Debt-free's the way to be
January 18, 2012 10:19 AM   Subscribe

I'm trying to get serious about paying down my student loans and car loans, but I'm not quite sure where to start.

These are the balances on my loans

1) Car loan: $4600, 11% interest, minimum monthly payment $78
(I'm currently paying $200/month)

2) Subsidized Undergraduate loans: $6490, 6.5% interest & $2625 @ 1.51% interest
(no minimum payment due on loans, currently in deferment)

3) Unsubsidized Undergraduate loan: $2773 @ 1.51% interest

4) Subsidized Graduate loans: $5968 @ 6.5%

I am currently halfway through grad school, so my student loans are in deferment and will be until December 2013.

I'm able to contribute approximately $400/month to my debts and I'm also getting a $2000 tax refund this year (and plan to continue receiving at least that much, if not more, every year). My job also reimburses me for a portion of my graduate tuition (so in reality, that $5968 loan will actually be closer to $2400 once I receive my reimbursement check).

My original plan was to pay $400/month on my car, as well as devoting my entire refund to that as well, and then work on my student loans, but now I'm thinking it might be better to use my refund on my student loans while they're in deferment so that once interest starts accruing after I graduate, the total principal balance will be smaller.

My goal is to be debt-free no later than December 2015, but hopefully sooner than that.

Based on all of this information....
Which debt(s) should I pay down with my tax refund?
Which debt(s) should I pay down with my monthly payments?
posted by chara to Work & Money (17 answers total) 4 users marked this as a favorite
I'd still go for the car loan first and foremost - 11% is a lot. Also, your undergrad loans' interest rate is so low as to almost not exist; the interest that will accrue, once you graduate, will be a lot, lot less than you'll see from your car loan.

Go with your first instinct - nuke the car loan as hard and fast as you can, then move on to the others in order of interest rate.
posted by Tomorrowful at 10:24 AM on January 18, 2012 [3 favorites]

It doesn't sound like cashflow is a problem for you right now, so I think you should go with the cheapest solution. The cheapest solution, in the long term, will be to go from highest interest to lowest interest. At 11% interest you should absolutely pay off you car ASAP. This means your tax refund plus everything extra.

After that, pay off whatever graduate loans you have left (at 6.5%).

I don't really know if it's better to pay off your unsubsidized loan or the loan in deferment with a higher interest rate. I would probably still go with the highest interest rate.

(Also, a $2000 tax refund is pretty big - can you change your W4 witholding election so that you get a little more each paycheck and a smaller refund? Then you can use that money to pay off loans faster throughout the year, which saves you even more money in the long run due to compound interest)
posted by muddgirl at 10:26 AM on January 18, 2012

I agree with Tomorrowful - I'd finish the car loan then work on the $6490 from undergrad.
posted by brilliantine at 10:27 AM on January 18, 2012

Also, on the current (not in deferment) loans you should be making at least the interest payment every month so that you're not growing your debt.
posted by muddgirl at 10:28 AM on January 18, 2012

Simple -- Pay what is producing the most interest now. Focus on one at a time. Absolutely pay off your car loan first.

Then pay the next highest interest (the 6.5% interest ones) -- for these, I would start with the one that has the lowest balance. The fewer bills you have, the better it feels.

Then the 1.5% ones -- again, starting with the lower interest one.
posted by DoubleLune at 10:31 AM on January 18, 2012

I'm also getting a $2000 tax refund this year (and plan to continue receiving at least that much, if not more, every year).

The other advice in the thread is good, highest to lowest interest for your situation, but a tax refund is a free 0% interest loan to the government. Fix your taxes so that you aren't getting this refund, I know it feels good, but you can use the money in the now to pay your debts down faster and accrue less interest.

tl;dr tax refunds might feel good, but the money is always better used in the now for debt or investment rather than at the end of the year.
posted by OnTheLastCastle at 10:34 AM on January 18, 2012 [3 favorites]

Response by poster: Sorry, I should clarify that all student loans are in deferment (no minimum payments are due), but the unsubsidized loan is accruing interest.
posted by chara at 10:34 AM on January 18, 2012

It may be accruing interest, but 1.5% is practically nothing; 11% is tremendous. Think of it this way: Every dollar you put into the car payment is worth many times more than the same dollar put toward the student loans. I'd still strongly recommend paying the minimum/interest-only on all of them except the car loan; with the others in deferment and partially interest free, and the graduate loan's relatively high rate being applied to only a modest amount... well, really, nothing's changed. Throw as much as you can at the car loan, as fast as you can.
posted by Tomorrowful at 10:42 AM on January 18, 2012

In that case, pay the unsubsidized one off once your car loan is paid.
posted by DoubleLune at 10:42 AM on January 18, 2012

I'd probably pay the car first.

You may want to think about putting some $ away monthly into an emergency fund, if you don't have one already and if it makes sense for you- the last thing you want is to have to rely on a credit card if something comes up.

I intellectually grasp the tax refunds are bad argument, but I still like receiving one! That said, at 11% and 6.5%, every dollar extra in taxes during the year is a dollar you could have used to pay one of those loans, so it's like the tax refund is costing you that 11% or 6.5%, so for now I'd probably get my withholding as close as I could.
posted by mrs. taters at 10:54 AM on January 18, 2012

Your first priority and last priority are no-brainers. As everyone else has suggested, you should be throwing as much money as possible at the high-interest car loan. Your last priority is definitely the subsidized low-interest loan.

Outside of those two, I think it's a little more open to opinion. However, here's the order in which I'd pay them off:

1. Car loan
2. Subsidized (high-interest) Grad Loan/Subsidized high-interest Undergrad loan
3. Unsubsizized (low-interest) undegrad loan
4. Subsidized low-interest undergrad loan

I think it could reasonably be argued that you should swap #2 and #3, but I think 1.51% is an amazing interest rate and, once we get beyond the recent economic unpleasantness, you may be able to get more than that in a savings account, so I wouldn't be in any great hurry to pay them off. So, pay the minimums for the low-interest loans and take a bite out of your high interest loans ASAP.
posted by Betelgeuse at 11:00 AM on January 18, 2012

The way I like to look at these things is to imagine that instead of paying down $X for a loan at a given interest rate, you are instead investing $X into a savings account at that rate. Financially these two situations are more or less equivalent, at least enough to make these kinds of decisions.

So in this case, you have four savings accounts that you could put your money into: one that pays 11% right now, one that pays 1.51% right now, two that pay 6.5% starting in 2014, and one that will pay 1.51% starting in 2014. So your first choice is pretty obvious, 11% is the highest rate by far, without even taking into account the tax benefits for student loan interest. Money you put in that today will make you 11% starting now. Then it gets slightly trickier, 1.51% is so low that it hardly makes you anything at all compared to 6.5%, but for the 6.5% you don't even start making money from it for two years. You could put your money into the 1.51% account now and start earning money from it, but that money will be locked up later when you would rather use it for the 6.5% loan. On the other hand if you put money into the 6.5% accounts, it will be locked up for two years earning nothing before the interest kicks in.

The best choice for you might be to pay off the 11% loan as soon as possible, then pay the minimum plus a little extra for the 1.51% loan while also saving up money as short term savings. Then in two years when your 6.5% loans kick in, shift as much money as you want from your short term savings into those loans. That way you're not locking in your money with those deferred loans earning you nothing for two years, but you still have the money saved up to pay down your loans if that's what makes sense to do in 2014.
posted by burnmp3s at 11:03 AM on January 18, 2012 [2 favorites]

By the way, if your numbers are correct, you can pay off almost all of your high-interest loans by the time your deferment ends. Then you'll just have the piddling 1.51% interest loans, which you can take a long time to pay off (if the current rate of return of savings accounts rebounds) or pay off more quickly (if interest rates on savings accounts stay low).

On preview: I think burnmp3s suggestion is excellent if you have the willpower to put aside the $400 each month that would have gone to paying off the high-interest subsidized loans. Then, you certainly have more flexibility with the money, can make a little in a savings account, and can always just pay off the 6.5% loans in a lump sum once the interest kicks in. However, some (myself included) feel better seeing that "money due" number go down rather than the "savings" number go up. I know they're totally equivalent in this case, but that's just the way my brain works.
posted by Betelgeuse at 11:10 AM on January 18, 2012

Do you have savings? If I were you, I would worry about how to make ends meet after grad school. I would pay off the car loan (because 11% is pretty high) and then save every other penny. After grad school, if you dont need the savings money, you can use it to pay off most of your loans at once. If you do need the money, you can live on it until you find work.
posted by twblalock at 11:21 AM on January 18, 2012

There are two angles to look at here, your cash-flow and we'll call it "the finances" (the terms are arbitrary and I haven't yet thought of something better for the second concept).

Cash-flow is pretty simple. Can you afford to make those payments? What if something weird happens (a sudden, unexpected expense for example)? It isn't 100% clear from the information provided but it looks like you have an extra $400 each month in addition to the minimum payments on your debt. Assuming that you also have a nice pile of emergency cash (or similar highly liquid asset or even access to a line of credit) on hand and assuming that you'll still be in a similar position when the student loan payments start (IE your income goes up and you still have an extra $400/month) you look fine on cash-flow.

The finances are also pretty simple. Always pay the highest interest rate off first. Always. In fact, you should tweak your W-4 a little bit to get a smaller refund so you'll have $500/month (or so) to put towards your debt. There is no other way in which you pay fewer dollars in interest.

The only time you don't pay the highest interest rate first is if there is a smaller loan with a high payment that puts your cash-flow at risk. If you had another car loan, for example, with a 9% interest rate but a $350/month payment (leaving you with an extra $50/month instead of $400) and the balance was low enough that you could pay it off within a year, you would want to pay that off first to give yourself some breathing room just in case.

The loans you have at 1.51% interest are a different animal. You're actually better off not making extra payments to those accounts since it's lower than the rate of inflation. If, and only if, these loans will stay at that interest rate you're actually better off spending your extra money on durable goods that you have had to buy anyways. The better option is to find CD's or something like a "Stable Bond" mutual fund that will return 2-4% and be very stable (IE, almost no losses ever). You'll earn more interest than you pay and if you paid those off and then something came up (IE you get done with school and need a few months to find a job) and you needed to barrow $5,000 there is no way that you will ever be able to barrow at that rate again.
posted by VTX at 11:25 AM on January 18, 2012

I should add that you dont have much debt (many people pay more for a Camry), and it should be totally manageable without sacrificing other things in life like savings.
posted by twblalock at 11:29 AM on January 18, 2012

I'd consolidate the loans ASAP and get the longest term possible.
posted by just sayin at 2:04 PM on January 18, 2012

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