30,000 dollars. Pay off loans or put it away?
May 20, 2009 10:43 AM   Subscribe

So, I have about 25,000 I'm about to receive a bit from a settlement. With additional savings I have, I will actually have about $30,000 total.This is basically all my money, period- other than that I live hand to mouth. I also owe about 10,000 in student loans. I'd really like to get rid of those loans. However, would it actually make more sense to put my money in a high yielding savings account?

I have a savings account that currently is 5% APR- which with 30,000 dollars would compound around $1,500 or so a year. But it seems like I might just as well pay off the student loans in a big chunk. Or would over the long run it make more sense just to keep paying the minimum on the student loans? The debt has been hanging over my head. But I like the idea of having the bank pay ME over a grand a year. Any advice?
posted by anonymous to Work & Money (31 answers total) 6 users marked this as a favorite
What interest are you paying on the student loans?
posted by Grither at 10:46 AM on May 20, 2009 [2 favorites]

Pay your loan. Interest rates could fall, and you will ALWAYS pay more to borrow money than you will receive by lending it to a bank in a savings account.

what's the interest rate on your student loan?
posted by Penelope at 10:46 AM on May 20, 2009 [1 favorite]

D'oh, anonymous. So yeah, in general, you're more likely to be better off paying off the loan, and then putting the rest into savings. That will still leave you with $1,000 coming in as interest from the bank. Pre-tax.
posted by Grither at 10:48 AM on May 20, 2009

Get rid of the loan. Seriously, the peace of mind is worth far more than the slight difference in profit that you might make in the long run. Pay off the loan, and then use the payment you would normally make into savings. Best of both worlds.
posted by kimdog at 10:48 AM on May 20, 2009 [1 favorite]

You haven't mentioned what the interest rate on your student loans are, or what the policies for early repayment are. Financially, it is smarter to pay off the loans if they are costing you more than the capital in your high-interest savings account. Also, I would double-check the APY of your savings account, many banks have decreased the interest rates on their accounts.
posted by onalark at 10:48 AM on May 20, 2009

Are you absolutely sure your savings account is still at 5%? Many of the big players: ING, Citi, etc, have greatly reduced the interest rates on their high yield savings accounts, usually to fall between 1-3%. The ING Orange savings account, which historically was the big 5+% high yield player, offers only 1.5% these days.

Note that they can change the rate on many of these accounts without notifying you explictly about the change, so you might log in on the web site or call and ask, and they'll say, "Yes, you're now at .85%." Most of the 5% offers these days seem to be for low balances (oh boy, 5% on the first $2500) or quickly disappear after a promotional period and revert down to just a couple of percent.

If you're truly getting 5%, and your student loan is less than 5%, it may be wise to keep around the $30,000 as an emergency fund, making a couple of dollars along the way. But if your savings account is like most these days and they dropped the rate on you, $19,000 in a 1.5% savings account and $0 in student loans may well be the more attractive option.
posted by eschatfische at 10:50 AM on May 20, 2009

Pay off the loan, if for no other reason than being debt free feels so damn good. Also, you'd still have a bunch of moneys after paying the loan off.
posted by chunking express at 10:56 AM on May 20, 2009

Another thing to think about: interest on student loans is tax-deductible (at least, for X years). So your rate is, effectively, smaller, at least until the last couple years of the loans (where you're paying mostly principal).
posted by notsnot at 11:04 AM on May 20, 2009 [1 favorite]

pay off loan. Who knows where you'll be in a few months/years. All your money could be gone for some as yet unknown reason. No loans = less hassle all the way around.
posted by edgeways at 11:08 AM on May 20, 2009

Pay the loan and save/invest the $20k. Best of both worlds.
posted by PFL at 11:12 AM on May 20, 2009

We need to know your interest rate on the loans, your marginal tax rate and the confirmed interest rate on the savings.

We also need to know your current job status, job security, academic situation (finished? going back?) and any major goals you have. It's not really possible for anyone to give you good advice without having a bit more information.
posted by acoutu at 11:13 AM on May 20, 2009

Are you sure you can actually pay off the loan? A lot of student loans won't let you pay early, and only credit prepayment towards future payments. So you still pay the same total amount of interest either way.

You should double check that, and if it's the case then you should put the money in a savings account, if not invest part of it.
posted by delmoi at 11:15 AM on May 20, 2009

Where is your savings account? I want in!
posted by BobbyVan at 11:21 AM on May 20, 2009 [1 favorite]

Seconding eschatfische that you're probably not getting 5% on your savings. I used to be a high interest hound, moving my money several times to get the best rates. Now they're too low to make it worth the hassle.

I ran a quick check on JD's blog and the highest rates were a tad over 2%. I'd guess that's lower than your student loan interest.

Paying off the loan is the best way to go, financially and for peace of mind.
posted by jaden at 11:22 AM on May 20, 2009

I would not pay off the loan, assuming it's a standard low interest student loan. Not all debt is bad and it's not just a "which costs less money" question. You are living hand to mouth now and may need the money for some other reason. It sounds like you're getting established in your career and you may change jobs, relocate, whatever. In other words, it would suck for you to pay off the student loan, then later have to go into debt at a higher rate because, for example, you couldn't meet a 20% down payment for a house. You can always pay the loan off later, when you're a bit more established.

You don't sound like the type to run up credit card debt either, so it's not like you can't trust yourself to be responsible with the money. Either way, good luck and congrats on your settlement.
posted by txvtchick at 11:27 AM on May 20, 2009 [1 favorite]

Do you qualify for a tax deduction on your student loan payments? Don't forget to factor that in.

Since this is all the money you have, I think paying off your student loans with it is not a good idea. You never know when something will happen where you need money, such as getting laid off etc. You want a little cushion. Even if you could maximize your long term wealth by paying off the loan, I wouldn't give up the cushion.
posted by caddis at 11:42 AM on May 20, 2009

I don't know if you also live in Asheville NC but yes, 5% interest at a local bank. Check in out mefites. Asheville Savings Banks.here's the link
posted by Rocket26 at 11:48 AM on May 20, 2009

If it's a question of paying off the loan or investing it and trying to turn a profit, I'd tend to agree with the majority here: pay off the loan. Unless you want to invest in something pretty damn risky, like stocks these days, the only financial products available pay 1-3% tops. Some CDs are as low as 0.5%.

But there's something else you might want to consider, which txvchick hints at: this is a big chunk of change. As in it will probably take you years to assemble this much cash all at once again. It might be worth considering whether you want to use that to do something like make a down payment on a house, replace your aging car, etc., things which require significant amounts of simultaneous capital. So yeah, paying off the loan might technically be the way to maximize the number of dollars you get from this settlement in the long run, but money basically exists to be spent, either now or later, so consider whether there is some long-term type purchase you might make with it.

This thinking doesn't only apply to really big ticket items either. It's expensive to be poor, and you might use this money to establish yourself so that you can avoid the kind of expenses ironically associated with having no money. Clothes may seem a trivial thing upon which to spend money, but a quality suit can last for years. Same goes for shoes/boots, etc. None of these things will give you an actual return, but all of them can represent significant savings down the road. You've now got the money to institute some of those kinds of changes. Hell, most banks offer extra free services if you maintain a sufficient monthly balance.

I'm facing a similar situation myself. I've recently come to a sum of money similar in scale to yours, and though I'm putting most of it towards my educational debt (which is far higher than yours, unfortunately), I'm keeping a little of it back to furnish my apartment (new job, I've got no furniture right now, etc.). My thinking is that I could spend a decent amount of money on nice furniture now, or half as much at a thrift store and then replace it over time. Ultimately, I realized that that would wind up being more expensive in the long run, so I'm getting the good stuff now while I've got the money.
posted by valkyryn at 12:06 PM on May 20, 2009

I vote for paying off the loan, but not because it will save you money, which it may or may not do. (But probably will.) The big advantage is that you would be debt free, and when you say you have $20K in the bank, that's exactly what you have! Not 20K minus 10K in the small print because you owe somebody some money that you should really get paid off as soon as possible. You don't have to worry about Yet Another Monthly payment. You'll have more freedom and piece of mind being out from underneath your debt. You get to have an excuse to throw a "I've paid off my college loans" party. You don't have to worry about losing your job and defaulting on your loan. Sure, college loans are low interest, but most can't be discharged by bankruptcy. (Not that you'll go bankrupt, but you never know. No reason to keep this albatross around you neck just in case.) And you get to decide exactly what to do with all of that money in the bank, not just the part you don't owe to someone. Your budgeting becomes easier when you don't have to add in that $XXXX for debt every month...

(And so on, and on.)
posted by Ookseer at 12:25 PM on May 20, 2009

There are many variables, as indicated up-thread. However, when I was in a similar scenario to you (in a different economic climate, however, YMMV), I did NOT pay back the loan, and this was the deciding factor in being able to buy my current house. In my scenario, the difference in interest rates was the way I approached this. I used the revenue from the cash to pay the loan. It sometimes makes sense, but it's not clear to me that it makes sense in your case, in this economic climate.
posted by kch at 12:32 PM on May 20, 2009

I'm just going to chime in and disagree again. The "freedom and peace of mind" of being debt free isn't that great when you're talking about the super-low interest student loans that people often get. Federal student loans are really, really cheap.

On the other hand, suppose, as other people mentioned, you have some kind of emergency that requires a lot of cash. If you pay back the debt and no longer have the cash, you'd have to go back into debt again to pay it off, and you would need to do it at a much higher interest rate.

Having money in the bank also yields "freedom and peace of mind"
posted by delmoi at 12:36 PM on May 20, 2009

I'm putting every extra cent I have to paying off my student loans. Financially, it probably makes a little more sense (but not much) investing it, but my total loan amount is so high, that I have very few career choices until this is taken care of. In five years, I'd really like to become either a mailman or a hobo.
posted by Slarty Bartfast at 12:48 PM on May 20, 2009

What emergencies are people going to deal with where having 20K free wouldn't cut it, but 30K free would? Fear of the $30,000 disaster doesn't seem like a good reason not to pay the loan off.
posted by chunking express at 12:56 PM on May 20, 2009

1) Pay off the loan because it'll make you feel better.

2) Start (and max out) a Roth IRA (with the $$ invested in an index fund, esp. if you're under 30).

3) Keep a $5000 emergency fund in high-yield savings, if you can find one. 6-month CDs might be better, if not (not as liquid, obviously).

4) Fix your living situation, if need be (ex.: If you're in an area without job prospects, move someplace better; If you have a long commute to work, move closer; Offer to pay your rent 2-years in advance in exchange for a discount; etc.)
posted by coolguymichael at 1:10 PM on May 20, 2009

Does paying the loan off according to the schedule vs. as a lump sum have some benefits in establishing a credit rating? A good credit rating may have some real benefits in its own right, and increasingly so in the post-easy-credit world.
posted by Rumple at 1:13 PM on May 20, 2009

I help people make these decisions for a living, but I am not your settlement consultant.

One issue to consider is *what kind of settlement* this is, because that affects how you will get taxed on it. Another to consider is whether the $25k is your net take, or whether attorney fees, case expenses, any liens, fees, etc. will reduce the net amount.

I can't help you much without knowing the answers to these questions, but feel free to MeMail or GMAIL me. Unfortunately, none of the answers above take into account any specific tax ramifications of the settlement, nor any tax planning/tax-free investment/tax offsets available.

Overall, use the best tax planning possible, invest the funds at a return higher than the student debt (pay minimum monthly payments), give NO MONEY to the relatives/friends who start knocking on your door with great real estate or business investment schemes, and keep a balance between liquid/illiquid savings.
posted by bunnycup at 1:31 PM on May 20, 2009

Pay off the loan.

I asked a similar question of someone who was a day trader once, and he had a very good point -- interest rates on most loans was probably more than interest rates on any savings account I'd ever find. No matter how good the interest rate on any savings account was, it would never be good enough to make back the money that I'd be paying out through a loan's interest. So paying off the loan all at once would mean that I'd get a much better rate of return -- because the interest rate on the loan was higher.
posted by EmpressCallipygos at 2:34 PM on May 20, 2009

chunking express, bad stuff doesn't usually happen just by itself, especially for people living hand to mouth. For example: you get in an auto accident (repair/replace car $). Because of that, you have to go in the hospital (assorted medical bills $). Because of that, you lose your job (lost income $ and job search $).

Alternatively, $30k compounds a lot quicker than $20k:

Future value of $30,000 @ 5% for five years: $38,288.45
Future value of $20,000 @ 5% for five years: $25,525.63

Future value of $30,000 @ 5% for ten years: $48,866.84
Future value of $20,000 @ 5% for ten years: $32,577.89

In order for $20k to get the same ten year return as $30k, you'd need 9.34% annual rate of return on that $20k. Depending on the terms of OP's loan, from a strictly financial point of view the "correct" answer could go either way.

But really it's more a matter of other opportunity costs than anything else, and right now OP doesn't know what those opportunities are. Until he (she?) is a bit more stable, I think he'd be better off keeping his options open.
posted by txvtchick at 3:08 PM on May 20, 2009

Listen to the people who tell you to run the numbers. It's generally not wise to make financial decisions based on what feels good. Not all debt is bad. Just stupid, unmanagable debt.
posted by gjc at 6:22 PM on May 20, 2009 [1 favorite]

It's true that low interest loans with tax benefits are not the worse thing in the world. That said, the feeling you get when you pay off your student loans is hard to quantify in a spreadsheet. And that should count for something.
posted by chunking express at 6:35 AM on May 21, 2009

I wouldn't pay off the debt if you're planning to buy a house anytime soon and if your interest rates are lower than the going rates for mortgages.
posted by salvia at 5:51 PM on May 21, 2009

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