Pay off student loans, or invest?

Have a question about your personal investments? No matter how simple or complex, you can ask it here.
Post Reply
bdc
Posts: 9
Joined: Sat Mar 17, 2012 12:57 pm

Pay off student loans, or invest?

Post by bdc » Sun Jul 28, 2013 2:06 pm

Quick question for the group:
1. I have approx $75,000 in student loan debt at 2.625% interest.
2. I have a car loan of approx $16,000 at 0.9% interest.

I am fully funding my 401K, with the remainder of savings going into a checking account. We rent our home, with little interest in purchasing at any point in the next 3-5 yrs. If I pay off these loans, we are debt free.

Question: Pay off the debt, or put the savings currently going into checking into a taxable investment account?

User avatar
BL
Posts: 8269
Joined: Sun Mar 01, 2009 2:28 pm

Re: Pay off student loans, or invest?

Post by BL » Sun Jul 28, 2013 3:29 pm

Roth, I-Bonds, Index stock funds in taxable.

gclancer
Posts: 500
Joined: Sat Apr 27, 2013 10:34 am

Re: Pay off student loans, or invest?

Post by gclancer » Sun Jul 28, 2013 3:39 pm

Are both rates fixed? For example car loans often only have fixed rates for the first 60 months. Make sure you're on track to have both paid off by the end of the fixed interest rate term. Otherwise I would agree - max Roth and max I-Bonds and increase stock allocation in 401k/Roth to account for I-Bonds.

bdc
Posts: 9
Joined: Sat Mar 17, 2012 12:57 pm

Re: Pay off student loans, or invest?

Post by bdc » Sun Jul 28, 2013 3:51 pm

Thanks for your comments. Interest rates are fixed.

User avatar
grabiner
Advisory Board
Posts: 22684
Joined: Tue Feb 20, 2007 11:58 pm
Location: Columbia, MD

Re: Pay off student loans, or invest?

Post by grabiner » Sun Jul 28, 2013 7:59 pm

I would suggest paying off the car loan if possible. While you won't save much in interest, you may save in other respects; for example, once the loan is gone, you can raise your collision and comprehensive insurance deductibles.

You might as well keep the student loan, as you earn 2.625% risk-free (and possibly taxable) by paying it off, and can earn more than that with very little risk by investing in munis (or take more risk by investing in stocks if you wish).
Wiki David Grabiner

User avatar
Watty
Posts: 14088
Joined: Wed Oct 10, 2007 3:55 pm

Re: Pay off student loans, or invest?

Post by Watty » Sun Jul 28, 2013 8:30 pm

You might not be interested in buying a house in the next few years but if you eventually do then having a 20% down payment will save you a lot in PMI and being able to get the best interest rate. If there is much chance of that then that could be a good choice.

Even with the 401K you might still be able to make a deductible IRA contribution may be possible. There are income limits on that so be sure to look at the details.

One thing to do somewhere along the way is to start saving up to pay cash for your next car so you might work that into your plans.

bdc
Posts: 9
Joined: Sat Mar 17, 2012 12:57 pm

Re: Pay off student loans, or invest?

Post by bdc » Sun Jul 28, 2013 10:48 pm

Thank you again for your replies. I am unfamiliar with I-bonds, uncertain as to whether these are appropriate for me. They appear to be a guaranteed return, perfect for increasing my fixed income allocation given the very real interest rate risk in the bond market, while also allowing me to expand my tax deferred space. They also seem like a great place to park cash if needed in short or intermediate time-frame. What's the downside of purchasing $10,000 in I-bonds every year starting now (I'm in my mid 30's, highest federal tax bracket)?

User avatar
grabiner
Advisory Board
Posts: 22684
Joined: Tue Feb 20, 2007 11:58 pm
Location: Columbia, MD

Re: Pay off student loans, or invest?

Post by grabiner » Sun Jul 28, 2013 11:43 pm

bdc wrote:Thank you again for your replies. I am unfamiliar with I-bonds, uncertain as to whether these are appropriate for me. They appear to be a guaranteed return, perfect for increasing my fixed income allocation given the very real interest rate risk in the bond market, while also allowing me to expand my tax deferred space. They also seem like a great place to park cash if needed in short or intermediate time-frame. What's the downside of purchasing $10,000 in I-bonds every year starting now (I'm in my mid 30's, highest federal tax bracket)?
The downside is that you will pay tax on the gains when you cash them in. If you are in your mid-30's, you might be just before retirement when the bonds mature, and still in the top tax bracket; you will have benefited from 30 years of tax deferral but still lose 39.6% of your gains or whatever the top rate is then. (I-Bonds are exempt from state tax.)
Wiki David Grabiner

User avatar
BL
Posts: 8269
Joined: Sun Mar 01, 2009 2:28 pm

Re: Pay off student loans, or invest?

Post by BL » Sun Jul 28, 2013 11:47 pm

Check http://www.treasurydirect.gov/indiv/indiv.htm for information. They need to be cashed in by 30 years with federal tax owed, so it is good if you are retired by then. Otherwise they are good for both short and longer time periods and can be cashed in after one year.

User avatar
JupiterJones
Posts: 2692
Joined: Tue Aug 24, 2010 3:25 pm
Location: Nashville, TN

Re: Pay off student loans, or invest?

Post by JupiterJones » Mon Jul 29, 2013 9:59 am

Me? I'd pay off the debt.

It's a cash flow thing. I like to get rid of the stuffI have to pay each month, leaving the stuff I choose to pay each month. (What if you lost your job, for example?)
Stay on target...

Batousai
Posts: 47
Joined: Mon Jul 30, 2012 11:21 am

Re: Pay off student loans, or invest?

Post by Batousai » Mon Jul 29, 2013 10:53 am

JupiterJones wrote:Me? I'd pay off the debt.

It's a cash flow thing. I like to get rid of the stuffI have to pay each month, leaving the stuff I choose to pay each month. (What if you lost your job, for example?)
Assuming he chose a reasonably liquid investment, he could pay the debt payment from the money (and extra interest he earned) he saved instead of paying off the debt. Remember, you can always pull out your contributions to a Roth without penalty.

Auream
Posts: 446
Joined: Thu Mar 20, 2008 1:07 pm
Location: Raleigh, NC Age: 33

Re: Pay off student loans, or invest?

Post by Auream » Mon Jul 29, 2013 12:52 pm

JupiterJones wrote:Me? I'd pay off the debt.

It's a cash flow thing. I like to get rid of the stuffI have to pay each month, leaving the stuff I choose to pay each month. (What if you lost your job, for example?)
If I lost my job, I'd rather have $16,000 in the bank than $300 less in monthly payments.

Also, on what planet does it make sense to pay off the 0.9% loan, but keep the 2.625% loan? People get too tied up on what the loan is for (i.e. car loan = bad, home loan or school loan = OK), rather than the rate and term of the loan. If the O.P. didn't say what the loans were for, but just said that he had a 0.9% loan and a 2.625% loan, would you really have said to pay off the 0.9% loan first?

As far as being able to raise deductibles, in my experience it rarely makes sense to do so on a newer car even after you pay it off. I currently have $500 deductibles for collision/comp on my autos through GEICO. PenFed (my lender) allows a $1K deductible, and of course if I paid off the loan it could be anything. But going from $500 to $1000 only saves a couple dollars a year, hardly worth it. Not that this is always the case, but I've checked every time I've shopped for auto insurance and it has hardly ever made sense to raise deductibles even if I don't have a loan.

User avatar
JupiterJones
Posts: 2692
Joined: Tue Aug 24, 2010 3:25 pm
Location: Nashville, TN

Re: Pay off student loans, or invest?

Post by JupiterJones » Mon Jul 29, 2013 1:40 pm

Auream wrote: Also, on what planet does it make sense to pay off the 0.9% loan, but keep the 2.625% loan? People get too tied up on what the loan is for (i.e. car loan = bad, home loan or school loan = OK), rather than the rate and term of the loan. If the O.P. didn't say what the loans were for, but just said that he had a 0.9% loan and a 2.625% loan, would you really have said to pay off the 0.9% loan first?
I actually didn't say which loan I'd pay off first. But yes, I'd probably pick the car loan. Not because it's a "car loan", but because of how I value cash-flow. The car loan has the lower balance and will therefore be paid off more quickly. I haven't crunched the numbers, but I suspect the extra interest paid by doing this way would not be that much--likely worth it to me in order to free up that payment.

Those who value things differently might prioritize the loans differently, of course.
Stay on target...

User avatar
ruralavalon
Posts: 13936
Joined: Sat Feb 02, 2008 10:29 am
Location: Illinois

Re: Pay off student loans, or invest?

Post by ruralavalon » Mon Jul 29, 2013 2:09 pm

bdc wrote:Quick question for the group:
1. I have approx $75,000 in student loan debt at 2.625% interest.
2. I have a car loan of approx $16,000 at 0.9% interest.


I am fully funding my 401K, with the remainder of savings going into a checking account. We rent our home, with little interest in purchasing at any point in the next 3-5 yrs. If I pay off these loans, we are debt free.

Question: Pay off the debt, or put the savings currently going into checking into a taxable investment account?
Might pay off the car loan, even with that low rate (effectively zero, net of inflation), just to simplify life and free up a little cash flow.

Some choices other than that, depends a lot on what the ultimate use of the money might be, and when you might want to use it (e.g. home down payment, education expenses) --

Roth IRAs : flexible withdrawals -- withdraw contributions (but not gains) at any time, for any purpose, with no penalty, and no tax; but a limit on amount you can put in annually; limits on your eligibility to contribute. Wiki article link: Roth IRA .

Taxable account, in tax-efficient large cap stock index funds: flexible withdrawals -- at any time, for any reason; tax at withdrawal only on gain and dividend portion of the withdrawal; no limit on what you can add annually. Wiki article link: Principles of Tax-Efficient Fund Placement .

I-bonds: cannot be cashed out in the first year, penalty if cashed out in first five years ; tax benefit varies depending on your tax rate at withdrawal, grows tax deferred for up to 30 years, tax free growth for qualified education expenses; inflation protection; limit on what you can add annually, but higher limit than for the Roth IRAs. Wiki article link: I Savings Bonds .
"Everything should be as simple as it is, but not simpler." - Albert Einstein | Wiki article link:Getting Started

User avatar
grabiner
Advisory Board
Posts: 22684
Joined: Tue Feb 20, 2007 11:58 pm
Location: Columbia, MD

Re: Pay off student loans, or invest?

Post by grabiner » Tue Jul 30, 2013 8:45 pm

Auream wrote:Also, on what planet does it make sense to pay off the 0.9% loan, but keep the 2.625% loan? People get too tied up on what the loan is for (i.e. car loan = bad, home loan or school loan = OK), rather than the rate and term of the loan. If the O.P. didn't say what the loans were for, but just said that he had a 0.9% loan and a 2.625% loan, would you really have said to pay off the 0.9% loan first?
Time value. Making an early loan payment is equivalent to buying a bond or CD at the same rate, with maturity when the loan is paid off. Thus, if you pay off a three-year car loan, you are effectively buying 36 CDs maturing in 1 to 36 months. If you pay off a student loan ten years before its natural payoff date, you are effectively buying 120 CDs maturing in 1 to 120 months, and you would demand a higher yield on the CDs to do that. And if you pay down the student loan early (rather than paying off the car loan) so that it is paid off in seven years rather than ten, you are effectively buying 36 CDs maturing in 7 to 10 years, which would demand an even higher rate.
Wiki David Grabiner

Gauntlet
Posts: 186
Joined: Wed Nov 30, 2011 10:06 am

Re: Pay off student loans, or invest?

Post by Gauntlet » Tue Jul 30, 2013 9:01 pm

+1 for paying of the debt (unless Roth is an option than I would do that). It is a risk free rate of return and a good habit to get into. In my opinion, limiting your debt simplifies your finances and if you ever have a time in your life when you are under financial stress (loss of job), the less mandatory monthly payments the better. When I purchased a new car this year, I was offered .9% and I still payed cash. :happy

mhalley
Posts: 6058
Joined: Tue Nov 20, 2007 6:02 am

Re: Pay off student loans, or invest?

Post by mhalley » Wed Jul 31, 2013 1:47 pm

I don't subscribe to the Dave Ramsey concept of their being no "good" debt. The car loan at 0.9 % is basically free money. If you took that 16 k and put it in a taxable account and it made a 6 percent return for 20 years, that would be almost 60k. if you took that 16k and paid off the loan, you would save $223, assuming a 3 year loan. Taking the money and putting it in a taxable mf seems much better to me. As for the student loans, again any interest rate less than inflation is "free" money and I wouldn't pay a dime on them. If you want to be debt free due to some psychological feeling of well being, then great. But feeling good is not always the most fiscally prudent move.
Mike

User avatar
hand
Posts: 1191
Joined: Sun May 17, 2009 8:42 pm

Re: Pay off student loans, or invest?

Post by hand » Wed Jul 31, 2013 1:55 pm

grabiner wrote:
Auream wrote:Also, on what planet does it make sense to pay off the 0.9% loan, but keep the 2.625% loan? People get too tied up on what the loan is for (i.e. car loan = bad, home loan or school loan = OK), rather than the rate and term of the loan. If the O.P. didn't say what the loans were for, but just said that he had a 0.9% loan and a 2.625% loan, would you really have said to pay off the 0.9% loan first?
Time value. Making an early loan payment is equivalent to buying a bond or CD at the same rate, with maturity when the loan is paid off. Thus, if you pay off a three-year car loan, you are effectively buying 36 CDs maturing in 1 to 36 months. If you pay off a student loan ten years before its natural payoff date, you are effectively buying 120 CDs maturing in 1 to 120 months, and you would demand a higher yield on the CDs to do that. And if you pay down the student loan early (rather than paying off the car loan) so that it is paid off in seven years rather than ten, you are effectively buying 36 CDs maturing in 7 to 10 years, which would demand an even higher rate.
Also probably worth mentioning that paying off a lower rate loan instead of paying down a higher rate loan (the snowball method) can make sense when cash flow considerations are a priority.

User avatar
hand
Posts: 1191
Joined: Sun May 17, 2009 8:42 pm

Re: Pay off student loans, or invest?

Post by hand » Wed Jul 31, 2013 2:01 pm

bdc wrote:Quick question for the group:
1. I have approx $75,000 in student loan debt at 2.625% interest.
2. I have a car loan of approx $16,000 at 0.9% interest.

I am fully funding my 401K, with the remainder of savings going into a checking account. We rent our home, with little interest in purchasing at any point in the next 3-5 yrs. If I pay off these loans, we are debt free.

Question: Pay off the debt, or put the savings currently going into checking into a taxable investment account?
To some degree, this depends on the expected stability and earning potential of your chosen career.

If you are a newly graduated doctor who has a couple years of low wages, then expects a substantial jump in income, using the debt to allow you to max out Roth / other retirement options now may make sense.
If your job prospects, future salary are risky, paying down debt probably makes sense.

Pay down debt vs. invest is a common discussion topic, bottom line you can't go too wrong by paying off debt, but may have more upside (with more risk) if you choose to invest.

User avatar
William4u
Posts: 1314
Joined: Fri Jun 01, 2012 3:02 pm

Re: Pay off student loans, or invest?

Post by William4u » Wed Jul 31, 2013 2:35 pm

Assuming you have a 6 month emergency fund (and given you max out the 401k, have no cc debt)...

1. Max Out Roth IRA (backdoor or regular) first.

2. Pay off high interest rate student loan second.

Post Reply