Should I pay off my student loans in full now while I have the cash to do so?
May 6, 2010 8:36 AM   Subscribe

Should I pay off my student loans in full now while I have the cash to do so? Are there any potential downsides to doing this?

I have $9000 in student loan debt in two Stafford unsubsidized loans ( $3000 in one and $6000 in the other). I have saved $20,000 in cash, currently sitting in a money market account. I carry no credit card balances and have no other debt. I invest 15% of my income in my 401k and 10% of my income in the stock market. My monthly living expenses are about $3300. I'm looking to buy a house in the next few years, so I'm saving money for a down payment.

I checked my credit score lately (732) and although I have 7 years of perfect payment history, it appears that my debt to credit ratio of 111% on the student loan may be affecting my score negatively. I cannot deduct the student loan interest according to [http://www.irs.gov/taxtopics/tc456.html] because I make over $70,000 a year. I'd like to improve my credit score now before I get into the mortgage game, and I don't like carrying debt in general. Any recommendations would be greatly appreciated.
posted by jjno to Work & Money (25 answers total) 2 users marked this as a favorite
 
If you don't like carrying debt, and you have the money, and you're not worried about losing your job before you can replenish your savings, I say go for it. There's no reason to hang on to the debt.
posted by shamash at 8:42 AM on May 6, 2010 [1 favorite]


If you are as frugal as your financial habits imply, you will easily be able to re-save the down payment and seed money for your house purchase over the next few years. Given that paying off these loans will not deplete your savings, I would say go for it. You have no tax advantage for staying in this kind of debt, so I'd say wipe it out and keep on saving.
posted by litnerd at 8:48 AM on May 6, 2010


it appears that my debt to credit ratio of 111% on the student loan may be affecting my score negatively

I don't know why you are assuming this, but with a sizable downpayment and stable income (and credit rating of 732!) I would think you should have no problem getting a mortgage with decent rates "in the next few years".

Mint.com (for example) considers anything over 720 "Excellent". I think you're worrying for no reason.

IANA Mortgage broker, banker or anything relevant, but I do have a mortgage.
posted by pkphy39 at 8:48 AM on May 6, 2010


Yes! Be debt free!
posted by MsKim at 8:57 AM on May 6, 2010 [2 favorites]


Unless you have your money invested in something that is growing faster than the interest rate you are paying on your unsubsidized loans, pay it off!

Being debt-free is a fabulous thing.
posted by ambrosia at 9:01 AM on May 6, 2010


We did this a few years ago, when our money was earning 5% (!) in an online savings account. It was a net money loser for us given that our loans were consolidated at 3%, but it was still totally worth it.

I would suggest that after you pay it off, you temporarily divert some of your 10% in the stock market to building up a savings/rainy day cushion. A general rule of thumb is to target 6 months worth of living expenses; if you are in a job that is anything but solid, 9-12 would be even better.
posted by Duluth?! I Hardly Know Her! at 9:03 AM on May 6, 2010


Honestly, you're doing better than me financially so I might not be the best source of advice for this, but I'd say hold on to your cash.

A score of 732 is not bad at all (according to this site you're just 30 points away from the best rates which are in the range of 760-850), but if you want to improve it, I'd suggest getting a line of credit (i.e., a credit card) instead of paying off your student loan. That would increase your credit-to-debt ratio -- with a salary of 70k and a credit score of 730 you'll probably start out with a credit limit of 5k-10k at least, and that will go up quickly (indeed, it's often as simple as calling them up and asking them to raise your credit limit).

The main reason I'm suggesting this is that the amount of cash you bring to the table when securing the mortgage is a much bigger deal than your credit score. If you pay off your loan you're effectively halving the amount of cash you have for downpayment (I know you're planning on saving more money, but let's say that you save 10k over the next year. Well, you're still cutting your cash by about a third). I can't see any situation where the bump in your score from no student loan debt exceeds the benefit you get from an addition $9k in cold hard cash.

Also, let's say something bad happens. It probably won't, but if it does you'll be glad you had that extra money lying around.
posted by Deathalicious at 9:10 AM on May 6, 2010 [1 favorite]


I know being debt free is great, but will paying these off adversely affect my credit score or credit report in any way? My experience so far has been that nothing is easy, intuitive or simple with the credit reporting agencies, and I'm not content with a credit score that's only at the 66th percentile, no matter whether it's termed "excellent" or not.

This article claims that paying off my student loan in advance will lower my credit score. Is there any truth to this?
http://ezinearticles.com/?How-Student-Loans-Lower-Your-Credit-Score&id=4022061
posted by jjno at 9:10 AM on May 6, 2010


Also, if and when you do get a nice mortgage, I still wouldn't pay off the student loans. Instead, use the money to pay off the house. Send extra checks to the bank with instructions that they should be applied towards the principal (I believe you should be able to do this without penalty). Reducing the debt on your home is way, way better than reducing the debt on your student loan.
posted by Deathalicious at 9:13 AM on May 6, 2010


I don't have all the nitty-gritty details of credit score analysis (Clark Howard would be a better source for that), but I paid off my (small) student loans in full as soon as they started bearing interest, and my credit score never suffered. History of good payment on student loans is a good thing, but I don't see ridding yourself of the debt reflecting negatively on your credit score. If you're concerned about your debt-to-credit ratio, ask your credit cards for an increase in your credit line.
posted by litnerd at 9:16 AM on May 6, 2010


I think it depends on how risk adverse you are.

I am fairly risk adverse, so I would pay off my loans first. You said you make over 70k, so you therefore have no tax benefit for keeping the loan on your books. I would also note that student loans are not generally dischargable in bankruptcy, so if for some reason you were to have hard times, you could not get the loans wiped absent some undue hardship. If you got rid of the loans now, you would also likely save yourself several thousand dollars in interest.


But if you have a low interest rate (what are stafford loans at these days? 7.5%? Lower if you got them earlier?), and aren't risk adverse, you could invest your current savings in something with a higher return and make more money this way. I.e. if you thought you could get a 10% ROI by investing in stocks over the same period you would pay off the loan, and your loans are 7.5%, you would net an extra 2.5% by investing in stocks.

If it were me, and I was considering taking on considerable debt in the future (buying a house), I would just pay off the loans now for a lower overall debt-load. It sounds like you are pretty frugal, and could probably save up the money once again quickly. But its really just about how much debt you feel comfortable with.
posted by HabeasCorpus at 9:17 AM on May 6, 2010 [1 favorite]


First of all pat yourself on the back/thank your lucky stars that you are in a way better financial position than most people, and remember that spending less than your income is the key to being financially stable. For the loan situation, here are the pros and cons of paying it off as far as I can tell:

Pros:
- Saved money in interest over the life of your loan.
- One less monthly expense. You can save more money every month (as long as you don't start spending more), and when you apply for a loan you will have more room between your monthly income and monthly expenses.
- No risk of missing a payment accidently or otherwise taking a hit to your credit because of this loan.
- Less debt on your credit report, as you mentioned.

Cons:
- Less money on hand in cash. You have around 6 months of expenses saved now, this would drop it down to closer to 3. Still not bad but something to think about.
- Opportunity cost of investing or earning interest from the money. Since interest rates are so low right now and you can't deduct the interest, this isn't that bad though, you're probably saving more by getting rid of the debt than you would by keeping it and earning interest.
- Less credit history building up. Every month you stay current on your loan, you increase your average account length and get another positive mark on your credit history, so closing an account or paying off a debt can slightly reduce your score.

Personally I would pay off the debt. You'll probably save more money in the long run, and although there are risks with both, the risk with paying it off will probably only be temporary until you build up more savings. If money market rates were great right now it would be a tougher question, but right now that cash isn't doing much for you. One thing you could ask yourself is, "If I was debt-free right now, would I take out a loan for $9,000 with these terms and just leave it sitting in the bank?"

Also, a couple of random tips. You mention that you put 10% into the market every month. Hopefully you are doing that through some sort of low-cost fund, because if you are doing individual orders you are going to be losing most of your earnings in fees. If you don't already have a Roth IRA and are not above the income limits, you should open one and max it out, so that you can invest tax-free but still have access to your contributions at any time. And if you don't already have a credit card or two, get one without an annual fee and never carry a balance on it. That will help you continue to establish your credit history in the years leading up to buying a house, even though it won't be costing you anything.
posted by burnmp3s at 9:20 AM on May 6, 2010 [1 favorite]


It's possible that continuing to make payments between now and when you plan to apply to the mortgage could help your score because it would give you a few more years of payment history. (It's only bad credit history that drops off after 7 years -- good credit history is forever.) But you'll have to weigh the value of that potential benefit against the interest rate you're paying now. If you want to both reduce your interest expense and benefit from a few more years of payment history, you could pay off most of the loan now but leave a big enough balance so that you're still paying the minimum $50/month for a few more years.

Also, if you really are going to wait a few years, it might also help your score to open a couple of no-annual-fee credit cards and set up some of your small monthly bills to auto-pay to the cards and then have your cards auto-pay in full every month. My understanding is the optimal number of open credit cards is 4-6 and the optimal utilization is greater than 0% but less than 10%. But if you open any new accounts, do it ASAP so that they've aged a few years before you apply for the mortgage.

Caveat: FICO score formulas are constantly being tweaked, so make sure that you have current information before you do anything major. Your Credit Score, Your Money & What's at Stake (2009) is a terrific book that is well-worth the investment of money and time to buy and read, and the folks in the CreditBoards.com forums are pretty good at keeping up on any new changes.
posted by Jacqueline at 9:27 AM on May 6, 2010


Fairly OT, but please don't be paying attention to ezinearticles.com. That site blows - it's only a bunch of advertorials. I'm not just talking a grain of salt, I'm saying don't eat there.

Kudos on your planning and saving skills. Cheers!
posted by mondaygreens at 9:31 AM on May 6, 2010


Up there, burnmp3s gave some great advice. While you probably don't need more than that, I wanted to give you a personal anecdote.

I finished paying off my student loans a couple of years ago when I had a cash windfall (inheritance). I paid them off in one fell swoop, leaving me debt-free in my mid-20's. As a result, the following things happened:

- My credit score didn't go up for a while, but I called up all of my credit cards to tell them the good news, and they all offered to raise my limit. I took one up on my offer, and now have an "emergency" card with a large limit on it, in case of unmitigated disaster. I hope never to use it, but it's comforting to know that I have it. Also, many cards offered to "bonus" me, meaning I got the gold where I was a silver before, and some extra perks for no additional cash layout. The concierge service is great!

- I bought my first home last year, and since I had no other debt, I got a very favorable mortgage rate! I was told point-blank by numerous mortgage brokers that not having any student loans or other debt was a big deal to lenders right now. I was considered a "low-risk" borrower and I was at the head of the negotiating table. It was incredibly empowering.

- My credit score did go up, but it took about a year for it to trickle "down." I went up around 30 points, which put me over 800. I felt like I won at life! As you probably already know, it feels really good to not have debt. It's worth celebrating.

- Ezinearticles.com is a site which aggregates non-checked advice, paying the lowest bidder. Don't rely on it as a source.
posted by juniperesque at 9:36 AM on May 6, 2010 [1 favorite]


I am planning to pay of my student loans like a maniac (I'm still in grace period as I write my thesis). I will pay off nearly $20,000 in two years if all goes according to plan.

I can see no reason to hang on to the loans. It won't help my credit score (also over 720) enough to keep paying interest on them. It's one more bill to keep track of every month. It's one more thing to worry about in case of layoffs, or extended illness, or just wanting to quit life and move to an island somewhere. If you pay off your loans in full, you will still have substantial savings (most American families don't even have one month's expenses in the bank) so it's not like you'll be putting yourself in a dangerous situation of being cash-poor.

If you really feel that you need to keep paying on them to extend your credit history, maybe pay off half or three-quarters in one payment, (focusing on the highest interest rate, if there's a difference or maybe just paying off the $6,000 loan entirely) and then pay the minimum payment on the rest until it's paid off. You'd have the benefit of not having to pay back as much interest while extending your payments over time.

Like I said, I'd still vote for pay them off and be totally debt free, but this middle option doesn't seem to have been presented yet.
posted by peanut_mcgillicuty at 10:03 AM on May 6, 2010


A 732 is a fine score.

According to FICO the median score is 723. You can also look at how a higher score would impact your mortgage options. According th FICO estimates, if you could move you score up 28 points, you could lower your interest rate about .222%.

I'd pay off the loan, but not because it might help your credit score. I'd pay it off because you'd lower your monthly debt load. That's a nice hedge against losing a job/financial risk since you'll have cut out a chunk of you monthly expenses. Having healthy savings is also a nice hedge, but I'm a big fan of being unencumbered by debt.
posted by 26.2 at 10:04 AM on May 6, 2010


Also, you say you're not content being in the 66th percentile, even if it's considered excellent. Keep in mind that the way your credit score is calculated is not a logical formula, and that most people with excellent financial habits (those who save up and pay cash, don't use credit for living expenses, pay their credit cards off every month, live within their means, etc) have less than ideal credit scores because financial instituations want you to carry debt. With a score that's already considered excellent, there's really no reason to continue playing the game, especially when that game has worked out so well for everyone over the last few years.

If you, like me, are a high achiever and find a good grade or a high score something to strive for, just keep in mind that you can always opt out if the means of getting that recognition require you to do something that doesn't make logical financial sense.
posted by peanut_mcgillicuty at 10:09 AM on May 6, 2010


Is the interest rate on the student loan lower than your expect stock market returns? If yes, then don't pay it off. It's cheap capital.

If no, pay it off immediately with your money market account and divert future stock market investments to the money market account, which I assume you're keeping in cash for a down payment in the near future. Once the money market is back to where it belongs, resume investing in the stock market. You'll still have some market exposure due to your 401k, and you meet your goal of saving for a house while enjoying the best expected rate of return.
posted by jewzilla at 10:19 AM on May 6, 2010


I live debt free 99% of the time. I also watch my over 800 credit score like a hawk. I can tell you, anecdotally of course, that paying that debt off will matter. As little as $1000 in debt makes a difference these days to my score and I earn a very nice income.

This is a perfect question for Suze Orman's show and as a regular watcher I'd be willing to lay odds that she'd tell you to pay it off. Why? Because you *never* know what will happen. If you should lose that job and start missing payments and the interest starts compounding... ouch. What is the interest rate now? Somewhere around 6 or 7%, yes? That's a fair amount of interest. Get rid of it.
posted by FlamingBore at 10:22 AM on May 6, 2010 [1 favorite]


Ultimately the question comes down to which is more valuable to you: money, or a credit score? It's not hard to imagine a future where your student loan rate is cheaper than the mortgage, and you could have saved a lot of money paying off the mortgage first.

I want to note that being the 'best' at credit ratings means being the best at borrowing money, under a variety of factors. If saving yourself interest impacts your credit rating, then that's to the lender's benefit not yours. A high percentile credit rating means 'most reliable sucker' more than 'great at managing money'. That said:

I have $9000 in student loan debt in two Stafford unsubsidized loans ( $3000 in one and $6000 in the other). I carry no credit card balances and have no other debt... it appears that my debt to credit ratio of 111% on the student loan may be affecting my score negatively.


You have 9k in debt total, and that exceeds your credit limit by 11 percent? Something is fishy here. Maybe it's just amortized interest pushing you over the original loan? If you want to improve that aspect, see if you can open up a no annual fee credit card. Literally freeze it in a block of ice if you're worried about abuse. Even 2k of unused credit will dramatically improve that number, as would paying a few thousand to bring you below your original balances. Doing both would help, and is really not a bad idea from a risk perspective.

As an individual, you're subject to a cash flow constraint: your available cash cannot go below 0. You can't spend money you don't have. To combat the risk that expenses will exceed available cash in a given month, we save. We also borrow, if we expect future income to rise. I don't think debt is a bad thing when used in a premeditated fashion, creepy bible interpretations of slavery be damned.

And having an unused line of credit to tap is pretty handy when you don't want to break a CD or earn a tax penalty. Plus, credit cards have limited fraud liability that your debit card doesn't offer.

P.S. I think that article is not very good. I bet 'reported triplicate' really means reported to all three agencies. Well duh.
posted by pwnguin at 10:30 AM on May 6, 2010 [2 favorites]


I am usually the one advocating people to keep their debt and save some money, for various reasons such as building savings, relative rates of return, etc. In your case you have no issue with saving and your alternative investment opportunities likely pay less than your loan amount so it might make financial sense to pay it off. On the other hand, now is a good time to buy real estate and you will want to have a nice down payment.

If you want to increase your credit score the best thing to do is get some credit cards and pay them on time. Get one with points or cash back and put everything on it. Be careful though that it does not affect your above average ability to save.
posted by caddis at 11:29 AM on May 6, 2010


Lots of good advise here. This is primarily an emotional decision, but the I've often felt the super-rational thing to do is invest in a bond ETF or index fund paying a low risk interest rate, something like Vanguard's Long Term Treasuries or Investment Grade, hopefully through a Roth IRA. Then pay the student loans using that account, arbitraging the difference in interest rates. That's a more risky strategy than paying them off, but less risky than putting it in the stock market.
posted by anotherpanacea at 12:15 PM on May 6, 2010 [1 favorite]


To clear up a few things: I just started paying off the student loan last January, so that's why the debt to credit ratio is 111% (there's accumulated interest). Also, I already have three credit cards which are all four years old or older, of which I only use one (the one with the highest credit limit, longest history and best rewards). The total credit limit on those is $19,000.

Thank you everyone for your input! I'll process it all and let you know what I decide.
posted by jjno at 1:52 PM on May 6, 2010


This is a perfect question for Suze Orman's show and as a regular watcher I'd be willing to lay odds that she'd tell you to pay it off.

Funny, I'd be willing to bet she'd tell you to keep your cash for now. Right now you barely have enough of an emergency fund as she defines it (6-8 months expenses). If you pay that loan in full, cut your emergency fund in half.

I guess it depends on how stable your job is. Can you just pay it a little more aggressively? The student loan shouldn't impact your desire to buy a house unless you are always late or something along those lines.
posted by getawaysticks at 2:38 PM on May 6, 2010


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