Talk:Paying down loans versus investing

I'm not really all that happy with the page as it currently stands -- it seems overly biased against early loan repayment. I'm going to do some work on it to try to add balance but I may overcorrect. --Sommerfeld 01:53, 11 November 2009 (UTC)

Take a look at the "What Links Here" (sidebar toolbox) to see if it helps to put things in context. --LadyGeek 02:47, 11 November 2009 (UTC)

Why should I make a comparison to bonds? Especially for a 401(k). You don't know when you will stop working, so the maturity date is unknown. 401(k) contributions can vary every year, especially if you change employers. Same for IRAs.

For taxable accounts, a comparison to "No-risk" municipal bonds is suggested. Recent indications are that is not such a safe course of action.


 * The "no-risk" municipal bonds are actually no-risk only if they are held to maturity (and match the payment schedule of the loan).Grabiner 02:49, 12 November 2009 (UTC)

Is the suggestion to actually invest in bonds? The writing is not clear. I was OK following everything up to the point of the bond comparison. Nothing in the Bogleheads' Guide to Investing or the Four Pillars of Investing mentions this approach. If I missed the point here, it's because I am confused on the intent. --LadyGeek 00:57, 12 November 2009 (UTC)

My intention wasn't to suggest investing in bonds, but to suggest that investing in bonds is a fair comparison. That is, if you can earn a higher guaranteed return by buying a bond than by paying down a loan, then it is better to buy the bond than to pay off the loan; you might still choose to invest in something else instead. On the other hand, if you can earn a higher guaranteed return by paying down the loan, it is better to pay down the loan, as you cannot earn a higher return on your investments except by increasing risk, and you have already chosen not to increase your risk with your investment strategy. Grabiner 02:49, 12 November 2009 (UTC)

Close Decisions Discussion
"If the decision is close, it is likely to be better to keep the loan." I really do not like this statement. It seems like an opinion statement, and one which I actually vehemently disagree with, despite the following few sentences justifying it. --Assumer 09:28, 20 March 2013 (EST)


 * The wording could be changed. "If the rates are close, there may still be an advantage in keeping the loan."  That is the point of the paragraph, and it's then up to the individual investor to decide whether the cost of keeping the loan at a higher rate is worth the potential benefit of being able to refinance or max out a 401(k). Grabiner 21:12, 21 March 2013 (CDT)

I don't understand the underlined section below (grabiner's suggestion incorporated). How do US Treasury and muni bonds relate to the cost of a loan? I think this statement should be revised.

"If the rates are close, there may still be an advantage in keeping the loan. One reason is that you can refinance your loan if interest rates fall, so the effective cost of the loan to you could be slightly less than its interest rate; in contrast, the Treasury cannot refinance its bonds, and most municipal bonds have only limited call provisions . In addition, if the choice is between investing in a 401(k) or IRA and paying down the loan, investing in the 401(k) or IRA will give you more tax-deferred investments, which will remain valuable even after you have paid off the loan." --LadyGeek 21:31, 21 March 2013 (CDT)


 * The rest of the article compares paying down a loan to investing in a bond with the same duration; if the loan rate is higher than the bond rate, then you will come out ahead by paying down the loan. However, this isn't quite a fair comparison; if you have a loan and a Treasury bond at the same rate, you can refinance the loan at a lower rate if rates fall, while the Treasury cannot refinance its bond, so there is a slight advantage for having the loan.  The option to refinance is worth something.Grabiner 13:24, 23 March 2013 (CDT)

Would this be an example of what you're saying? "If the rates are close, there may still be an advantage in keeping the loan due to changing rates. Let's assume you have $10,000 to either pay down a 5% loan, or invest in a 5% treasury bond. If rates fall to 2% next year, for example, and you had paid off the loan, you are stuck buying treasury bonds at 2% in the future. However, if you had bought treasury bonds, then you may be able to refinance your 5% loan at 2%, and are also holding a 5% treasury bond."

--assumer 21:21, 24 March 2013 (EST)


 * I just updated the section, but didn't see your example.

If the decision is close, it is likely to be better to keep the loan. One reason is that you can refinance your loan if interest rates fall, so the effective cost of the loan to you could be slightly less than it's interest rate.

For comparison, the Treasury cannot refinance its bonds so it can not take advantage of lower rates. Most municipal bonds have only limited call provisions.

In addition, if the choice is between investing in a 401(k) or IRA and paying down the loan, investing in the 401(k) or IRA will give you more tax-deferred investments, which will remain valuable even after you have paid off the loan.
 * I still don't understand the muni bond call provisions. Feel free to undo or modify what I've just edited.
 * --LadyGeek 20:41, 24 March 2013 (CDT)

I wanted to discuss it here and come to a consensus before adding that example to make sure I got the facts right. So if my example above is correct, then there are 2 reasons to keep the loan if interest rates fall (ability to refinance a loan, and owning a higher interest bond)? Is this correct? Perhaps we should move this to the forum to get input from others? --assumer 07:39, 25 March 2013 (EST)


 * Forum discussion is always good. I'm still unsure about the muni bond call provisions. --LadyGeek 20:15, 25 March 2013 (CDT)


 * Forum link: http://www.bogleheads.org/forum/viewtopic.php?f=1&t=113520&p=1651278#p1651278 --Assumer 06:53, 26 March 2013 (CDT)

Reader feedback: For a beginner (as I imagine...
50.136.132.193 posted this comment on 7 April 2015 (view all feedback).

"For a beginner (as I imagine many readers are) it would be great to get a little more direction on where we should look to find bond return rates to compare to our loans. The page says paying off a loan can be compared to investing in a 'risk-free asset'. Does that mean that one should compare a loan with interest rate X and term Y to a US Treasury Bond with term Y to see if the interest rates for the US Treasury Bond is higher or lower than X? What website should we look at to find the interest rates for US treasury bonds? (Imagine you are a beginner. What pieces of information would be useful for actually putting this into practice. Thanks!)"

Any thoughts?

LadyGeek 18:04, 7 April 2015 (CDT)


 * Common links for current bond rates:

--Blbarnitz 04:23, 8 April 2015 (CDT)
 * Bloomberg
 * Bonds Rates & Credit Markets, Wall Street Journal
 * Daily Treasury Yield Curve, US Department of the Treasury

Total-interest percentage (TIP)
I'm not sure that the Total Interest Percentage is relevant here. It is a useful number to know, but it does not really affect the decision whether to pay down the loan, because the decision is made for each payment, and because of the time value of money. If you have a 4-year loan and a 10-year loan at the same rate, the same dollar prepayment will save you more Total Interest Payment if made against the 10-year loan, but it is probably a better deal to pay down the 4-year loan. (The reason is that you can then decide in 4 years to use the eliminated payment to pay down the other loan, which is now a 6-year loan, and get the same 10-year return as if you paid down the 10-year loan in the first place. Alternatively, if rates rise or you have another use for the money, you could do something else with the money.) Grabiner 21:26, 30 October 2022 (EDT)


 * I agree with your points that the relevance would not be appropriate here. Additionally, I'm concerned about misleading readers. As noted in the source cited in How much total interest do you pay on a loan?, What is the Total Interest Percentage (TIP) on a mortgage?, TIP is not the same as the interest rate (and will be much larger). Also note that TIP does not include upfront fees, whereas APR does (in the context of a mortgage loan). --LadyGeek 22:07, 30 October 2022 (EDT)


 * Without further caveats, I'm concerned that inexperienced readers may misinterpret total percentage as an interest rate. I have removed the section until we have a consensus. We can discuss this in the private wiki editor's forum. --LadyGeek 07:54, 31 October 2022 (EDT)