Comments on: Payoff CC with student loans? Then invest or pay off loans?

Question: Payoff CC with student loans? Then invest or pay off loans?

Anonymous — Wed, 12 Sep 2007 12:58:17 -0800

I am using extra student loan money at 6.8% (mostly unsubsidized) interest rate to pay off my credit cards (about 25K) worth. What should I do when I get a bunch of other cash? Pay off loans or invest?

I will soon be getting $5K cash and will probably get some additional money for freelance jobs, while I am in grad school (MBA). My wife and I would like to buy a house at some point in the next few years.

So what do I do with the cash? Invest it (I typically return about 20% yearly on individual stocks...obviously riskier so maybe index fund?) Put it in a high yield savings account? Other thoughts?

Some have said I should immediately make payments on my student loan...seems to me if I can beat the 6.8% on the student loan I should save the money for the house.

(p.s. lest you think I am irresponsible with the 25K in debt their are valid reasons I won't go into..I am annoyed by it but it was mostly unavoidable)

By: kcm

kcm — Wed, 12 Sep 2007 13:03:49 -0800

You have to beat nearly 14% due to taxes on short term returns. If you have debt, pay it off before you invest. There are certainly situations where this is not an absolute rule for everyone, but if you're asking, you're not in that group.

By: shinynewnick

shinynewnick — Wed, 12 Sep 2007 13:05:22 -0800

Why not pay down the credit card debt directly with the cash, instead of paying into student loan?

By: wangarific

wangarific — Wed, 12 Sep 2007 13:05:48 -0800

On your investments you'll have to pay taxes when you realize the gain, so you'll have to earn at least 9% (assuming 25% tax bracket) to be breaking even... think you can beat that and are you willing to carry that risk just to earn the difference?

Now think of that in absolute dollar values... 1% of $5000 is only $50. So if you think you can earn 10%, you're really being paid only $50 a year for the risk... is it worth it?

(I hope my math is all right but I think my point made it through ok)

By: bitdamaged

bitdamaged — Wed, 12 Sep 2007 13:16:04 -0800

This is a classic Time -Value-of-Money problem.

By: Bulgaroktonos

Bulgaroktonos — Wed, 12 Sep 2007 13:17:12 -0800

wangarific, where are you getting those numbers form? You should never need to earn money to realize a gain, they tax capital gain not capital assets.

Assuming you pay the taxes on the 5,000 now and you keep the investments for longer than a year, you should only have to give up 15% of the gain to the government. If you can actually make 20% for say three years, you're looking at about $8,000 when you're done minus taxes. $3,000 is a lot, but it's not really going to impact a home purchase.

By: ourobouros

ourobouros — Wed, 12 Sep 2007 13:47:15 -0800

I don't know much about investing, but I did just read an interesting post on this: Should I invest my student loans? His basic point is that the risks of investing probably won't pay off in the short-term, and he recommends a high-yield savings account for short-term parking. So my question would be: what is "a couple of years," really?

The other thing you might consider is: do you currently have a savings cushion (about 3 months worth of living expenses)? If not, then don't invest just yet.

By: griffey

griffey — Wed, 12 Sep 2007 14:08:20 -0800

Not to mention that if these happen to be Federal Student loans, using them for other than tuition, fees, and materials could be breach-of-contract. Not likely, yes, but still.

And, what others have said. By the time you factor in taxes and risk, you really aren't making much. Then again, you invest in single stocks, it sounds like, so risk is something you may just not care about.

The smart move is pay the loan off, don't accrue more debt, and invest your pay going forward.

By: wangarific

wangarific — Wed, 12 Sep 2007 15:35:53 -0800

Bulgaroktonos:

anon's investments have to be 6.8% in order to make it "worth it" but he/she will have to beat it by more than his marginal tax rate because his earnings, if realized and in short term, will be taxed at that rate. So, if he's in the 25% tax bracket, earning 9% would give him an after tax realized gain of 6.75%, which is close enough. That's how I arrived at him having to earn at least 9%.

Now, earning 9% isn't enough because that only breaks even, he only "earns" that which exceeds the 9%... plus the amount he's talking about is $5k and 1% of $5k is a mere $50, which probably makes it not worth the effort (esp. if you consider transaction costs)

Did that make sense?

By: wangarific

wangarific — Wed, 12 Sep 2007 15:36:56 -0800

Ahhh shoot, my math was terrible, i taxed the whole thing not just the gain. ignore me. :)

but you shouldn't invest the money anyway, just pay off the debt

By: acoutu

acoutu — Wed, 12 Sep 2007 15:43:51 -0800

It doesn't sound like you have an emergency fund. I'd establish one to cover you for up to six months before paying down student loans.

When I was doing my MBA, we read a famous case study about a woman who was a director at the Apple start-up before founding her own extremely successful seed catalogue company. In the case, she was quoted as saying that all MBAs should have "screw you" money, so that they can walk away from any job they hate. At least, I think that's who said it. Anyway, that's sort of like having an emergency fund. :)

By: edjusted

edjusted — Wed, 12 Sep 2007 22:24:23 -0800

20%...I hope you're not expecting to do that *every* year. Over a few years it's possible...unlikely, though. For purposes of calculating what you should do, you should probably figure more like 10% a year for stocks.

By: ikkyu2

ikkyu2 — Thu, 13 Sep 2007 09:10:39 -0800

If you or your wife have any earned income, drop the money into a Roth IRA and invest it there. You two will be able to pull out up to $10K each for your down payment.