Author Topic: Student Loan Question  (Read 5366 times)

RhythmKats

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Student Loan Question
« on: July 15, 2013, 05:34:40 PM »
I'm pretty new to this blog, but slowly working my way through the catalog!

I've always been naturally frugal and as an adult it's been a way of life because I don't make much money, and my work is somewhat sporadic.

A little background: I'm 32. I have about $30k @3.75% in student loan debt. I do not have any other debt.

I recently inherited some money from a relative who passed away. After solidifying my emergency fund, I have about $8k to play around with. I am self employed, so I don't have a 401k that I can max out. I do have a Roth IRA. I've contributed $2,400 to the Roth for 2013. I will use some of the $8k to max that out for this year.

Should I use the remainder of the $8k to make a larger payment on my student debt? Or should I invest it in some other vehicle where the return would be higher than the 3.5% that I'm paying on my loan? Someone suggesting holding onto the rest of the $ and using it to max out my IRA for 2014 as well. I'm guessing the Mustachian thing to do is to plug away at the debt, but I'd love to hear what others think.

Feel free to ask questions if you need more info.

Thanks!

MoneyLifeandMore

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Re: Student Loan Question
« Reply #1 on: July 15, 2013, 07:43:12 PM »
This is a tough one and totally depends on the person and their views on money and debt. If the 3.75% is a fixed rate loan, I'd just leave that alone and invest the money, personally. You could wait and contribute to your Roth next year or you can contribute to a taxable investment account if you decide to take this path. There are also retirement accounts that you can set up as a self-employed person, although they do come with expenses.

However, if you hate debt and it keeps you up at night then you can use it to pay the debt off. I don't get that vibe from you though because you asked this question rather than just slamming the money against your loans.

Lackland

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Re: Student Loan Question
« Reply #2 on: July 16, 2013, 12:05:31 AM »

Should I use the remainder of the $8k to make a larger payment on my student debt? Or should I invest it in some other vehicle where the return would be higher than the 3.5% that I'm paying on my loan? Someone suggesting holding onto the rest of the $ and using it to max out my IRA for 2014 as well. I'm guessing the Mustachian thing to do is to plug away at the debt, but I'd love to hear what others think.

Feel free to ask questions if you need more info.

Thanks!

I've been working on a similar financial quandary, but with much higher interest rates. The loans have been quite literally driving me crazy, but while stressing out about it I came up with a way to compare the loan to a potential investment. How much is your monthly payment, and how many payments do you have left?

RhythmKats

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Re: Student Loan Question
« Reply #3 on: July 16, 2013, 07:22:48 AM »
@MoneyLifeandMore Thanks for your response. The loan generally hasn't been bothering me. It's my only debt and has been manageable. The rate is fixed. I am on a graduated repayment plan. I have been paying $150/month. Next month I enter the next phase and will start paying $300/month. I think that's what made me start thinking about trying to get rid of it faster. I'd love to just have the $300 a month to invest.

Perhaps I'll set aside enough to max out my Roth for this year and next and apply the remainder to my loan. I also have a monthly Roth contribution of $100 built into my budget, so I don't even need to set aside a full $5500.00. Am I correct in thinking that I wouldn't have to pay taxes on a taxable investment account unless I sold? If I invested in an index fund with the idea of holding long term, I wouldn't necessarily have to worry about that, right?

My income is somewhat sporadic. I always make enough. Sometimes I make an extra $1K a month and other months it's only $200 or so. Maybe I'll just try to put a little extra on the monthly payments when possible.

@Lackland as stated above, my payment will be just under $300/month beginning in August. I think my projected payoff date is 2026.

Rebecca Stapler

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Re: Student Loan Question
« Reply #4 on: July 16, 2013, 07:37:39 AM »
$30k at 3.25% seems like a modest student loan debt to me. I hate my SLs with the fire of a thousand burning suns, but it's because the payments are so high that they are holding me back. If you invest the entire $8k in your Roth for 2013 and 2014, the average return should be higher over the next 13 years than you will pay in your SL interest. So, I think you should max out 2013 and 2014 IRAs, and go to a standard repayment plan instead of the graduated (unless this is the last phase of your graduated plan, and it is the highest payment). This will reduce your monthly "extra," but you know it will go towards paying down your debt. As for the "extra" that is left over, whether you put it towards your SL or invest it I think is up to your comfort level with having the SL debt and your stomach for investing. Paying off your SL is a guaranteed 3.75% rate of return, whereas with investments YMMV.

RhythmKats

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Re: Student Loan Question
« Reply #5 on: July 16, 2013, 07:43:48 AM »
Thanks for that perspective Stan! I am at the last level of graduation, so it'll be $300/month until it's gone. I think we all hate our SL's with "the fire of a thousand burning suns!" Haha...I love that! I'm leaning in the direction of investing since those early investment $$ have to work the hardest.

TrulyStashin

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Re: Student Loan Question
« Reply #6 on: July 16, 2013, 07:45:39 AM »
Look into a SEP or SIMPLE Ira, both of which you're eligible for thanks to self-employment.   They have much higher contribution limits than the Roth and would make a good addition to the Roth you're using.

I'd invest the cash and deal with the debt through aggressive paydown planned in my monthly budget.


Lackland

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Re: Student Loan Question
« Reply #7 on: July 17, 2013, 12:52:35 AM »
@RhythmKats: Hey, finally did some math for you. Looks like $300/month on a $30K loan at 3.25% costs you about $4,922 over 9.7 years, until it's finally paid off. Paying all $8K onto the principal and then continuing to make the $300 payment the following month would reduce the total interest to about $2484 over 6.8 years. You save $2,476, and three more years of hassle, with a lump-sum payment.

If you choose to invest the $8K instead of using it for a loan payoff, it'd only make sense if you made more money on that investment than you "lose" by not paying down your loan over the same time period. So then what's the annual simple interest rate on $8K that would get you to at least $2,476 in 9.7 years? By my calcs, it's  [(8000+ 2476)/(8000)]^(1/9.7) - 1, which is 2.82%. I'm told that's a really low interest rate for an investment in something like an index fund; if you get a higher return, you end up with more net worth at the end of 9.7 years even if you just make the $300 monthly payments.

Furthermore, just doubling your monthly payment to $600 with future income has the same effect in terms of saving you money on the loan; you only lose $2184 in interest, and are done with the loan in 4.5 years.

RhythmKats

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Re: Student Loan Question
« Reply #8 on: July 17, 2013, 05:45:09 AM »
Lackland,

Thanks for running those numbers! Seems like it makes more sense to invest the money.

sassy1234

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Re: Student Loan Question
« Reply #9 on: July 17, 2013, 03:27:28 PM »
I am asking myself the same question.  I have $30,000 at 3.1% interest, and $10,000 at 2.1%.  I love paying these stupid loans down, it is so exciting.  Now that I finished my higher interest rate loans, I am questioning if I should stop paying more than I need to and start investing.  I am 30 and hardly have anything (savings, investments), since I have been paying loans the past 5 years.  The problem is that I get such an emotional rush when I pay down the loans, I hate debt! 

I have 2 options. 

A. Pay $5,000 per month and finally get ride of my st. loans in a few months
B. Start investing, get a better return, and pay the min. on the st. loans. 

What do others think?  How can I balance my emotions verses basic math?

randymarsh

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Re: Student Loan Question
« Reply #10 on: July 17, 2013, 03:34:48 PM »
I second the SEP and Solo 401k.

MoneyLifeandMore

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Re: Student Loan Question
« Reply #11 on: July 17, 2013, 06:28:02 PM »
I am asking myself the same question.  I have $30,000 at 3.1% interest, and $10,000 at 2.1%.  I love paying these stupid loans down, it is so exciting.  Now that I finished my higher interest rate loans, I am questioning if I should stop paying more than I need to and start investing.  I am 30 and hardly have anything (savings, investments), since I have been paying loans the past 5 years.  The problem is that I get such an emotional rush when I pay down the loans, I hate debt! 

I have 2 options. 

A. Pay $5,000 per month and finally get ride of my st. loans in a few months
B. Start investing, get a better return, and pay the min. on the st. loans. 

What do others think?  How can I balance my emotions verses basic math?

If they are fixed rate loans, I say start investing. The more time you have the more your money will compound and grow! Once your balance starts growing in your savings, retirement or investment account it can get very addictive as well. With loan rates so low, if they're fixed, you'll likely never get another chance to have such a great arbitrage opportunity. Of course, the stock market could crash tomorrow and you lose money, but if you're in it long term you should be fine.

Rebecca Stapler

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Re: Student Loan Question
« Reply #12 on: July 18, 2013, 02:31:56 PM »
I am asking myself the same question.  I have $30,000 at 3.1% interest, and $10,000 at 2.1%.  I love paying these stupid loans down, it is so exciting.  Now that I finished my higher interest rate loans, I am questioning if I should stop paying more than I need to and start investing.  I am 30 and hardly have anything (savings, investments), since I have been paying loans the past 5 years.  The problem is that I get such an emotional rush when I pay down the loans, I hate debt! 

I have 2 options. 

A. Pay $5,000 per month and finally get ride of my st. loans in a few months
B. Start investing, get a better return, and pay the min. on the st. loans. 

What do others think?  How can I balance my emotions verses basic math?

With an 8 month timeline to get rid of them all, I can see the temptation. But I would focus on 2013 retirement contributions if I had $5k/month to invest. Does your employer provide a 401k match? Do that first. Then I would max out an IRA for 2013.

In terms of the thrill of paying down that debt, maybe you could split the difference -- $2500/mo to the loans and $2500/mo to invest. How stable is your job? If you  could find yourself unemployed in the near future, that would be added incentive for me, personally, to get rid of the debt. Does it make sense math-wise over the long term? No. But it does add stability to not have a loan payment every month.

Rewdoalb

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Re: Student Loan Question
« Reply #13 on: July 18, 2013, 02:43:11 PM »
@RhythmKats: Hey, finally did some math for you. Looks like $300/month on a $30K loan at 3.25% costs you about $4,922 over 9.7 years, until it's finally paid off. Paying all $8K onto the principal and then continuing to make the $300 payment the following month would reduce the total interest to about $2484 over 6.8 years. You save $2,476, and three more years of hassle, with a lump-sum payment.

If you choose to invest the $8K instead of using it for a loan payoff, it'd only make sense if you made more money on that investment than you "lose" by not paying down your loan over the same time period. So then what's the annual simple interest rate on $8K that would get you to at least $2,476 in 9.7 years? By my calcs, it's  [(8000+ 2476)/(8000)]^(1/9.7) - 1, which is 2.82%. I'm told that's a really low interest rate for an investment in something like an index fund; if you get a higher return, you end up with more net worth at the end of 9.7 years even if you just make the $300 monthly payments.

Furthermore, just doubling your monthly payment to $600 with future income has the same effect in terms of saving you money on the loan; you only lose $2184 in interest, and are done with the loan in 4.5 years.

If paying the loan off with the lump sum lets you get rid of it in 6.8 years, shouldn't your second calculation be set up to reach $2,476 in 6.8 years instead of 9.7?  Which would essentially be a higher rate of return?

As a long time lurker who registered to clarify this point, I will be quite embarrassed if I'm missing something obvious :)

MakingSenseofCents

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Re: Student Loan Question
« Reply #14 on: July 20, 2013, 09:50:08 AM »
Hmm this is tough. I just finished paying off my $40K in student loans, but they were at much higher interest rates (mostly 6.8%), so I had no problem with wanting to pay them off as quickly as possible.

So I guess it all depends on how you feel about debt.

MoneyLifeandMore

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Re: Student Loan Question
« Reply #15 on: July 22, 2013, 08:16:24 PM »
Hmm this is tough. I just finished paying off my $40K in student loans, but they were at much higher interest rates (mostly 6.8%), so I had no problem with wanting to pay them off as quickly as possible.

So I guess it all depends on how you feel about debt.

In this case I could see a person going either way. A 6.8% return is decent, and if your debt makes you feel uneasy I don't think it'd be a horrible choice. But why go all or nothing? You can always go half and half, invest half and pay down debt with the other half!