student loans + investing

February 5, 2007 2:55 PM

student loans + investing

I have a large student loan debt that will take me quite a long time to pay off. My question is: is there some way to invest that would help me pay off these loans quicker (i.e. in 10 vs. 30 years)?

posted by risslestomp to work & money (20 comments total)

What's the interest rate on your loans? If it's less than 5 percent, then you can get a better savings rate than that at the moment. If it's more, then you're better off paying as much of the loan off possible early.
posted by grouse at 3:06 PM on February 5, 2007

Ah, student loans. As a final-year student in London i have rather a large amount of debt looming. I plan to pay as little off as possible, tbh. In the hope that a government will be elected which will wipe out my debt entirely.
posted by cardamine at 3:13 PM on February 5, 2007

Grouse is right. But since student loan interest is tax-deductible, don't look at the interest rate on your loans; look instead at the interest rate on your loans after adjustment for the tax deduction.

For instance, if the interest rate on your loans is 4%, but you're in the 25% tax bracket, the effective interest rate is (4% x (1 - 0.25)) = 3%.

Given this, it's very rare that it ever makes sense to pay off a student loan faster than required.
posted by ikkyu2 at 3:17 PM on February 5, 2007 [2 favorites]

What everyone else said. The rates on my loans are fairly high, so it makes more sense for me to pay them off quickly than it does to invest the money. If your rates are low, through consolidation, or whatever else, pay them off slowly and invest your money elsewhere.

With low loan rates, you might consider a CD or an online savings account with someplace like ING Direct - they've got a 4.5% interest rate right now. (And some nice referral bonuses for new members, if you know someone)
posted by chrisamiller at 3:24 PM on February 5, 2007

Regarding the deduction for interest paid on student loans, keep in mind that there's a dollar cap on the deduction and it phases out if you're over a certain income level. The precise formula of the phaseout is complicated, and you can find more information here, but a single person making more than about $70k isn't going to see any benefit.
posted by Mr. President Dr. Steve Elvis America at 3:42 PM on February 5, 2007

Thanks everyone for the advice. I am actually looking at ING right now. My interest rates are low, but right now I am on a 30 year plan because anything other than that would render my monthly payments too high for my current income.

And cardamine, I also wish that somehow a gov't could be elected that would wipe out student loan debt. Doubt that will happen too soon though : ( I'm often envious of my German husband with zero educational debt.
posted by risslestomp at 3:54 PM on February 5, 2007

Given this, it's very rare that it ever makes sense to pay off a student loan faster than required.

I had a great job out of college, and paid my loans off quickly. That enabled me to leave the job when it went bad and work for high-risk startups. If you might want to do this, or go volunteer in third world countries, paying your debt off quickly will remove the obligation to send a check in every month.
posted by b1tr0t at 4:04 PM on February 5, 2007 [1 favorite]

While I would be happy to make a quick referral by sending you an ING Direct invite, it behooves me to point out that other banks have higher interest rates. HSBC's Online Savings account is 6% through April 30, and 5.05% after that.
posted by grouse at 4:08 PM on February 5, 2007

Student loans are something that so many people have to contend with these days, (at least in England...and don't even get me started on the difference between England and Scotland...) i don't think paying it off should be a worry/priority. I know i said i have a large debt, but i'm firmly in the 'so what' camp. This debt was imposed upon me...if i were two years younger when top-up fees were brought in, i doubt i would have chosen to go to university. Too expensive, and not worth it for the amount of teaching i get. ANYhoo, my position is, don't pay off any more than you have to. Yes, they're loans, but i'm under the impression that having them doesn't make that much difference to your other borrowing capacities.

(And they're unfair, so don't pay them)
posted by cardamine at 4:42 PM on February 5, 2007

my position is, don't pay off any more than you have to

This could be very unwise in some situations. If you have lots of money in loans and can pay them off sooner, you can save a lot of money.

A hypothetical ex-college student X with 50 grand in loans at 5% a year:
If they pay it back over 10 years, they pay $13,639.22 in interest. If they pay it back over 30 years, they pay $46,628.28 in interest.

30 grand or so is not a trivial difference.
posted by chrisamiller at 4:49 PM on February 5, 2007

cardamine, I believe student loans in England are automatically recovered by the government from your payslip once you earn more than £15k p.a., so I don't think you get much choice about paying them off early/late/not at all...
posted by matthewr at 5:25 PM on February 5, 2007

chrisamiller (and b1tr0t), you need to calculate the opportunity cost of paying off early. eg chrisamiller's example assumes that the only alternative to paying off the student loan is to stick the money in a jar until later, when in fact it's not really hard to find a better return than that of the loan.
posted by pompomtom at 5:32 PM on February 5, 2007

pompomtom: You're right that chrisamiller is making an error as you state. But bitrot is not (and wouldn't overlook such a thing, as evidenced by his comment history on such topics)--he's making the point that being rid of a fixed charge (i.e., the monthly loan payment), the OP may have more freedom to seek experiences that may not provide a steady cashflow.
posted by mullacc at 9:13 PM on February 5, 2007

To clarify: I said in my first comment that if you can find investments with higher interest than your loan, you should go for it. This is my advice to the original poster.

My other response was to cardamine, who was advocating waiting as long as you can to pay them off. I was simply pointing out that this may not always be a good idea (if you have high interest rates, can't find good investments, etc).
posted by chrisamiller at 9:35 PM on February 5, 2007

I had a similar conversation earlier today with a financial planner.

First, your question is a little confusing. Are you trying to pay off your loan early, or are you trying to find a better use of your money? You certainly could find a better return than 5%, but how does that get you out of debt sooner? The money is still locked up someplace (ie in an investment account) where you can't use it. Make sure your loans are locked in at a low interest rate, and make minimum payments if you so choose. It's "good" debt that won't be looked at unfavorably when you go get a home loan or a business loan.

I have ultimately decided to do what b1tr0t and mullacc alluded to. Pay it off as quickly as possible. My educational debt (>200K) is a giant weight around my neck -- it is constantly dictating to me the kind of job have to take, a job I might not love just so I can cover the payments. Until this thing is paid off, I can't go work on a fishing boat in Alaska or take time off to write the Great American Novel or be a stay-at-home Dad. Having that kind of freedom has got to be worth something to you.

And cardamine, I also wish that somehow a gov't could be elected that would wipe out student loan debt. Doubt that will happen too soon though : ( I'm often envious of my German husband with zero educational debt.

If my wife wasn't from a country with free education, we'd be financially sunk. Boo American Government that doesn't invest in education!
posted by Slarty Bartfast at 10:23 PM on February 5, 2007

Note that student loans can also provide a source of cheap life / disability insurance.
posted by raf at 5:23 AM on February 6, 2007

chrisamiller: Sorry, I didn't notice your earlier comment.
posted by mullacc at 10:33 AM on February 6, 2007

General wisdom is to stretch out loan repayment as far as possible while simultaneously investing your money rather than using money to pay off those loans. This is because student loans are tax-favored, so the "real" interest rate you're paying on them is significantly lower than what it looks like you're paying. Same idea on mortgages. If you save instead of paying it off, you can then use that saved & invested money any time to pay it off to a greater degree than you would have been able to if you'd immediately paid off your loans anyway (so the whole paying it off to avoid having to work a certain kind of job for the next 30 years doesn't make sense if you can control your spending).
posted by lorrer at 3:47 PM on February 6, 2007

This is because student loans are tax-favored, so the "real" interest rate you're paying on them is significantly lower than what it looks like you're paying.

ikkyu2 already showed how to calculate how much lower your effective interest rate is earlier in this thread.
posted by grouse at 4:11 PM on February 6, 2007

chrisamiller's argument doesn't only neglect opportunity cost, but it also totally neglects inflation. Yes, you pay more interest if you pay off slowly, but you pay it in dollars (or euros) that are worth much less. Right now, $46,000 is a decent annual living wage here in the US; in 30 years it'll be a decent wage for two months work, maybe.
posted by ikkyu2 at 3:36 PM on February 9, 2007