Check from Grandma!

August 23, 2006 11:32 AM

What should I do with $10,000?

I'll have to start paying off my student loans in less then three years. This money will not cover all of my debt. Should I pay off the debt I have right now, knowing that I’ll have to take out more loans to be able to graduate, or should I do something else with the money to make paying the loans off easier in the future? Or is here something else I should spend the money on that’s worth having the student loan debt?

posted by CaptMcalister to work & money (36 comments total)

Pay off your debt with the HIGHEST APR first (creditcard, variable rate car loans, etc). If your student loans are subsodized government loans, then you will not be paying interest on them (if you are not a student). I would not rush to pay them off. If you only have $15k or so in debt for school, I wouldn't worry about paying that off to get more.. I know people with nearly 100k in debt with no issues.

I wouldn't blow the money on toys -- pay off high interest loans first, and then put the rest away in CD, or savings account as a rainy day fund.

My 2c.
posted by SirStan at 11:37 AM on August 23, 2006

If I got a check for ten grand today i would put $1,000 in savings for emergencies. Pay off $8,500 of student debt. Thank Grandma by treating myself with the last $500.
posted by iurodivii at 11:37 AM on August 23, 2006

Student loan debt is usually the last form of debt you want to pay off early, if you have credit card, car loan or other forms of debt.

If I didn't have any other obligations I needed to repay, I would put $7500 towards my loans and the other $2500 to travel someplace I've never been.
posted by Blazecock Pileon at 11:38 AM on August 23, 2006

Is the interest on your student loans currently accumulating? Is it accumulating at a rate higher than 5 percent per year?

If the answer to either of these questions is "no," you should open an HSBC Direct account and make 5.05% interest per year. That's $750 in free money in the first 12 months, more if interest rates rise?
posted by croutonsupafreak at 11:42 AM on August 23, 2006

You should invest it all in a couple of no-load mutual funds. Student loans have low interest rates and your job should allow you to make payments which eat into them quickly. Start your nest egg.
posted by OmieWise at 11:49 AM on August 23, 2006

The stupidest financial thing many people do is pay off their student-loan debt before they have to. There aren't that many opportunities to borrow money at a low interest rate and get a tax deduction in the process.

Here's what you should do with your money:

1) Do you have six months of emergency savings? If not, put enough money in a bank account (HSBC, as croutons recommends), or some other liquid source paying 5% interest, and have it as a rainy-day fund. Many financial problems stem from unexpected setbacks. $1000 might be the right amount, or it might not be enough: how much do you spend in a month? Some people might be better off using the whole $10,000 as emergency savings.

2) If your student loan is cheap (less than 7-8%), then don't don't don't pay it off any earlier than you have to. Talk to your bank about opening an IRA and starting a retirement fund (preferably invested in diversified equities through an index fund) with what's left over. If you're in school now, there isn't going to be Social Security when you get older, and you need to start saving now now now.

3) If, somehow, you already have an IRA, and you've made the maximum contribution for the calendar year, then budget a few hundred on tangible items that will improve your quality of life (or a vacation that broadens your mind), and use the rest to pay for expenses student loans won't cover.
posted by commander_cool at 11:53 AM on August 23, 2006 [2 favorites]

What SirStan said.
posted by k8t at 11:54 AM on August 23, 2006

Thanks for the answers so far. I am still in school (undergrad) so I am not yet paying interest. I not sure exactly how much longer until I graduate but probably two and a half years, and then I think I have another 6 months before I start accumulating interest. Besides student loans I have no other debt or obligations besides school costs.
posted by CaptMcalister at 11:59 AM on August 23, 2006

One more important thought before you start spending....

No one has ever said "gee, I wish I didn't have $10k in the bank for a rainy day".

The opposite is a different story.

Again, I would advise against buying toys, or using the money for anything except keeping for retirement, or as a downpayment on a house, paying off high interest creditcards, or the such. Its alot easier to justify spending more if you spend any of it.
posted by SirStan at 12:00 PM on August 23, 2006

I agree with croutonsupafreak. Consolidated, my student loan interest rate is 2.857% or something insane like that and could easily find somewhere to stash the money I'd spend no paying my loan upfront and come out ahead. The same is likely to be true of you- once consolidated, with direct deposit and never over drafting, making more money from that $10,000 by investing it versus paying off a low interest loan in fairly easy. This is assuming you have no outstanding CC or high-interest loans as others have mentioned.
Also, think of it this way: You can start earning interest now by investing, whereas you don't start paying loan interest until you graduate. If you are bent on paying off your loans soon, deposit the 10k someplace where you can get the money in 3 years (a 3-year CD?). That way, you can pay off more than the 10k you originally started with.
Lastly, the sooner you can start to invest for retirement, you can retire that much sooner or retire with that extra house on the beach. Paying off the student loan ASAP won't make as big a difference in the long-run.
posted by jmd82 at 12:01 PM on August 23, 2006

CaptMcaliser --> I believe you have a year deferment before you need to repay loans. You can also defer them if you continue your education within this period.

Ie -- You can take a year off, and then go back to grad school, and never pay a cent in interest or loan repayment.

You only get one 1 yr deferment, and one 6 month deferment I believe. Don't quote me on that--Call your local student aid office.
posted by SirStan at 12:02 PM on August 23, 2006

You may not be paying interest, but are you accumulating interest? That's the critical inquiry. The first question is a question of cash flow, while the second is a question of actual economic impact to your financial situation.
posted by commander_cool at 12:03 PM on August 23, 2006

You're young, so do something interesting with the $10K - blow it on travelling somewhere.
posted by the cuban at 12:06 PM on August 23, 2006

I'd also suggest that you don't pay off your student loans. The reason is that there are many programs out there that might repay your loans for you, depending on what kind of work you do.

For example, I know several people who are getting their student loans paid off by the National Institute on Health's Loan Repayment Program, as the government wants to encourage people to go into these health research fields. I've also heard of similar programs for people who go into teaching and spend some of their career in inner city schools.
posted by jasper411 at 12:11 PM on August 23, 2006 [1 favorite]

commander_cool: Many types of loans do NOT accumulate interest while you are in school. Mostly the unsubsodized kind.
posted by SirStan at 12:12 PM on August 23, 2006

metafilter needs an edit mode

A subsidized loan is awarded on the basis of financial need. You won’t be charged any interest before you begin repayment or during deferment periods (click here for more information). The federal government “subsidizes” the interest during these periods.
posted by SirStan at 12:12 PM on August 23, 2006

I am not accumulating interest.
posted by CaptMcalister at 12:13 PM on August 23, 2006

All the more reason not to pay the loan. You'd be throwing away money that the federal government is giving you.
posted by commander_cool at 12:24 PM on August 23, 2006

Save $2500 for taxes.
posted by Roger Dodger at 12:24 PM on August 23, 2006

I agree with the people who suggest setting some of it aside for future debt payments. But if you're still in undergrad and will be applying for more financial aid next year, this money could count against you. If you have significant financial resources (I'm not sure if $10,000 counts as significant in this situation) you might not qualify for some subsidized loans, scholarships, and grants. Check with your school's financial aid office.
posted by chickletworks at 12:25 PM on August 23, 2006

Yeah, SirStan is correct.

My totally non-expert, non-guaranteed opinion is that you shouldn't put this money into a retirement savings account. For one thing, Grandma has already paid taxes on this money, so you've lost the bonus of contributing pre-tax dollars. Secondly, the stock market is not making huge gains right now, and it's probably not going to make huge gains in the next 3 years. Money you dump into a diverse portfolio of mutual funds today is unlikely to earn more than 5% interest each year for the next 3 years -- and it will be completely out of your reach for the next 40+ years. Whereas with an account like HSBC's, you can guarantee yourself a 5% rate of return for probably at least another year or two (hard to predict when the Fed might start lowering interest rates, but those days seem far off), have the money available for emergencies, AND (drum roll please) use the money in a few years to purchase a house -- which can go a long way towards solidifying your financial future.

In 3 years when you graduate, you can start dumping pre-tax (and hopefully employer-matched) money into an IRA or a 401(k). And you can take Grandma's money and buy a house, so you can stop paying rent and start earning equity.
posted by junkbox at 12:29 PM on August 23, 2006 [2 favorites]

Ladder a CD Portfolio.
posted by grateful at 12:40 PM on August 23, 2006

"Save $2500 for taxes."

CaptMcalister don't panic. I give Maw $10K every year, and neither her nor I have ever incurred taxes on this gift. My accountant (I use KPMG) once sent me an IRS document on this very topic (warning: pdf).

Just for reference, Maw earns about $18K pa, your specific situation may differ but whenever the subject of taxes comes up on AskMe I always direct folks to a qualified accountant.
posted by Mutant at 12:42 PM on August 23, 2006

Chickletwork raises a good point. It's entirely possible the $10k will just make the school charge you more money next year, and you may want to arrange with your grandmother to wait three years to give you the money.

NB that in many parts of the country, buying a house is a lot riskier than putting money in the stock market, however.
posted by commander_cool at 12:44 PM on August 23, 2006

I'm assuming US and the standard federal financial aid system here... Subsidized federal loans are awarded on the basis of need, but your level of need is reassessed every year. Now that you have assets of your own, the school will assume that those assets are available to pay for your education. Unlike money in your parents' name, it will assume you don't need any of that money for anything but yourself and your schooling. So next year's level of financial need will go down by a large % of the amount you have in the bank when you fill out the FAFSA. The school and federal government will not care whether the money is in your checking account, long-term savings, or a risky investment. They also won't care about whether you need the savings for a rainy day, your future, or a downpayment on a house. They'll want it in the form of a check from you.

You'll probably have the option to take unsubsidized loans at that point, but interest will accumulate on those while you're in school.

You're now in a tricky financial aid situation. The assets also shouldn't be hidden - penalties for purposely lying on a FAFSA go up to $20,000 or jail time. Yes, the financial aid system is very stupid and penalizes people with a long term outlook. If I were in this situation, I would probably keep a small reserve for emergencies (regardless of the impact on aid eligibility) and then stretch out the money as long as possible to avoid having to take out unsubsidized loans in the future. You absolutely shouldn't pay off any subsidized loans you already have. Also, if you've been considering anything more expensive education wise (a summer, semester, or year abroad, for example, or an unpaid internship), now is the time to do it. Things like investments or a retirement nest egg will most likely have to wait until you're out on your own and no longer need financial aid.

This page lists aid-maximizing strategies, and specifically mentions that grandparents should wait to give money for education until the grandchild has graduated. There's lots of other good advice there as well, but some of it is a little deeper than you may want to go into right now.
posted by pekala at 12:56 PM on August 23, 2006

Jesus, not even a single hookers 'n blow answer. Y'all are so pragmatic.

Token irresponsible answer:

Yeah, pay off credit cards and cars, blah blah blah. But save at least some of it for a great trip, an experience like skydiving, or a cool laptop, or a leather couch or something else fun.

Everyone has debt, and even if you pay off some, you'll just have more someday. And I can tell you paying off debt isn't nearly as fun as spending cash!
posted by M.C. Lo-Carb! at 3:19 PM on August 23, 2006

A Deco Edgar Brandt Art Glass Snake Vase?

(Sorry). But seriously, life is cheap in south asia, afica... You can learn a lot by travelling the world.
posted by rocco at 4:07 PM on August 23, 2006

Once you're out of school and earning a living wage (I forget the exact amount, but it's easily discovered) your student loans are no longer tax deductable.
posted by jewzilla at 7:17 PM on August 23, 2006

You marked junkbox's answer best, so you should know that it contains some errors.

First of all, he may not be aware of it, but he's arguing against putting the money in a "Traditional IRA" with his "pre-tax dollars" argument. Of course you wouldn't do that - you'd put it into a Roth IRA.

Second, he doesn't seem to understand that 5% yield in a savings account outside a Roth IRA is equivalent to 4% or less yield within the IRA, depending on your tax bracket, because outside an IRA, the gains are taxed. Not only that, savings and short-term CD yields are taxed at the full short-term Federal and State income tax rate, rather than the 15% maximum tax on long term capital gains, so using a savings account is a doubly wrong way to try to make money. When you factor in the miracle of compounding, the difference over many years is enormous.

Third, the principal you put into your Roth IRA is always available to you for immediate penalty-free withdrawal. Only the gains are "locked away for 40+ years."

Fourth, mutual funds are speculative investments, but they don't earn "interest," they earn capital gains. The HSBC savings account that junkbox mentions is currently offering a 5.05% annualized yield, but the rate changes every month, so putting money into it won't lock that rate in. To lock the rate in for 3 years, you need to buy a 3 year CD. The idea that a diversified equity portfolio couldn't beat a 5% annual yield on a CD over the next three years is a prediction that junkbox is making, and in my opinion it's a pretty poor prediction. Stocks historically outperform other investments.

I think you should put $4K of your windfall into a no-fee Roth IRA, dump it into some kind of low-load equity fund, and forget about it for 40 years.
posted by ikkyu2 at 7:31 PM on August 23, 2006

As I'm sure ikkyu2 knows, you can't put $10,000 into a Roth IRA unless you've actually earned $10,000 this year. You can't put in more than you've made.
posted by croutonsupafreak at 9:47 PM on August 23, 2006

You can't put in $10,000, period.
posted by phearlez at 12:07 PM on August 24, 2006

open a brokerage account and buy Elan stock and options.
posted by indigo4963 at 1:36 PM on August 24, 2006

In coming back to this I thought I would mention that if you go the IRA route you should look into making a 2006 and 2007 contribution (you can do the 2007 contribution on Jan 1) with this money so that you can avoid any maintenance fees. If you go with one of the industry's low-cost alternatives, Vanguard, there's a $10 fee per-fund if you're under $5,000 in that fund.
posted by phearlez at 2:03 PM on August 24, 2006

I would honestly go with getting an experience of some fashion. A study-abroad trip, volunteering, start-up money for a business, whatever. It need not cost you all the $10k - you can still invest what you have, but you'll need to invest in your life too.
posted by divabat at 2:40 PM on August 24, 2006

Right, phearlez. $4K is the contribution cap for 2006, and you need to have $4K in earned income in order to be allowed to make such a contribution.

It's worth remembering that if your income is low enough, you qualify for the "saver's credit." That means that if you contribute $2K or more, and your income is low, Uncle Sam basically gives you up to $1000, free, just for contributing. This calculator can help you find out if you qualify and for how much.
posted by ikkyu2 at 7:04 PM on August 24, 2006

Also, if you're worried about the FAFSA, bear in mind:

Post-tax contributions to retirement plans are not reported on the FAFSA (except to the extent that they are included in AGI). For example, a Roth IRA is funded with post-tax dollars, and so the contributions are not included on Worksheet B of the FAFSA.

According to the FAFSA, your IRA assets are *not* counted as assets you are expected to use to fund your education. Putting the money in the IRA ducks the problem that Chickletworks points out - and you still get to keep the money.
posted by ikkyu2 at 7:13 PM on August 24, 2006