Student loan payoff: keep in cash or payoff now?

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Student loan payoff: keep in cash or payoff now?

Postby MNsnow123 » Mon Dec 17, 2012 1:02 am

Greetings! I have a couple questions at the end, but I'll give you guys the helpful information up front. In the last year or two I've been reading the forums and gathered a lot of great information! I'm looking for some advice on my personal situation as I am starting out my investing journey and planning a successful future.

Background info (Single, 30 years old, rent an apartment, Recent decent paying job and I've been saving a lot over the last 2 years). Income: 80k/year

Assets:
35k retirement accounts (trad IRA)
40k cash accounts

Liabilites: (school loans)
6,500 @ 3.1 % private student loan
18,000 @ 3.625 federal student loan (consolidated)

Expenses: 1500/month all inclusive (rent, insurance, food, etc)

Retirement (employer matches 6% contribution)

Future Goals:
-Buy a house (decent homes are around 275k) in the next 2-3 years
-Get married

Questions:

1. Should I pay off my loans right now with cash? The reason I have been a little hesitant is that I have lower interest rates on my loans. Or perhaps pay off the 3.625% rate first? Maybe gradually pay them off throughout 2013? Pay the minimums for a couple years? I will eventually get a mortgage in the next 2-3 years at x rate.

2. How much cash should I have in my emergency fund set aside?

3. Retirement contribution funding order question: First, I'm putting my 6% contribution to my retirement 403b to get the match (free money). Should my second order to be focusing on funding a Roth IRA to max? Then after Roth is maxed, go back and contribute to the 403b??
Last edited by MNsnow123 on Thu Dec 20, 2012 6:43 pm, edited 2 times in total.
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Re: Student loan payoff: keep in cash or payoff now?

Postby Bob's not my name » Mon Dec 17, 2012 9:20 pm

Your marginal rate is probably 36%, because you're in the 25% federal bracket, the student loan interest deduction phaseout, and a high tax state. (Under current law that will not increase next year, since you'll probably lose the student loan interest deduction altogether but your bracket will increase to 28%, so you'll still be at 35% total marginal rate.) At that rate, you should prioritize pre-tax (401k) savings over post-tax (Roth IRA) savings, unless your 401k is really high cost.

The rates on your student loans are not low. If you had contributed more to your 401k in 2012 you could have increased the deductibility of the loans by getting yourself under the student loan interest deduction phaseout. However, the law may change on that in 2013. I suggest you wait to see what wonders the government works on the tax code and then decide whether to pay off the loans in 2013.

Note: You say "recent" about your job, so it's unclear what your gross 2012 income is. I assumed $80,000 in the above discussion. Maybe it's less.

Is that private loan rate variable?
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Re: Student loan payoff: keep in cash or payoff now?

Postby MNsnow123 » Mon Dec 17, 2012 11:05 pm

Thanks for your reply! My job is 18 months old (which I consider recent) and 80k will be my gross this year.
Private loan rate is fixed.
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Re: Student loan payoff: keep in cash or payoff now?

Postby market timer » Mon Dec 17, 2012 11:15 pm

I wouldn't pay any more than the minimum on these loans. Maxing out the 401K and Roth should take priority, along with downpayment savings and wedding expenses.
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Re: Student loan payoff: keep in cash or payoff now?

Postby gurujji » Tue Dec 18, 2012 12:09 am

MNsnow123 wrote:1. Should I pay off my loans right now with cash?


another idea (viewpoint) on student-loan -- viewtopic.php?f=2&t=99549&newpost=1556604#p1440283
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Re: Student loan payoff: keep in cash or payoff now?

Postby Watty » Tue Dec 18, 2012 1:31 am

You have $24,500 in student loans. You would be doing very good if you could invest that money halfway safely and beat your student loan interest rates by 2%. That would be $500 a year if things work ot well.

Right now you are paying almost $900 a year in student loan interest to get the chance to make that back plus that $500. There are lots of ways that it would work out badly and I don't see a lot of possible upside. I don't think that keeping the student loans just to invest the money is worth the risk.

There could be other reasons to keep the student loans though'

1) So you have more money to put into retirement accounts. You have low expenses for your income so you have plenty of disposable income to do lots of retirement saving.

2) So you have a large down payment to buy a house. This is a possibility but you also have to watch your debt to income ratio which will be used to in the mortgage application approval process. It would be good to make a spreadsheet to project what your numbers will look like in say 18 months if you do or don't pay off the loans.
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Re: Student loan payoff: keep in cash or payoff now?

Postby NYBoglehead » Tue Dec 18, 2012 1:40 am

Watty wrote:You have $24,500 in student loans. You would be doing very good if you could invest that money halfway safely and beat your student loan interest rates by 2%. That would be $500 a year if things work ot well.

Right now you are paying almost $900 a year in student loan interest to get the chance to make that back plus that $500. There are lots of ways that it would work out badly and I don't see a lot of possible upside. I don't think that keeping the student loans just to invest the money is worth the risk.

There could be other reasons to keep the student loans though'

1) So you have more money to put into retirement accounts. You have low expenses for your income so you have plenty of disposable income to do lots of retirement saving.

2) So you have a large down payment to buy a house. This is a possibility but you also have to watch your debt to income ratio which will be used to in the mortgage application approval process. It would be good to make a spreadsheet to project what your numbers will look like in say 18 months if you do or don't pay off the loans.


+1

I don't want to misread your situation or ask personal questions but you list getting married as one of the near-term goals. Are you engaged to be married yet? If not I wouldn't be setting aside money for a wedding. There will be time to set aside money for that once you have a precise timeline associated with the wedding.

Debt to income ratio is calculated to see how much house you can afford so as the previous poster mentioned sometimes having less debt means more than having a large down payment. Your expenses seem to be pretty low, how much are you setting aside monthly into cash savings? (non-retirement accounts). If you are not maxing out your 401k you should be, you might be able to lower yourself into a bracket where it makes more sense to max out a Roth IRA in addition to the 401k.

I'm an anti-debt guy so I'm usually in the camp that says knock out the debt so long as you are not jeopardizing your ability to weather the storm if you lose a job or some other misfortune comes your way.
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Re: Student loan payoff: keep in cash or payoff now?

Postby umfundi » Tue Dec 18, 2012 3:21 am

Get a copy of your credit reports and see what they say. You can get your reports free once a year.

I would advocate simply paying off the loans. Simplify your life. In my book, borrowing money to make investments is almost always a bad idea. Which is what you are doing, if you have resources you could use to pay off the loans.

If you're looking to buy a house, get your credit record in shape. Be sure you have at least a couple of credit cards (different brands) with decent credit limits. Never carry a credit card balance month to month. Be sure you have an adequate car, if you need one. (Don't buy a new car the month before you apply for a mortgage.) Get the cards now, so the down spike in your credit score subsides by the time that you need a mortgage.

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Re: Student loan payoff: keep in cash or payoff now?

Postby jlq39 » Tue Dec 18, 2012 6:45 am

Questions:

1. Should I pay off my loans right now with cash? The reason I have been a little hesitant is that I have lower interest rates on my loans. Or perhaps pay off the 3.625% rate first? Maybe gradually pay them off throughout 2013? Pay the minimums for a couple years? I will eventually get a mortgage in the next 2-3 years at x rate.

YES, you should pay off your loans right now with cash!

2. How much cash should I have in my emergency fund set aside?

3-6 months of expenses.

3. Retirement contribution funding order question: First, I'm putting my 6% contribution to my retirement to get the match (free money). Should my second order to be focusing on funding a Roth IRA to max? Then after Roth is maxed, go back and contribute to the max traditional IRA??

Yes!
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Re: Student loan payoff: keep in cash or payoff now?

Postby Bob's not my name » Tue Dec 18, 2012 7:04 am

jlq39 wrote:3. Retirement contribution funding order question: First, I'm putting my 6% contribution to my retirement to get the match (free money). Should my second order to be focusing on funding a Roth IRA to max? Then after Roth is maxed, go back and contribute to the max traditional IRA??

Yes!
No, this doesn't make any sense. First, you can't max a Roth IRA and then contribute to a traditional IRA. Second, as I said above, when your marginal rate is 36% you should max your pre-tax account (401k) before making post-tax contributions to a Roth IRA. A $5,500 Roth contribution will require $8,600 of gross salary, on which you will pay $3,100 of income tax. Instead, contribute the $8,600 to your 401k and pay no income tax on it.

Even if you decide to pay off your student loans immediately, waiting two weeks until 2013 MIGHT pay off, depending on what they do to the tax code. If you have capitalized interest on those loans you may be able to get a deduction in 2013 that you're not getting in 2012 because you didn't contribute enough to your 401k to get your AGI under the student loan interest deduction phaseout.
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Re: Student loan payoff: keep in cash or payoff now?

Postby jlq39 » Wed Dec 19, 2012 4:28 pm

Bob's not my name wrote:
jlq39 wrote:3. Retirement contribution funding order question: First, I'm putting my 6% contribution to my retirement to get the match (free money). Should my second order to be focusing on funding a Roth IRA to max? Then after Roth is maxed, go back and contribute to the max traditional IRA??

Yes!
No, this doesn't make any sense. First, you can't max a Roth IRA and then contribute to a traditional IRA. Second, as I said above, when your marginal rate is 36% you should max your pre-tax account (401k) before making post-tax contributions to a Roth IRA. A $5,500 Roth contribution will require $8,600 of gross salary, on which you will pay $3,100 of income tax. Instead, contribute the $8,600 to your 401k and pay no income tax on it.

Even if you decide to pay off your student loans immediately, waiting two weeks until 2013 MIGHT pay off, depending on what they do to the tax code. If you have capitalized interest on those loans you may be able to get a deduction in 2013 that you're not getting in 2012 because you didn't contribute enough to your 401k to get your AGI under the student loan interest deduction phaseout.


My fault, I didn't read it close enough. I thought he meant contribute enough to get match in 401k...then he should max out Roth IRA, then go back and max out 401k. I still stand behind all my answers with this additional clarification.
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Re: Student loan payoff: keep in cash or payoff now?

Postby Spades » Thu Dec 20, 2012 1:54 pm

MNsnow123 wrote:Future Goals:
-Buy a house (decent homes are around 275k) in the next 2-3 years
-Get married

Questions:

1. Should I pay off my loans right now with cash? The reason I have been a little hesitant is that I have lower interest rates on my loans. Or perhaps pay off the 3.625% rate first? Maybe gradually pay them off throughout 2013? Pay the minimums for a couple years? I will eventually get a mortgage in the next 2-3 years at x rate.

2. How much cash should I have in my emergency fund set aside?

3. Retirement contribution funding order question: First, I'm putting my 6% contribution to my retirement to get the match (free money). Should my second order to be focusing on funding a Roth IRA to max? Then after Roth is maxed, go back and contribute to the max traditional IRA??


Howdy MNsnow,

So to quickly answer your questions.

1. Yes, pay off your loans as quickly as possible without degrading your emergency fund.

2. A good recommendation is 6 months of expenses. I have 3 months because of the lack of danger of being fired in the military.

3. This is the harder one. You need to determine how you want to buy your future home and how that will tie into your investment strategy.

I'm in a situation where I've decided to fund both my home buying fund and my tax advantaged accounts (after the match). How do you want to buy your future home? I'm wanting to put more than 20% down and get a castle.

:sharebeer
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Re: Student loan payoff: keep in cash or payoff now?

Postby MNsnow123 » Thu Dec 20, 2012 6:21 pm

NYBoglehead wrote:
Watty wrote:
I don't want to misread your situation or ask personal questions but you list getting married as one of the near-term goals. Are you engaged to be married yet? If not I wouldn't be setting aside money for a wedding. There will be time to set aside money for that once you have a precise timeline associated with the wedding.

Debt to income ratio is calculated to see how much house you can afford so as the previous poster mentioned sometimes having less debt means more than having a large down payment. Your expenses seem to be pretty low, how much are you setting aside monthly into cash savings? (non-retirement accounts). If you are not maxing out your 401k you should be, you might be able to lower yourself into a bracket where it makes more sense to max out a Roth IRA in addition to the 401k.

I'm an anti-debt guy so I'm usually in the camp that says knock out the debt so long as you are not jeopardizing your ability to weather the storm if you lose a job or some other misfortune comes your way.


I'm not engaged at this point and my timeline is getting married in 2-3 years. Thank you to everyone who posted so far for your input!
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Re: Student loan payoff: keep in cash or payoff now?

Postby MNsnow123 » Thu Dec 20, 2012 6:43 pm

Bob's not my name wrote:
jlq39 wrote:3. Retirement contribution funding order question: First, I'm putting my 6% contribution to my retirement to get the match (free money). Should my second order to be focusing on funding a Roth IRA to max? Then after Roth is maxed, go back and contribute to the max traditional IRA??

Yes!
No, this doesn't make any sense. First, you can't max a Roth IRA and then contribute to a traditional IRA. Second, as I said above, when your marginal rate is 36% you should max your pre-tax account (401k) before making post-tax contributions to a Roth IRA. A $5,500 Roth contribution will require $8,600 of gross salary, on which you will pay $3,100 of income tax. Instead, contribute the $8,600 to your 401k and pay no income tax on it.

Even if you decide to pay off your student loans immediately, waiting two weeks until 2013 MIGHT pay off, depending on what they do to the tax code. If you have capitalized interest on those loans you may be able to get a deduction in 2013 that you're not getting in 2012 because you didn't contribute enough to your 401k to get your AGI under the student loan interest deduction phaseout.


I made an error in my initial post when I was asking about the order I should put money into different retirement vehicles (403 match first, then roth, then back to 403?).

I had stated traditional IRA when I meant to say 403b.
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