Comments on: Can you please help me understand my school loans?

Question: Can you please help me understand my school loans?

sharkfu — Wed, 23 Jul 2008 16:23:11 -0800

Can you please help me understand my school loans? Boring numbers and interest rates within.

I'm embarrassed that I don't understand this stuff but I guess it's better to ask and learn...

I have two loans, a private loan and a Federal loan (which I consolidated several years back from Federal loans with higher interest rates). I have enough money to pay off one in entirety, but I'm not sure which one to do so to save the most money. Loan details below:

Private Loan
Original principal balance: $12,632
Outstanding principal balance: $5,297
Interest rate: 5.0%
months remaining: 59 months (by 5/28/2013)
monthly fee: ~$112
Total amount to be repaid (from this point to end of loan term) $6,563

Federal Student Aid - Direct Subsidized Consolidated Loan, Fixed Interest Rate
Original Balance: $14,203
Principal Paid $10,085
Interest Paid $3,567
Interest Outstanding $9.59
Outstanding principal balance: $4,118
Interest rate: 6.075%
months remaining: 26 (by 10/14/2010)
monthly fee: ~$164

Note: The Federal Student Aid website was much more confusing than the private loan one and I could not find a "Total Amount to be repaid (from this point to end of the loan term)"

Several questions:

1) Which loan should I pay off completely right now to save the most money?

2) Does the interest outstanding amount of $9.59 mean all the interest for the loan was loaded on the front and I'll be repaying capital only from this point forward? Or is that only interest due this month based up the principal remaining?

3) If I'm going to pay off one in entirety, is there a way to put it on credit card (and then immediately pay the credit card) so I can at least earn points/ miles? The only options I see for 10 day payoff on the two sites involves checks/ direct bank transfers.

Thank you for any insight you can provide...

By: SirStan

SirStan — Wed, 23 Jul 2008 16:38:02 -0800

1. You should be getting tax credits for the federal loan, so while it is a higher APR, that credit might outweigh the higher APR. (Ie, private loan would be who I would pay off -- unless you get tax credit for both, then go for the higher value one!)

2. Interest might be calculated per day? 14203 @ 6.075 means you are paying roughly (6.075/365) $2.36/day in interest...

3. Not usually -- my lender offers CC payments, but charges 3% extra. Ballance transfers offer no bonus.

By: SirStan

SirStan — Wed, 23 Jul 2008 16:40:53 -0800

On second though; if you could claim a tax benefit on both loans, I would pay them off on the APR ratio. So if you had $14k to pay, I would put it 60% towards the federal loan, and 40% towards the private loan. That way you are getting the best pay-back on interest savings over time.

By: SirStan

SirStan — Wed, 23 Jul 2008 16:58:23 -0800

http://brinkerhoff.org/askmefi/payment.xls <>
Basically you have 4 options:

1. Do nothing
Interest is roughly 990.1427047

2. Pay off loan 1:
Interest is roughly 382.4407858

3. Pay off loan 2:
Interest is roughly 692.701919

4. Pay off $5259 split at a 60/40 ratio
Interest is roughly 357.3343911

This does not factor in any tax benefit you might receive from the interest of the loan, but the xls file shows how my 60/40 ratio makes the most sense, and saves you a few extra dollars over plan 2.

By: Dec One

Dec One — Wed, 23 Jul 2008 18:53:39 -0800

Sorry to give you conflicting answers, but the previous answers are just wrong.

1) Any extra money you can put toward your loans should go to the one with the higher interest rate. You're probably getting the same tax deduction for interest on both loans. Do they both send you 1098E forms every January? Are you deducting it on your tax returns?

SirStan's option 3 puts only $4,118 towards your loans. Of course you are going to owe more under this example than you would if you put $5,269 toward your loans (which SirStan does in options 2 and 4). If you have $5,269 to put towards your loans, pay off loan 2 (which will cost $4,118 + $9.59) and put the remaining $1,141 towards loan 1.

2) It's the accumulated interest since your last payment. Interest is always accumulating at the rate of... interest! Right now, it's accumulating at $0.69 per day, which is your daily interest rate (6.075% / 365) multiplied by your current principal ($4,118). Not multiplied by your original balance, as SirStan calculates.

3) No, for two reasons I can think of. One, it's not a purchase; it's a cash advance, so you won't earn points. Two, your borrower would have to pay a fee to accept a credit card payment, and they have no reason to do that.

By: Dec One

Dec One — Wed, 23 Jul 2008 19:49:05 -0800

Oops, that should read "your lender would have to pay a fee..."

By: SirStan

SirStan — Wed, 23 Jul 2008 19:53:12 -0800

Sorry Dec one, but I was fairly clear with my example scenarios... sharkfu said he had enough $$ to pay off one loan.. so i based my figures off from that idea.. thats what my scenarios show in the xls file -- i am not wrong

Conventional wisdom DOES say "put $$ towards your highest APR", but thats the high school diploma explanation. The best answer is to split your payment based on APR between your loans (As I showed in Example 4). You can easily fix example 3 by applying the remander of the payoff to the lower loan to the higher loan and see this.

You have my numbers -- change them yourself and see. Lets say there is an option 5. You have $5297 to spend. You pay off the higher APR loan (4118 worth) and apply the rest ($5297-4118=1179) towarsd the other loan. You end up paying $429 in interest.

The simple solution is always, pay off the largest APR first. If you want to be smart and use your college education, you pay based on the ratio of APRS as I said in option #4.

Pay with this formula:

Payment towards loan 1 = ( (loan 1 apr)/(loan 2 apr) ) /2 * money you have to pay with

Payment towards loan 2 = ( ( loan 2 apr)/(loan 1 apr) ) / 2 * money you have to pay with.

This comes out to .6075 vs. .3925 (or 60%/40%).

This is the best course of action.

By: GlowWyrm

GlowWyrm — Wed, 23 Jul 2008 23:46:29 -0800

If your private loan has a variable rate, I would suggest you pay that one down first. If it has a variable rate, the private lender can jack up the interest rate to whatever makes them happy. Just because that private loan has a lower rate right now, if it's variable you may see it far exceed the rate of the federal loan.

By: Dec One

Dec One — Thu, 24 Jul 2008 04:38:44 -0800

sharkfu said he had enough $$ to pay off one loan

Sharkfu did not say that, and even if he/she did, it wouldn't make any sense. The loans have different payoff amounts. If you can afford to put $5,297 towards one loan, then you can afford to put $4,128 towards the other loan and have money left over. Your spreadsheet compares apples to oranges.

And where in the world did you get those formulas? Is there a web source you can point to? The simple solution is the best solution when it comes to paying off debt. Each dollar borrowed is costing you money in interest. Each dollar borrowed at 6.075% interest costs you 6.075 cents per year. Each dollar borrowed at 5% costs you 5 cents per year. If you have 10 dollars you want to use to pay down debt, putting all of it towards the 6.075% loan will save you 60.75 cents per year. Putting $6 towards that loan, and $4 towards the other loan will save you about 56 cents per year (36 cents from the 6.075% loan, 20 cents from the 5% loan). I apologize that I don't have time to change your spreadsheet so it shows this.

GlowWyrm has a point, but I'm assuming that if that lender could jack up your rate, they would have done it already. You should check to make sure.

By: explosion

explosion — Thu, 24 Jul 2008 13:54:24 -0800

1) To save the most money in the long run, always pay off loans with the highest interest rate. In the short run, you might find yourself with more spending cash by paying off the one with the highest monthly payment, but in the long run, you want to eliminate higher-interest debt before lower-interest debt, always.

2) The $9.59 is interest that's accumulated so far this month. Loans always accumulate interest until they're fully paid off.

3) There really is no way to use your credit card to accumulate points. They've made sure to close all the loopholes that would ever allow this. They want you to spend money on credit cards, not just get free points for your loan payments, mortgages, etc.

All in all, pay off the second loan first. It's both a smaller remaining balance, and a higher interest rate.