After recently finishing the last of my formal education (so far), I was able to consolidate my student loans. I received two pieces of information in the mail from the lender, one good and one not really that good. First, the good news.
You are eligible to receive a 0.25% interest rate reduction when you enroll in our automatic payment program… Enrollment will save you both time and money, and will prevent any delayed or forgotten payments.
This would lower the interest rate from 4.25% to 4%. That’s a good deal. However, another piece of mail — you know, they could probably lower their interest rates further if they’d stop wasting so much paper — makes me want to accelerate my payments as quickly as possible.
The lender has provided an amortization schedule for the approximately $20,000 I have in student loan debt (outstanding undergraduate loans plus graduate loans I didn’t pay back with my reimbursements). Even with a cool 4.25% interest rate, after the twenty-year schedule they suggest, providing a monthly payment of $127.04, I will pay $9,973.84 in interest before this loan has completely disappeared.
That is way too much money to spend on interest in my opinion. While some people say it’s not horrible to carry debt at favorable rates, and I may agree in some cases, I need to find a balance in order to avoid the interest payments that add up to a massive amount year after year.
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Can you not pre-pay?
That’s my question too.
Automatic payment doesn’t exclude pre-payment. You might not be able to get them to reamortize the loan, but you should be able to send in an extra payment once or twice a year.
A lot of sites even let you do that online.
I struggle with this question, too.
I’ve got a vehicle loan at 4.75%, a student loan at 5.375% and a mortgage at 6.25%. Unfortunately, the balances are lowest on the lowest interest rate and highest on the highest rate.
Should I keep paying just above the minimum on the vehicle and student loans and put extra toward the mortgage (my current strategy)? It’s probably the best purely logical choice since I’m paying down the high interest, high balance loan.
But I know that accelerating payment of the small loans and paying them off would free up lots of extra money that could then go to the mortgage. Doing that would feel better, too, since I’d have only one loan within two years.
Decisions decisions…
I don’t see much point in making extra payments to student loans. The only time you should do this is if you have enough to pay off the loan.
Unlike credit cards, making extra payments isn’t going to reduce your next monthly payment. If you want to pay off a loan early, take the extra money you want to pay and put it into a savings account. Then, when you have the money to pay off the remaining principle, go for it. But if you make payments along the way, you’re preventing your money from working for you.
If you have enough reserves I don’t see any reason not to just pay the damn thing off. In fact your balance statement for sept says you have $22K in cash :)…if I were you, I won’t have second thoughts about paying the entire loan off right now.
Some reasons why you wouldn’t want to do that:
1. You are expecting a big purchase soon and require quite a bit of reserve cash.
2. You get tax benefits/other benefits on the loan.
3. Any other reason that will earn you more than 10K in 20 years.
The 10 or 20 year amortization period is great for a recent graduate just starting their career, but that is far too long for me. I had a 10 year amortization period and paid my loans off in about 6 years. (my lender allowed me to make extra principal payments with automatic payment.) Now that I am married I am working my wife’s balances down.
As for prioritizing my acceleration payments I would pay them off in this order:
1. Credit Cards
2. Auto loans
3. Student loans
4. 2nd mortgage / Line of Credit
5. Mortgage
My lender also reduces my interest rate by .25% for paying automatically and if I pay on time for 36 months, they reduce it another 1%. You should check if they offer that as well.
$9,973.84 may sound like a lot of money, but you need to consider if it’s in your best interest to pay it off early.
For example, if you can get a further 1% reduction after 2-3 years, you’re down to 3% interest rate. Also, if your student loan interest is tax deductible, your effective interest rate at that point would probably be around 2%. You can certainly earn a higher rate of return by putting that money to work elsewhere.
Yes, $10K may seem like a lot of interest, but you need to consider that it could actually be costing you MORE money by neglecting to invest any extra money you have because you decided to pay off the loan.
The reason people say it’s okay to carry debt with low interest rates isn’t because the money isn’t real; it’s because it could actually cost you money to pay it off early.
As you know Jim at Financial Blueprint did a similar article a few months back. I guess I am wondering why people have two different frame of mind,
1) How much money am I losing to interest
2) How much money am I gaining with compound interest
Yet, few relate the two in the same article.
Yes, you are paying someone $10,000 in interest. And by paying $87 more, you would pay the loan off in 1/2 the time (10 years) and cut what you pay in interest paid down to a little over $5,000 (in half – Wow one would say).
Yet, if that same $87 was invested at 8% return, you would have $16,000 in just 10 years. Your loan would be $12,000 left. Thus, even if you do pay it off in full then, you are still ahead by $4,000.
Now, many have said, but 4.25% is a guarunteed return and stock market is not. So, where are you invested? All CDs (due to the guarunteed return) or in stocks because you invest for long haul?
It is a preference in risk. Yet, many say they are risk adverse (give me guaruntee return by paying off early) when paying off debt yet say they are risk takers when investing for long haul in stocks. Yet, they never really look at the two and say what is my overall strategy.
Thanks for all these great comments so far. There’s a lot to respond to…
I think Steve is right. Just take the money that you would have spent and put it in an investment over the next ten years. If it’s a diversified portfolio you should be able to make about 8% or more on the money over the ten years.
Maybe you’ll want to do some creative bookkeeping so that it doesn’t appear as if you have this debt hanging over your head.
Let us not forget that student loan interest is tax-deductible. The deduction can be found on line 26 of form 1040. Depending on the amortization schedule, you could be paying predominately interest in the first few years of the loan. This provides another reason not to rush and pay down principal. Considering that traditional IRAs offer a tax deduction as well, I’d focus on maxing out that IRA (if you are within the income limits) before paying extra principal to the student loans.
One thing that is missing from the calculation is taxes you would have to pay on the gain from your investments. I am struggling with the same question. My student loan is only 3% but i get no deduction because of my income. My income is taxed at the highest rate, so that cuts my gains from my CD and savings acount almost by more than 1/3. Although I do come out slightly ahead, I wonder if the emotional satisfaction from paying off my student loan early would be worth it.