Author Topic: When NOT to pay off SL debt?  (Read 4605 times)

uppy

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When NOT to pay off SL debt?
« on: January 19, 2014, 08:34:23 AM »
So I've been doing some reading. (Noob alert.) And I read somewhere that the only time it would NOT make sense to pay off my student loan debt before investing was if my SL debt was at a lower interest rate than my potential returns on investments. Obvious right?

Well, I have a chunk of SL debt that is consolidated at a fixed rate of 5.25%. Granted I can't invest as much if I'm making loan payments each month, but wouldn't it make sense to take advantage of the probable returns of ~7% in stocks/bonds?

Or is that nonsense since it would be effectively only a 1.75% return if I subtract what I'm paying on the loans?

Still, 1.75% over the 10 years I'll be paying off the loans could be something, rather than nothing. But then...I could pay it off faster and invest more sooner if I put it ALL towards the loans now, and waited to invest.

Maybe I answered my own question but I am still confused about this.

KingCoin

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Re: When NOT to pay off SL debt?
« Reply #1 on: January 19, 2014, 09:12:42 AM »
The key component you're missing is risk. Paying off your student loans is a risk free (and tax free) 5.25%. Stocks are risky and volatile, so you need a higher return to compensate. Most medium term, risk free investments yield in the neighborhood of 0-3%.

As long as you have enough liquidity, I'd pay down the loans first.

uppy

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Re: When NOT to pay off SL debt?
« Reply #2 on: January 19, 2014, 09:40:03 AM »
You can't go back and fund your IRA for 2011 after paying off your loans in 2013. I figured that even if the interest paid on my student loans completely canceled out the interest earned on my retirement savings in those years, it would be worth it in the long run. And because we've job hopped so much, we've spent very little time with access to 401ks, so I'm doubly glad I used them when I had them.

That's sound logic to back up what I was thinking, however I don't have access to a 401k through my job, so I can't take advantage of employer benefits or tax deferment. So in that case it still would not make sense not to pay off the SLs.


I'm pretty happy with the choices I've made, but I see people here with student loans at 2% and 3%, and if I'd had those, I might have done differently.

Whoa! How the heck do you get a student loan at 2% or 3%?? Mine were all subsidized and were't that good. Those must be from years ago, I guess.

The key component you're missing is risk. Paying off your student loans is a risk free (and tax free) 5.25%. Stocks are risky and volatile, so you need a higher return to compensate. Most medium term, risk free investments yield in the neighborhood of 0-3%.

As long as you have enough liquidity, I'd pay down the loans first.

Thanks. I always forget to think of loan interest in that way. That 5.25% is essentially a return I can get, versus not having them paid off at all (i.e. losing that money). However I am young and the investments would be long term probably index funds, and the avg. return I often hear quoted for 10+ years is around 7% or even 8%. Still I see your point.

What would you call "enough" liquidity, in terms of percentage of income, etc?

thepokercab

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Re: When NOT to pay off SL debt?
« Reply #3 on: January 19, 2014, 09:55:33 AM »
Quote
Whoa! How the heck do you get a student loan at 2% or 3%?? Mine were all subsidized and were't that good. Those must be from years ago, I guess.

I graduated in 2006 with approx $12,000 in student loan debt, spread over two loans.  One with an interest rate at 1.85% and another at 2.1%.  I really have no idea why these were so low, especially when I read about folks who have loans at 6%, 7% and above. 

Needless to say, i've been paying mine off as slow as possible... 

Joel

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Re: When NOT to pay off SL debt?
« Reply #4 on: January 19, 2014, 11:00:22 AM »
I would likely take the guaranteed 5.25% return over taking the chance on the stock market in the short term. The sooner those loans are no longer over your head, the better.

uppy

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Re: When NOT to pay off SL debt?
« Reply #5 on: January 19, 2014, 11:04:11 AM »
You can't go back and fund your IRA for 2011 after paying off your loans in 2013. I figured that even if the interest paid on my student loans completely canceled out the interest earned on my retirement savings in those years, it would be worth it in the long run. And because we've job hopped so much, we've spent very little time with access to 401ks, so I'm doubly glad I used them when I had them.

That's sound logic to back up what I was thinking, however I don't have access to a 401k through my job, so I can't take advantage of employer benefits or tax deferment. So in that case it still would not make sense not to pay off the SLs.


You can still put money into an IRA or Roth IRA for tax benefits, even if you don't have 401k access. Also, I noticed in your journal you're an independent contractor. In that case, you absolutely have access to a 401k. You can set one up for yourself and fund it as both an employee AND employer. You'll want to google "Solo 401k" to learn more if you're considering that route.

I feel dumb that I did not know this. I will have to look into it.

hoosierEE

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Re: When NOT to pay off SL debt?
« Reply #6 on: January 19, 2014, 12:22:41 PM »
The risk from not investing X is you lose out on the potential gains.  The risk from defaulting on your student loans is jail.

Thought experiment:
You are debt-free.  Do you (a) invest slowly while remaining debt-free or (b) take out a loan in order to invest more quickly?
The answer depends on your risk tolerance and how much value you personally attach to your financial freedom.

uppy

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Re: When NOT to pay off SL debt?
« Reply #7 on: January 19, 2014, 01:40:34 PM »
The risk from not investing X is you lose out on the potential gains.  The risk from defaulting on your student loans is jail.

Thought experiment:
You are debt-free.  Do you (a) invest slowly while remaining debt-free or (b) take out a loan in order to invest more quickly?
The answer depends on your risk tolerance and how much value you personally attach to your financial freedom.

I don't quite follow the logic here. Who said anything about defaulting?

uppy

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Re: When NOT to pay off SL debt?
« Reply #8 on: January 20, 2014, 07:35:53 AM »
The risk from not investing X is you lose out on the potential gains.  The risk from defaulting on your student loans is jail.

Thought experiment:
You are debt-free.  Do you (a) invest slowly while remaining debt-free or (b) take out a loan in order to invest more quickly?
The answer depends on your risk tolerance and how much value you personally attach to your financial freedom.

I don't quite follow the logic here. Who said anything about defaulting?

Nobody said you're going to, but it is a relevant consideration. Student loan debt is non-dischargeable in bankruptcy, therefore you should take it into account when weighing whether to invest or pay off the loans.

The question isn't whether I will pay off the loans, the question is whether I will pay them off sooner or later. It seems like sooner is the better option under the circumstances. But even if I was to invest I would keep making minimum (or greater) payments towards the SL debt. Something disastrous would have to happen for me to default and/or declare bankruptcy. I take it as essential that it would be a bad idea to invest the totality of an emergency fund -- something that makes investing for the time being out of my reach, anyway! ;)