mortgage. If I die, my loans disappear, likewise for my wife.  While I hope this doesn't happen, isn't this sort of a built in life insurance policy?  Seems like there would be some value to our situation to throw extra money towards a mortgage as the survivors reap this benefit.

[nereo]

One of the things I have wrestled with that no one has brought up is the hedge inherent in most student loans, including our own.  Only one party owes the debt, unlike something like a mortgage. If I die, my loans disappear, likewise for my wife.  While I hope this doesn't happen, isn't this sort of a built in life insurance policy?  Seems like there would be some value to our situation to throw extra money towards a mortgage as the survivors reap this benefit.

To be clear - this is true if it is a federally backed (US) student loan.  If you have a private student loan (or a federal student loan that was refinanced through a private company) the lender will first attempt to collect from your assets upon your death.  This means that while your spouse won't have to make loan payments, the lender can first take money from your savings and bank accounts BEFORE that money gets passed on to your spouse.  Also, cancellation of debt (COD) is a taxable event - that means if you die with $72k of debt, your taxes that year will reflect an additional $72k, which your estate will have to pay before your benefitiaries get their inheritence.  Again, there's a (somewhat convoluted way) around this if you have a federally backed student loan, but it isn't an easy process.

Kind of OT, but if you are thinking about such things I would consider getting a term life insurance - enough to cover you between now and when you are FI.  I was able to get a $0.5M 10 year term for $23/month.  In less than 10 years I won't need it anymore.

[superathlete]

Nereo,

The loans are all federal.  I didn't know about the taxation issue, but am not going to worry too much about it. Life insurance should cover any taxes due.

We have $500,000 in life insurance for my wife (20 year term) and due to health issues, I can only get 1.5x salary through my work.  We aren't financially independent, but we certainly aren't dependent upon either of us working.

We've run the numbers, with two surviving children, social security for survivors, savings and the assumption that each spouse can take care of themselves in the other's absence, we are comfortable that either of us would be fine financially should the other perish. Likewise, should disability occur.

[nereo]

Nereo,

The loans are all federal.  I didn't know about the taxation issue, but am not going to worry too much about it. Life insurance should cover any taxes due.

We have $500,000 in life insurance for my wife (20 year term) and due to health issues, I can only get 1.5x salary through my work.  We aren't financially independent, but we certainly aren't dependent upon either of us working.

We've run the numbers, with two surviving children, social security for survivors, savings and the assumption that each spouse can take care of themselves in the other's absence, we are comfortable that either of us would be fine financially should the other perish. Likewise, should disability occur.

Great - sounds like you are on top of things.  In that case, I still support paying the minimum in SL every month and plowing all additional money into savings - chances are you'll earn far more in the market over the next 5-10 years, especially when you factor in the inflationary effects on the loan.  In the very unlikely event that you die, then that debt is gone (another very small reason not to pay it off too soon).

All of that said, there's no one 'right' answer here - if you get an emotional boost having no loans and less savings, then pay them off early. 

[superathlete]

Thanks for all your help to all who contributed.  It's nice to have some somewhat like-minded folk to bounce a relatively complex idea off of.