Aggressive loan paydown on sub-2.5% fixed debt?

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xraygoggles
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Aggressive loan paydown on sub-2.5% fixed debt?

Post by xraygoggles » Thu Aug 01, 2019 12:26 pm

I have ~185k remaining on student debt at 2.45% fixed 5-year payoff.

I have a high enough income that, if I live like a resident for one more year, I can pay it off by August 2020 in exactly one year. I have asked this same question in the WCI forum, and most people there recommended either splitting 50/50 taxable investments/debt relief and some even recommended letting the cheap debt ride for the entire term, and just invest in a taxable account. I should mention I'm 2nd year out of training living in HCOL area as a single guy. I already max out all tax-advantaged accounts. I do not have any money in a taxable account yet, since I spent my 1st year all on this same debt (initial amount was ~320k).

I would really like to be done with this debt once and for all, but it's probably not the best decision from a numbers perspective. Any thoughts on this?
“Compound interest is the eighth wonder of the world. He who understands it, earns it ... he who doesn't ... pays it.”

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Re: Aggressive loan paydown on sub-2.5% fixed debt?

Post by Flyer24 » Thu Aug 01, 2019 12:30 pm

Pay it off and be debt free. Wouldn’t that be a good feeling a year from now?

Charon
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Re: Aggressive loan paydown on sub-2.5% fixed debt?

Post by Charon » Thu Aug 01, 2019 12:34 pm

It doesn't really matter. At your income levels, and fairly similar timelines (one year vs. five years), it really doesn't matter.

The only issue is that you say "live like a resident for one more year" to pay off this debt. I assume this means you will not "live like a resident" if you choose not to pay off this debt, and therefore you won't have an equivalent amount to invest. That does matter.

Long term, what will matter most for you is keeping your lifestyle modest relative to your income. It can be very tempting to spend extravagantly, since your income allows it and many of your peers will.

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Meg77
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Re: Aggressive loan paydown on sub-2.5% fixed debt?

Post by Meg77 » Thu Aug 01, 2019 12:44 pm

2.45% is about the cost of inflation; in other words that is free money. Plus it's on a short repayment period.

You can earn over 2% in a money market account. I'd save 3-6 months of expenses before doing anything. The liquidity and the flexibility that a good savings cushion provides is worth the marginal cost of keeping the loan.

I probably wouldn't invest in the stock market in a brokerage account before paying it off though. With markets at all time highs and in the longest bull run, it's hardly a given that stocks will outperform the cost of that loan for the next 5 years. 30 years sure, but 5 years is a very short time horizon to bet on stock performance at this point in the cycle. Once you have your savings where you want it, just knock the debt out with excess cash flow.
"An investment in knowledge pays the best interest." - Benjamin Franklin

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Re: Aggressive loan paydown on sub-2.5% fixed debt?

Post by fyre4ce » Thu Aug 01, 2019 12:51 pm

I was going to say max out tax advantaged accounts first, but you're already doing that.

Advantages of taxable money:
-better liquidity (if you need some cash in a year, you'll have to take out another loan, probably at higher interest)
-potentially higher return than loan, especially if you're investing in mostly stocks, which is likely at your age
-inflation protection (taxable investments should respond to inflation with higher nominal returns, and your loan is a fixed nominal rate, although on this short of a time horizon this effect doesn't matter much)

Advantages of paying down debt:
-guaranteed return (how will you feel if you put $180k in a taxable account in stock mutual funds, and the market crashes and you lose $80k?)
-easier to get "fired up" burning down a debt than building a taxable account. This path will possibly support better financial behavior
-asset protection benefits. once you pay down the loan, you can't be sued for that money; not so for taxable account

I'd take the 50/50 approach and pay the loan off in two years. It's a better balance than paying it off in one year and not having any non-retirement money, and running out the debt 5 years.
Last edited by fyre4ce on Thu Aug 01, 2019 12:56 pm, edited 1 time in total.

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xraygoggles
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Re: Aggressive loan paydown on sub-2.5% fixed debt?

Post by xraygoggles » Thu Aug 01, 2019 12:55 pm

Meg77 wrote:
Thu Aug 01, 2019 12:44 pm
You can earn over 2% in a money market account.
Not true. I'm in 37 federal and 12.3 state tax brackets.
“Compound interest is the eighth wonder of the world. He who understands it, earns it ... he who doesn't ... pays it.”

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xraygoggles
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Re: Aggressive loan paydown on sub-2.5% fixed debt?

Post by xraygoggles » Thu Aug 01, 2019 12:58 pm

Charon wrote:
Thu Aug 01, 2019 12:34 pm
The only issue is that you say "live like a resident for one more year" to pay off this debt. I assume this means you will not "live like a resident" if you choose not to pay off this debt, and therefore you won't have an equivalent amount to invest. That does matter.
No, I didn't mean that. I plan on building a taxable account with the majority of the payments I was making towards the debt.

I just meant in order to pay it off in one more year, I would just need to not go on any extra lavish vacations or buy another Tesla.
“Compound interest is the eighth wonder of the world. He who understands it, earns it ... he who doesn't ... pays it.”

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Re: Aggressive loan paydown on sub-2.5% fixed debt?

Post by Charon » Thu Aug 01, 2019 1:05 pm

xraygoggles wrote:
Thu Aug 01, 2019 12:58 pm
I would just need to not go on any extra lavish vacations or buy another Tesla.
At some point I lose interest in the money problems of people who talk like this :wink:

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Re: Aggressive loan paydown on sub-2.5% fixed debt?

Post by fyre4ce » Thu Aug 01, 2019 1:07 pm

xraygoggles wrote:
Thu Aug 01, 2019 12:58 pm
Charon wrote:
Thu Aug 01, 2019 12:34 pm
The only issue is that you say "live like a resident for one more year" to pay off this debt. I assume this means you will not "live like a resident" if you choose not to pay off this debt, and therefore you won't have an equivalent amount to invest. That does matter.
No, I didn't mean that. I plan on building a taxable account with the majority of the payments I was making towards the debt.

I just meant in order to pay it off in one more year, I would just need to not go on any extra lavish vacations or buy another Tesla.
From a behavioral perspective, I strongly suggest not buying “extra lavish vacations” or “another Tesla” until all debts are gone. Otherwise you’re buying these things on borrowed money.

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Re: Aggressive loan paydown on sub-2.5% fixed debt?

Post by fyre4ce » Thu Aug 01, 2019 1:08 pm

xraygoggles wrote:
Thu Aug 01, 2019 12:55 pm
Meg77 wrote:
Thu Aug 01, 2019 12:44 pm
You can earn over 2% in a money market account.
Not true. I'm in 37 federal and 12.3 state tax brackets.
Don’t forget 3.8% net investment income tax.

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xraygoggles
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Re: Aggressive loan paydown on sub-2.5% fixed debt?

Post by xraygoggles » Thu Aug 01, 2019 4:11 pm

fyre4ce wrote:
Thu Aug 01, 2019 12:51 pm
I was going to say max out tax advantaged accounts first, but you're already doing that.

Advantages of taxable money:
-better liquidity (if you need some cash in a year, you'll have to take out another loan, probably at higher interest)
-potentially higher return than loan, especially if you're investing in mostly stocks, which is likely at your age
-inflation protection (taxable investments should respond to inflation with higher nominal returns, and your loan is a fixed nominal rate, although on this short of a time horizon this effect doesn't matter much)

Advantages of paying down debt:
-guaranteed return (how will you feel if you put $180k in a taxable account in stock mutual funds, and the market crashes and you lose $80k?)
-easier to get "fired up" burning down a debt than building a taxable account. This path will possibly support better financial behavior
-asset protection benefits. once you pay down the loan, you can't be sued for that money; not so for taxable account

I'd take the 50/50 approach and pay the loan off in two years. It's a better balance than paying it off in one year and not having any non-retirement money, and running out the debt 5 years.
Thank you, that was helpful. 50/50 sounds reasonable enough. Although if the market starts to tank, I could always go 70/30 stocks/debt, to buy equities cheap I suppose.
“Compound interest is the eighth wonder of the world. He who understands it, earns it ... he who doesn't ... pays it.”

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Re: Aggressive loan paydown on sub-2.5% fixed debt?

Post by grabiner » Thu Aug 01, 2019 7:22 pm

xraygoggles wrote:
Thu Aug 01, 2019 12:26 pm
I have ~185k remaining on student debt at 2.45% fixed 5-year payoff.
xraygoggles wrote:
Thu Aug 01, 2019 12:55 pm
I'm in 37 federal and 12.3 state tax brackets.
This implies that the debt is non-deductible, and paying it off would be a risk-free and tax-free 2.45% return. A partial prepayment on the loan has a 5-year duration, decreasing over time, but you make the decision now whether to pay down the loan or invest the money. The low-risk 5-year return available to you is 1.55% on Admiral shares of Vanguard CA Intermediate-Term Tax-Exempt. Therefore, you will come out ahead by paying it off rather than investing in a taxable account at the same risk level. That is, you should pay it off with money you would have otherwise invested in munis, and sell bonds in your IRA/401(k) to buy more stocks for an amount you would have otherwise invested in stocks.

Continue to max out your IRA and 401(k), as this space is of permanent value.
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Re: Aggressive loan paydown on sub-2.5% fixed debt?

Post by welderwannabe » Thu Aug 01, 2019 7:26 pm

Meg77 wrote:
Thu Aug 01, 2019 12:44 pm
2.45% is about the cost of inflation; in other words that is free money.
The fed does not seem to agree
I am not an investment professional, but I did stay at a Holiday Inn Express last night.

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Re: Aggressive loan paydown on sub-2.5% fixed debt?

Post by gclancer » Thu Aug 01, 2019 7:34 pm

grabiner wrote:
Thu Aug 01, 2019 7:22 pm
That is, you should pay it off with money you would have otherwise invested in munis, and sell bonds in your IRA/401(k) to buy more stocks for an amount you would have otherwise invested in stocks.

Continue to max out your IRA and 401(k), as this space is of permanent value.
+1

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Re: Aggressive loan paydown on sub-2.5% fixed debt?

Post by ThriftyPhD » Thu Aug 01, 2019 7:37 pm

xraygoggles wrote:
Thu Aug 01, 2019 12:26 pm
I have ~185k remaining on student debt at 2.45% fixed 5-year payoff.

I have a high enough income that, if I live like a resident for one more year, I can pay it off by August 2020 in exactly one year. I have asked this same question in the WCI forum, and most people there recommended either splitting 50/50 taxable investments/debt relief and some even recommended letting the cheap debt ride for the entire term, and just invest in a taxable account. I should mention I'm 2nd year out of training living in HCOL area as a single guy. I already max out all tax-advantaged accounts. I do not have any money in a taxable account yet, since I spent my 1st year all on this same debt (initial amount was ~320k).

I would really like to be done with this debt once and for all, but it's probably not the best decision from a numbers perspective. Any thoughts on this?
You're going to get responses that range from 'let it ride, that rate is low' to 'pay it off today, debt is a cancer'.

The reason is that your interest rate is low enough, and the term short enough, that the difference between taxable earnings and the debt rate is not going to really move the needle. Sure, you will earn less in a money market account after tax than what the loan is costing you, but it won't be a big difference.

So it instead comes down to preference. One camp here hates debt. Passionately. There are those that would bend over backwards to pay off a 0% interest only non callable loan because they are so debt averse. It has nothing to do with the rate, but is behavioral in wanting to avoid any debt. The other camp will see that 2.45% is ~ the same as savings earnings, but the savings gives you a different kind of value: liquidity. Liquidity has value above and beyond the 2.5% interest your money market fund will earn, don't discount it's value.

From a numbers perspective, assuming a dollar will go to either the loan or savings, the two options are a wash. It comes down to how you balance debt aversion against liquidity.

Personally, I would at least build a 6 month emergency fund, then have a balance for any known large upcoming expenses, then consider paying off the loan. 2.45% is low enough I'm not sure I would pay it off early even then.

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Re: Aggressive loan paydown on sub-2.5% fixed debt?

Post by firebirdparts » Thu Aug 01, 2019 8:10 pm

The important decision is to live simply. What you do with all the excess cash is secondary. That’s what I think. If the debt is motivational, that’s important.

If I were you, I would not be able to resist looking at market valuation and leading indicators today and that would convince me the math actually says pay it off. If the market dropped 40% I might change my attitude.
A fool and your money are soon partners

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Re: Aggressive loan paydown on sub-2.5% fixed debt?

Post by jbranx » Thu Aug 01, 2019 10:00 pm

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Re: Aggressive loan paydown on sub-2.5% fixed debt?

Post by Dude2 » Fri Aug 02, 2019 2:46 am

I'm one of those "pay off the debt" people, but I can see the argument for simply letting it ride. With your salary, and, being that you are in the early stages of your career, you may need a few years to achieve stability and pursuit of happiness and/or plow some money back into establishing yourself in your career. I don't know. I assume if a person were to consider going into private practice, for example, they'd need some capital on hand. Certainly nobody would want you to waste money on frivolous things, but there could be legitimate use for shorter term money. Perhaps build some up first, and then go into a 50/50 mode.

The only reason I could see to go all-out paying it off would be if you are in regret about your career choice. You would not want to be in the position of having taken beaucoup loans and then ending up without the corresponding high-paying job. Therefore, in that situation, paying it off ASAP would be wise.

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Re: Aggressive loan paydown on sub-2.5% fixed debt?

Post by Meg77 » Fri Aug 02, 2019 12:53 pm

welderwannabe wrote:
Thu Aug 01, 2019 7:26 pm
Meg77 wrote:
Thu Aug 01, 2019 12:44 pm
2.45% is about the cost of inflation; in other words that is free money.
The fed does not seem to agree
Ha, good point. Particularly with the short 5 year time horizon - the official inflation rate is certainly below historical 2-3% levels and will likely continue to be. Though ACTUAL inflation as experienced by consumers (who buy food and gas and homes which are not included in Core CPI as measured by the Fed) is a lot higher.
"An investment in knowledge pays the best interest." - Benjamin Franklin

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