Pick One: $2400 saved over 12 months, or $2400 cash gift up front?
November 9, 2010 6:33 PM   Subscribe

MoneyFilter: I have been paying back a loan and will continue paying back for several more years. A birthday gift in this context, has two options: (a) to permit me to cease making payments for one year ($200/mo) and resume payments 1 year from now and each month of this year being marked as paid (a savings of $200/month for 12 months), or (b) be given the equivalent $2400 cash up front.

In that context, would receipt of the up-front gift NOT appropriately knock off a year total from the loan, so that I would have one less year to pay the loan (and resume paying monthly payments on the regular due date without stopping but with the final payment date down the line being a year sooner), or would that be like receiving the gift twice?

Even if I were simply given an outright gift of $2400, having no bearing on mortgage payments as context, which would be a better choice? Not having to pay for 1 year out of a loan and still be current when the year is completed, or getting an up-front $2400 cash gift? Or is it the same?

(To be technical, the actual loan payment is $199.49/mo, and the actual offered gift is $2400, a difference of $0.51/mo, or $6.12 more if given up front).
posted by Quarter Pincher to Work & Money (18 answers total)
Does this loan charge interest?
posted by birdherder at 6:41 PM on November 9, 2010

If you can apply the full amount in one lump sum against the loan, but continue paying each month until it's paid off (don't take a break) the $2400 will save you money. This is because you are knocking that amount of the principal, which means that you will reduce the amount of interest paid over the life of the loan. The result is that paying of $2400 of the loan now will save you more than a year of payments at the end of the loan.
posted by Simon Barclay at 6:44 PM on November 9, 2010

If the loan interest rate is higher than what you could expect from investing that money, then use it to pay down the principal of your loan and continue to make monthly payments as usual. If you could get a higher return by investing it, then do so and continue to make minimum monthly payments.

Basically, unless the peace of mind you get from not having to make payments for one year is really of great value to you, you should keep paying off your debt and not make advance payments.
posted by holterbarbour at 6:45 PM on November 9, 2010

Do you have any other outstanding debts that charge interest?
posted by salvia at 6:45 PM on November 9, 2010

Money now is worth more than money later. Even just using 3% inflation, 12 $200 payments is only worth $2,361.45 today.

Take the $2,400 now, invest it in something liquid and conservative like a money market fund and keep making payments on the loan.

If I knew the terms of your loan (interest rate, current balance, remaining term) I could tell you what the impact of the two options is on your loan in terms of dollars saved.
posted by VTX at 6:51 PM on November 9, 2010

This question cannot be reasonably answered without considering your entire portfolio of debt, any investment options open to you, and probably also your income and tax status.

That said, ceasing payments for a year is probably the worst way to apply this money.

If you can apply the money to the principal of the loan, then it's simply a matter of determining the highest interest debt you have (this loan, or any other), and applying the money there. Alternatively, apply it to any investment opportunity you believe will return a higher rate than the highest rate on any debt you have (NB: you will have to consider tax implications. I do not know your jurisdiction but, where I am, interest earned is taxable, so paying off debt is almost always more sensible).
posted by pompomtom at 6:55 PM on November 9, 2010 [1 favorite]

I'm a little fuzzy on what you're asking, and without knowing the rate of the loan it's hard to give you a number. But it would almost certainly be better to receive $2,400 up front and use it all as a payment on the principal of the loan, since it will reduce the total interest you'll end up paying.

If you had $10,000 in debt on a 4% APR loan and you pay $200/mo, it would take 4 years 8 months to pay it off. But if you made one extra monthly payment of $2,400, then reverted to the minimum $200/mo after that, you would be debt-free in only 3 years 7 months. So you end up saving more than a year (around a year and a month in this scenario) by paying for a year up front. Plus, you know, you don't have the debt hanging over you for as long. If your debt is larger or the APR is higher, the savings are even more dramatic thanks to the evil magic of compound interest: changing the debt to $20,000 at the same APR but keeping everything else the same (including the lump sum amount), you would end up with 6 months for free. So your gift would essentially be worth $3,600 (you save $1,200 over the scenario where you spread it out).

You might want to play around with this debt planner: http://cgi.money.cnn.com/tools/debtplanner/debtplanner.jsp
posted by en forme de poire at 7:03 PM on November 9, 2010

Response by poster: The loan does charge interest, and the payments being made $200/mo include payments to the principal and to the interest both, combined.
posted by Quarter Pincher at 7:04 PM on November 9, 2010

Response by poster: For the sake of reducing variables, there are no other debts, and neither the saved $200/mo nor the up-front sum will be used toward the loan.
posted by Quarter Pincher at 7:09 PM on November 9, 2010

Response by poster: That is, each of the twelve months that $200 of funds not applied to the loan (but each month still counted as if paid, per the gift) will be applied to other monthly bills unrelated to loans.
posted by Quarter Pincher at 7:14 PM on November 9, 2010

Response by poster: Assume the up-front lump would be spent on bills that do not accrue interest and could be paid either at length (by saving $200/mo to be therefore applied, or by lump $2400, without penalty for either option).

I'm trying to focus on whether -- being able to not-pay for 12 months (but each month being credited as if they were paid and remain current, so that when resuming a year from now, I would resume making payments -- is or isn't better than just getting $2400 up front.

If I went with the first option, the total number of months I will have to pay is reduced by 12, although the final payment date remains the same (in 2016, say). Would receiving the $2400 up front also warrant knocking off 12 months (so that the 2016 date for the final payment, instead, be 2015) or would that be like "getting $2400 twice" ?
posted by Quarter Pincher at 7:30 PM on November 9, 2010

Would receiving the $2400 up front also warrant knocking off 12 months (so that the 2016 date for the final payment, instead, be 2015) or would that be like "getting $2400 twice"?

It's double counting. All that the up front gift means is that you now have the $2400 for this year's payments all at once... those payments still have to come from somewhere. But if you were to use the $2400 as a lump-sum loan payment, then you'd finish at least a year early (and probably even earlier! see above).
posted by en forme de poire at 7:37 PM on November 9, 2010

Another option would be to take the lump sum and split it 50-50. Use $1200 to pay down part of the loan principal, then use the rest to make the next 6 months' worth of payments. You would then get half a year of not making payments, plus you would finish six months ahead of schedule, and you would still save some money on the total interest paid (you would get around ~$80 "for free" in the $10K/4% scenario I mentioned).
posted by en forme de poire at 7:45 PM on November 9, 2010

Between the two, you're better off taking the $2,400 even if no other variables are counted. Furthermore, if you have any other debt that charges interest, you're even more better off taking at least some but preferably all of the $2,400 and using it to pay down the principle on that debt.
posted by VTX at 7:55 PM on November 9, 2010

Take the $2400 now. Think of it this way: you pay $200 per month, no matter what. You can take $2400 now and pay $200 per month or you can take $200 every month and pay $200 every month. Of course, you are better off to take the money sooner rather than later. If you take the money now, you can put it in a savings account and earn interest on the balance as it declines (which will be roughly $20 if you have a good savings account).

Assume the up-front lump would be spent on bills that do not accrue interest

But if I understand correctly, you won't be earning (or saving) any interest on this amount, in which case it does not matter.
posted by ssg at 8:06 PM on November 9, 2010

In the context I'm reading into it, it sounds like maybe the person giving the gift is the same person to whom you are making the payments?
In any case, it doesn't sound like receiving the up-front gift would remove your obligation to keep making monthly payments for a year. It's basically the same gift either way- something to the tune of 'I'm going to give you $2400 this year to spend on whatever you want'. You're either getting $2400 now or $200 each month.
If you took the $2400 and applied it directly to the outstanding debt, then it's more of 'I'm going to pay/forgive the last year of your loan'.

In that context, or in any other context, I'd vote for taking the $2400 lump sum.
By the numbers, it's a better deal because you could put it in the bank and earn some interest on it, and maybe be a few bucks ahead at the end of the year.
As a practical matter, if you take the lump sum, you can spend it all on something cool (if you want). If you take the $200 a month, you'll just get used to spending $200 more every month - and it's gonna be more painful when next year rolls around and you're taking what amounts to a $200/mo pay cut. ymmv of course
posted by itheearl at 8:21 PM on November 9, 2010

It doesn't sound like paying the loan early to reduce principal and thus save interest is an option (private party loan where those calculations would be too much trouble?). So, there isn't a significant financial benefit either way, and whether one is better than the other would depend on your personality.

1. You're in the habit of paying that $200 now. If you're like most people, when you suddenly don't have to pay $200, you'll find other things to spend that $200 on. Then, a year from now when you resume payments, it may feel like an additional burden. Given that, you may prefer to take the lump sum now which will give you a big boost while you continue to meet your monthly budget.

2. With a lump sum, you get 1 gift and forget about it soon. With the monthly debt forgiveness, you get 12 smaller gifts that may extend your good feelings throughout the year.

One isn't better than the other objectively, so subjectively, which sounds better to you?
posted by willnot at 10:31 PM on November 9, 2010

I'd take the lump sum - for a lot of the good reasons set forth. Both the ones that make financial sense, but also because I don't like the idea of getting out of the habit of paying that $200/month and then having to resume it after a year.
posted by mrs. taters at 6:05 AM on November 10, 2010

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