Yet another student loan

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Would you pay?

Pay as much as you can on the loan
16
62%
Make the minimum payments
5
19%
Meet somewhere in the middle
5
19%
 
Total votes: 26

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g$$
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Yet another student loan

Post by g$$ »

Hi all,

I'll apologize in advance for yet another student loan question. I'm debating whether I should continue to make advanced payments on my student loans or if I should be saving for a down payment. I've already paid off all the high interest loans, which were around 7% so I'm now left with one loan that has an extremely low interest rate.

This post has more of my finances in the typical format, but here are the relevant details.

Emergency Funds = 6 mo expenses
Debt: $41,000 @ 2.75% (variable) student loan
Income: ~90K, very good job security
Tax Filing Status: Single
Marginal Tax Rate: 25% Federal, 9.3% CA
Age: 26
Currently making the maximum contributions to 401(k), Roth IRA, HSA, and ESPP.

Some other details about the loan:
I will not be eligible for the student loan interest deduction this year but I may be partially eligible next year. Probably wont be a huge tax break though.

If I don't pay down the loan I will start saving for a down payment on a house. I probably won't purchase a house for at least 10y. I'm lucky to have a very nice 401(k) that allows after-tax contributions and in-service withdrawals. I would probably make after tax contributions to the 401(k) then roll those over to a ROTH to minimize taxes on any gains.

When I started I had many student loans. Several of the other loans had rates around ~7% so it clearly made sense to pay those early. With this last one I'm not so sure.

So what would you do? Would you pay the loan or save for a down payment? Maybe just split the two and call it a day?

Thanks,

-G$$
Last edited by g$$ on Mon Aug 06, 2012 12:36 am, edited 2 times in total.
maxim81
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Re: Yet another student loan

Post by maxim81 »

I personally would pay down the loan as fast as possible since (I assume) you have no other debt (renting or staying at parents). It will be a good feeling once the loans are off the books. You can then focus exclusively on saving for a house/investing/etc.

Good luck.. student loans are painful :)
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g$$
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Re: Yet another student loan

Post by g$$ »

maxim730 wrote:I personally would pay down the loan as fast as possible since (I assume) you have no other debt (renting or staying at parents). It will be a good feeling once the loans are off the books. You can then focus exclusively on saving for a house/investing/etc.

Good luck.. student loans are painful :)
Two lucky guesses! This is my only debt and I'm renting in San Francisco. Rent here is absurd.
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market timer
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Re: Yet another student loan

Post by market timer »

How much extra per year are you considering paying down? If it's something like $10-15K/year, I'd just buy I bonds instead. You would not lose much at all on the interest rate differential, and you'd be preserving liquidity, which you do not have much of due to your retirement contributions. Think of it as an emergency fund and downpayment fund. You are doing the right thing by maxing out 401K pre- and post-tax.
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Toons
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Re: Yet another student loan

Post by Toons »

With laser like focus Pay it off as fast as you can,then you can focus your energy on saving money :happy
"One does not accumulate but eliminate. It is not daily increase but daily decrease. The height of cultivation always runs to simplicity" –Bruce Lee
TheDev
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Re: Yet another student loan

Post by TheDev »

Toons wrote:With laser like focus Pay it off as fast as you can,then you can focus your energy on saving money :happy
I agree with this.
Default User BR
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Re: Yet another student loan

Post by Default User BR »

With those rates, I wouldn't be in any hurry. You can up your after-tax contributions and take a wait and see on what your variable rates do.


Brian
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g$$
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Re: Yet another student loan

Post by g$$ »

market timer wrote:How much extra per year are you considering paying down?
Just a quick estimate, but I think I could make an extra 1,000 per month.

-g$$
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HardKnocker
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Re: Yet another student loan

Post by HardKnocker »

Debt is a cancer.

Pay it off and be free.
“Gold gets dug out of the ground, then we melt it down, dig another hole, bury it again and pay people to stand around guarding it. It has no utility.”--Warren Buffett
Default User BR
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Re: Yet another student loan

Post by Default User BR »

HardKnocker wrote:Debt is a cancer.
Debt is a financial tool. One should learn to operate their finances without fear.


Brian
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Re: Yet another student loan

Post by Mudpuppy »

There are some important risk factors missing in your post. And it is hard to give an answer (short of those the classic debate between the "pay off all debt now" crowd and the "some leverage is okay" crowd) without answering the following questions: Is this a federal loan or a private loan? What are the terms of the variable rate (e.g. when does it reset and what is the rate formula)? Can it be converted into a fixed rate (e.g. if it's federal, can it be consolidated to lock in the rate)?
Grt2bOutdoors
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Re: Yet another student loan

Post by Grt2bOutdoors »

Default User BR wrote:
HardKnocker wrote:Debt is a cancer.
Debt is a financial tool. One should learn to operate their finances without fear.


Brian
Agree, everything in moderation.
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Confused
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Re: Yet another student loan

Post by Confused »

Blanked for privacy
Last edited by Confused on Fri Nov 06, 2015 12:14 am, edited 1 time in total.
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g$$
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Re: Yet another student loan

Post by g$$ »

Mudpuppy wrote:Is this a federal loan or a private loan? What are the terms of the variable rate (e.g. when does it reset and what is the rate formula)? Can it be converted into a fixed rate (e.g. if it's federal, can it be consolidated to lock in the rate)?
These are some good questions.
1. This is a private loan.
2. The rate is reset monthly.
3. Interest Rate = Prime Rate + 0bps. I get a 50bps reduction in the rate for enrolling in autopay.
4. The loan can not be converted to a fixed rate.

For what it's worth, right now I'm leaning towards making extra payments only because it simplifies things.

-g$$
Default User BR
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Re: Yet another student loan

Post by Default User BR »

Confused wrote:No way. Zero debt is the way to go. Nobody can knock on my door, send me a letter, or call my phone to remind me that I owe them money because I don't owe anybody a penny.
Again, fear is no way to run your financial life. "Fear is the mind-killer."[1]


[1] Frank Herbert's Dune, of course.

Brian
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Re: Yet another student loan

Post by Johm221122 »

Default User BR wrote:
Confused wrote:No way. Zero debt is the way to go. Nobody can knock on my door, send me a letter, or call my phone to remind me that I owe them money because I don't owe anybody a penny.
Again, fear is no way to run your financial life. "Fear is the mind-killer."[1]


[1] Frank Herbert's Dune, of course.

Brian
+1 there is good debt,but most debt is bad.Every situation is different
Mudpuppy
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Re: Yet another student loan

Post by Mudpuppy »

g$$ wrote:
Mudpuppy wrote:Is this a federal loan or a private loan? What are the terms of the variable rate (e.g. when does it reset and what is the rate formula)? Can it be converted into a fixed rate (e.g. if it's federal, can it be consolidated to lock in the rate)?
These are some good questions.
1. This is a private loan.
2. The rate is reset monthly.
3. Interest Rate = Prime Rate + 0bps. I get a 50bps reduction in the rate for enrolling in autopay.
4. The loan can not be converted to a fixed rate.
The formula is actually pretty decent for a private loan. However, it has the potential for more variability than a loan that resets on an annual basis, although recent history hasn't experienced that due to the prime rate remaining unusually static. I do find market timer's suggestion of accumulating I-Bonds earmarked to paying off the loan to be an interesting one, but there is no guarantee that I-Bonds will break even for you (prime rate - 0.50% + accounting for federal taxes on I-Bond earnings), and a quick back-of-the-envelope calculation shows I-Bonds haven't broke even for the last couple of years at your interest rate. I-Bond accumulation (along with more retirement savings) is a strategy I employ for my student loans, but mine are fixed at 2.375% which means I-Bonds do break even or do better for me in most years.

If you could have locked in the rate, then I wouldn't advise being in too much of a rush to pay it off, since likely rates on earnings will rise in the future. I don't make accelerated payments on my student loans because they are fixed at such a low rate. But since your loan rate will rise with the prime rate and you can't lock in the current low rate, then I would agree with paying it off quickly. Once rates start to rebound, your loan rate will rise right along with them (and at a rapid pace since it resets monthly). And it's just high enough now that it would be hard to find a "safe" place to invest the money to outpace the interest charges you have to pay. So paying it off makes sense for your situation, although I would advise to not go on an extreme "financial diet" since your rates are low enough that we're talking about a small amount of interest savings between paying it down or investing in something like I-Bonds.
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Re: Yet another student loan

Post by JupiterJones »

Default User BR wrote:
Confused wrote:No way. Zero debt is the way to go. Nobody can knock on my door, send me a letter, or call my phone to remind me that I owe them money because I don't owe anybody a penny.
Again, fear is no way to run your financial life. "Fear is the mind-killer."
When you consider that "fear" is just another way of saying "risk tolerance", I think it's a perfectly acceptable way to run one's financial life. While I agree that you generally need to take some amount of risk to get anywhere in life (finanically and otherwise), you should still always take your own personal fear-o-meter into close consideration (and realize that not everyone's is calibrated the same as yours).

Anyway, wanting to keep the money you make and having the freedom to be able to do whatever you choose with it, instead of being locked in to giving it to a creditor who has enslaved your paycheck, doesn't necessarily have anything to do with risk/fear. It's just a Nice Thing that's well worth shooting for.

$41,000 of student loan debt is a financial boat anchor. Yeah, you can finagle the numbers this way and that and decide that it's financially advantagous to keep the anchor around and just buy a more powerful outboard motor to compensate. And maybe you'd be right. But I'm still going with the simple approach of just getting rid of the dang anchor. :D

JJ
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Default User BR
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Re: Yet another student loan

Post by Default User BR »

JupiterJones wrote:Anyway, wanting to keep the money you make and having the freedom to be able to do whatever you choose with it, instead of being locked in to giving it to a creditor who has enslaved your paycheck, doesn't necessarily have anything to do with risk/fear. It's just a Nice Thing that's well worth shooting for.
That certainly sounds like a dispassionate analysis.


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Re: Yet another student loan

Post by regularguy »

Newbie here, so maybe this is a silly question: But doesn't the OP's question amount to the relative value of paying off his student loan at 2.75% or doing something else with his money? Wouldn't his loan's interest rate have to go up a good deal before he wouldn't be better off (in the long term) just investing in stocks in a non-tax-protected account?

Would others' answers be different if his loan were at a fixed interest rate?
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Re: Yet another student loan

Post by roymeo »

I know I was mis-focused and over-focused on paying off my student loans. But I started with about 7 different ones and the monthly minimum payment for each added up to quite a bit. I would have been better getting an emergency fund together and paying off the highest interest rate rather than several different methods (paying toward the smallest so my monthly minimum was smaller in case of an emergency, throwing extra money at them all, throwing extra money at them randomly) but you don't seem to be in anything like that situation.

I'd still probably pay off the loan for that "if the worst happens" case you then have one less thing to worry about. Set yourself up with a semi-aggressive but manageable payment amount. Kill the loan.

AND THEN, keep that same semi-aggressive but manageable payment going to your new house down-payment fund. You'll have already set yourself up for savings success by putting the money to the side for something that you 'need' to do, it should be easy to transfer the diligence to something you 'want' to do.

roymeo
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Re: Yet another student loan

Post by grabiner »

regularguy wrote:Newbie here, so maybe this is a silly question: But doesn't the OP's question amount to the relative value of paying off his student loan at 2.75% or doing something else with his money? Wouldn't his loan's interest rate have to go up a good deal before he wouldn't be better off (in the long term) just investing in stocks in a non-tax-protected account?
The key issue is the trade-off between returns and risk. If you invest in any bonds at all, then you would have a higher expected return if you sell your bonds to buy stocks. However, most investors have some bonds, because they would prefer to get a lower expected return than the stock market with less risk.

And the same argument applies to the comparison between paying off loans and investing. If the OP put spare cash into Limited-Term Tax-Exempt, he would earn 0.64% (taxable in CA) at short-term rates, and would pay 2.75% on his student loans at short-term rates, so this is a fair comparison. Selling the bond fund and paying down the loans would not change his risk profile but would allow him to earn more money.

And if he wants to earn more than an expected 2.75%, he can still do that while paying down the loans; he can pay down his student loans (earning a guaranteed 2.75%) and then sell a bond fund in his IRA to buy a stock fund (increasing the return from a low-risk 1.79% on Total Bond Market to whatever the stock fund earns which could be -50% or +50%).
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Re: Yet another student loan

Post by Mudpuppy »

regularguy wrote:Newbie here, so maybe this is a silly question: But doesn't the OP's question amount to the relative value of paying off his student loan at 2.75% or doing something else with his money? Wouldn't his loan's interest rate have to go up a good deal before he wouldn't be better off (in the long term) just investing in stocks in a non-tax-protected account?

Would others' answers be different if his loan were at a fixed interest rate?
As I already said in my response, my answer would be a bit different if g$$ did have a fixed rate or if the variable rate were lower. Even as it is, I am a bit ambivalent towards the "sacrifice everything to pay it off now" approach since one is splitting some very fine hairs between paying off the interest and the earnings one could get from I-Bonds or similar investments. For example, I wouldn't advocate putting off retirement contributions just to eliminate this debt given how closely it follows the prime rate. But certainly I see no problem with taking any excess income and redirecting it towards this purpose since g$$ already has a sufficient emergency fund and already maximizes retirement, HSA and ESPP contributions.
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Re: Yet another student loan

Post by grabiner »

regularguy wrote:Would others' answers be different if his loan were at a fixed interest rate?
Yes. If you have a fixed-rate long-term loan and buy a long-term bond at the same interest rate, you have no risk; you will earn as much interest on the loan as you pay on the bond. If you have a variable-rate loan and you buy a long-term bond at the same interest rate, you have interest-rate risk; if rates rise, the interest you pay on the loan will rise, and the value of your bond will drop so that you can no longer sell it to pay off the loan.

Therefore, you should compare the rate on a variable-rate loan to the yields on short-term bonds when you decide whether to pay it off, and compare the rate on a fixed-rate loan to the yields on long-term bonds.
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Re: Yet another student loan

Post by JupiterJones »

Default User BR, perhaps employing sarcasm, wrote:
JupiterJones wrote:Anyway, wanting to keep the money you make and having the freedom to be able to do whatever you choose with it, instead of being locked in to giving it to a creditor who has enslaved your paycheck, doesn't necessarily have anything to do with risk/fear. It's just a Nice Thing that's well worth shooting for.
That certainly sounds like a dispassionate analysis.
Fair enough. I'll rephrase the paragraph for the passion-averse:

Cash flow = good

:sharebeer

JJ
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Re: Yet another student loan

Post by JupiterJones »

regularguy wrote:Newbie here, so maybe this is a silly question: But doesn't the OP's question amount to the relative value of paying off his student loan at 2.75% or doing something else with his money? Wouldn't his loan's interest rate have to go up a good deal before he wouldn't be better off (in the long term) just investing in stocks in a non-tax-protected account?
As has been mentioned, one should factor risk into these sorts of comparisons.

But even with that, the calculation would only give you the financial/mathematical aspect of "value". But as I generally tend to see things, there's more to "value" and "better off" than just the raw numbers.

For example, paying off a loan might incur a certain long-term financial cost, but the added value the debtor might ascribe to being debt-free could make that cost worth it. Conversely, there might be a greater long-term cost to keeping a loan around, yet the debtor might place an equivalent-or-higher value on, for example, maintaining the liquidity of money they would otherwise use to pay off the loan.

JJ
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Re: Yet another student loan

Post by Mudpuppy »

By the way, I just wanted to take a moment to say "way to go" to g$$ for being in such good fiscal shape at the age of 26 that we're all just splitting hairs on how rapidly the student loan should be eliminated. To be 26 with a 6 month emergency fund and maximizing contributions to a 401k, IRA, HSA and ESPP is just great! That sort of accomplishment often gets lost in the clutter of debate here, but it absolutely deserves a moment of congratulations.
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Re: Yet another student loan

Post by g$$ »

Thanks for all the advice. I really do appreciate the thoughtful answers I've received in this thread. I've decided to pay the loan in advance, but I'm not going to go out of my way to live like a monk till it gets paid off. Extra cash flow will go towards some combination of loan payments/recreation.

I think its certainly possible to outpace the rate of return on the student loan. Especially if I'm willing to make after-tax contributions to the 401(k) then roll those over to a roth. I don't think its worth the added complexity though... For one thing, it will make my taxes far more complicated. For another, if i pay off the loan, i will have one fewer account to keep track of. I'm also not entirely convinced the rollover strategy is legal. Basically, I'm going to pay it off because i like the simplicity.

I'll check back in a couple years from now once the loan is payed off.

Thanks all!
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