Paying off Loans vs. Investing and Capitalization of Debt

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Topic Author
seekingriches
Posts: 2
Joined: Sun Oct 09, 2016 12:13 pm

Paying off Loans vs. Investing and Capitalization of Debt

Post by seekingriches »

Hello!

My wife and I have approximately $23,000 in cash available to pay down student loans or invest (in addition to $36,000 we are holding onto as an emergency fund). I would appreciate advice on which of the two we should give precedence to: paying off the debt or investing. I am going to be applying $5,500 to my Roth IRA (my wife's is maxed out already for the year), so really the question is what to do with the other $17,000.

Currently, we owe $110,000 for private student loans at 6.8% interest and have no other debt. Our investments, both in retirement accounts and other accounts are worth $167,000. We are in the 25% tax bracket, filing jointly. We have tended to favor investing, given that that keeps the money available to us. However, the guaranteed savings of paying off the debt (vs. the hypothetical return of investments) makes that choice attractive, too.

In thinking about this, my wife told me that she is under the impression that her student loan debt only capitalizes under certain conditions, like starting to pay off the debt again after a period of forbearance. Otherwise, interest is not added to the capital -- you only pay interest on the original principal. I have not been able to find any information that absolutely confirms or rebuts that idea. Can anyone tell me what the general practice is with regards to compounding of student debt (a link to an authoritative resource would be great) and explain the implications if that is true? If student loans only accumulate simple interest but investments in bonds or stocks compounds, should that change how you compare the two options?

I would appreciate any insights or advice forum members could offer me. I've been going around in circles about this decision. Thanks for reading through my post!
Dottie57
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Re: Paying off Loans vs. Investing and Capitalization of Debt

Post by Dottie57 »

seekingriches wrote:Hello!

My wife and I have approximately $23,000 in cash available to pay down student loans or invest (in addition to $36,000 we are holding onto as an emergency fund). I would appreciate advice on which of the two we should give precedence to: paying off the debt or investing. I am going to be applying $5,500 to my Roth IRA (my wife's is maxed out already for the year), so really the question is what to do with the other $17,000.

Currently, we owe $110,000 for private student loans at 6.8% interest and have no other debt. Our investments, both in retirement accounts and other accounts are worth $167,000. We are in the 25% tax bracket, filing jointly. We have tended to favor investing, given that that keeps the money available to us. However, the guaranteed savings of paying off the debt (vs. the hypothetical return of investments) makes that choice attractive, too.

In thinking about this, my wife told me that she is under the impression that her student loan debt only capitalizes under certain conditions, like starting to pay off the debt again after a period of forbearance. Otherwise, interest is not added to the capital -- you only pay interest on the original principal. I have not been able to find any information that absolutely confirms or rebuts that idea. Can anyone tell me what the general practice is with regards to compounding of student debt (a link to an authoritative resource would be great) and explain the implications if that is true? If student loans only accumulate simple interest but investments in bonds or stocks compounds, should that change how you compare the two options?

I would appreciate any insights or advice forum members could offer me. I've been going around in circles about this decision. Thanks for reading through my post!
Your wife signed papers in order to get the loan. Find them and review the terms. It sounds wrong that no interest is acruing at this point. The place that gave the loan wants to make money. No interst acrual doesn't help the lender.
Topic Author
seekingriches
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Joined: Sun Oct 09, 2016 12:13 pm

Re: Paying off Loans vs. Investing and Capitalization of Debt

Post by seekingriches »

To clarify, I am not asking about whether interest is accruing -- I know it is -- but whether and how capitalization is occurring (when interest is added to the amount of the capital). We've looked at her documentation and not gained much clarity.
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LAlearning
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Re: Paying off Loans vs. Investing and Capitalization of Debt

Post by LAlearning »

Are you in a PSLF program? If not you need to refinance stat. Then pay them off.
I know nothing!
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camillus
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Re: Paying off Loans vs. Investing and Capitalization of Debt

Post by camillus »

I'm guessing about 2/3 of those on this board would advocate paying off your loan at 6.8% before funding retirement accounts (except 401k match).
51% US / 34% ex-US / 15% “bond”
Kencufc
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Re: Paying off Loans vs. Investing and Capitalization of Debt

Post by Kencufc »

My student loans capitalized the interest on Jan 1 for the interest accrued the following year. I had federal loans. While in residency, I paid infest only on my loans. The minimum payment suggested by the services on the income based was actually less than the interest accrued. I made sure no extra interest capitalized. Certainly it's better to pay more than that if you can.
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