1.85% on 45k student loan - just pay the minimum?
April 11, 2014 11:06 AM   Subscribe

So, I'm selling my house and will have some extra cash, finally. I have a consolidated student loan that after years of steady payments, has come down to a very low 1.85% interest rate. Given the current economic conditions, and an intense desire to have my money work hard for me after years of being in the doldrums, should I up the payment and try to save a tiny bit on interest? Or would it be better to stuff my IRA, or put money into a no-load fund or index?

I'm not at all a seasoned investor, and am having some health problems (brain fog/fatigue), so the more simple and straightforward approach to dealing with my house sale proceeds, the better. I do have a little pipe dream: take some of the money from the house sale, sell off all my possessions, and just wander around, taking odd jobs...is that crazy?
posted by ihavequestions to Work & Money (12 answers total) 2 users marked this as a favorite
I would pay the minimum on the student loans until they are paid off. Advice will vary on what to do with a pile of cash, but low-cost index funds are a popular choice.
posted by deadweightloss at 11:09 AM on April 11, 2014 [2 favorites]

Student loan interest is generally deductible up to $2500 which will be a factor here that doesn't apply to most other loans.
posted by holgate at 11:12 AM on April 11, 2014 [1 favorite]

FYI, if you're not paying the minimum on your student loans, the servicing agency is still calculating your interest as if you are, which means you're paying too much interest. So if you do end up paying down the loan faster, you have to write to them to request reimbursement of the interest the've been collecting. They won't give it to you automatically (because they're horrible, yes).

You know you can follow that pipe dream to some degree without compromising the rest of your life, right? Why not take a little bit of that money and spend the summer traveling? Or move to a new town for a few months and explore. Or spend the summer somewhere inexpensive, like Thailand or Peru. Seriously, if you're old enough to have owned a house yet haven't spent some time wandering, exploring a new place in wide-eyed wonderment, you really ought to give yourself the chance to do it! It can be far more valuable than the several thousand dollars (possibly less if you're able to be very frugal, more if you like things fancy) it'll cost to get there and cover your basic needs.
posted by tapir-whorf at 11:29 AM on April 11, 2014 [3 favorites]

A lot of this will come down to your preferences. I'm debt-averse, so I paid my student loans of years ahead of time, but my interest rate was much higher than 1.85%.

It also depends on the amount of money we're talking about here and your overall financial position. If we're talking about $10k in loans, and your savings/proceeds from your house is a lot more than that, and you have good job security, than I would say pay off the loans, because while 1.85% is a low interest rate, it's still higher than what you'd earn by having that money sit in a savings account.

But if on the other hand the loan amount is a high percentage of your savings/liquid assets and/or you feel you have a non-negligible chance of needing your rainy-day fund (job loss, illness), than I would pay off the loans over time by paying the minimum or slightly more.

Edit: I see that you specified the loan amount at $45k. I would probably pay that off over a longish period of time unless your liquid assests are several times that.
posted by Asparagus at 11:37 AM on April 11, 2014

Will you be taxed differently if you don't roll this into a new house?
posted by tilde at 11:44 AM on April 11, 2014

Well, think of it from the reverse angle. If someone offered to loan you money at that rate would you take it? Me, I would borrow as much money as I could get at that rate. Thus, in your case I would not want to pay it back now. I feel fairly confident in being able to get 6% plus in a low risk manner. If you do not feel the same it would make a lot of sense for you to pay off the loan now.
posted by jcworth at 11:54 AM on April 11, 2014 [3 favorites]

Student loan debt can't be discharged in bankruptcy. I'm sure you think that's not a concern, and odds are you are right. However, if something does go horribly wrong in your life and you need to claim bankruptcy, not having those loans hanging over your head even coming out of bankruptcy might be worth a lot more to your mental well-being than anything else you can do with the money.
posted by COD at 11:55 AM on April 11, 2014

Response by poster: Thanks for the answers, all helpful thoughts! Tilde - I'm well under the threshold for capital gains tax on house sale proceeds.

I am interested in minimizing my taxes, since I won't have the mortgage interest/property tax deductions anymore. I was thinking that for that reason alone, I should stuff the IRA to the gills.

I like your thinking tapir-whorf, and a change of pace/scenery/everything is what I really want, when all is said and done. The value of using some of the money for an amazing experience is huge, but at the same time, I'm trying to be (somewhat) responsible about what I'm doing, and see if I can't make that cash really work for me. The student loan is the only debt I have, once mortgage is booted out.

(A bit of back story: house was owned for almost 10 years, and it was a huge emotional and financial sink for about the same amount of time. I'm not underwater, but the difference between what I paid and what I'm getting for the house makes it as if I basically rented for the same amount of time. Also, my job is not particularly stable, and I'm considering making a possibly drastic career change, anyway.)
posted by ihavequestions at 12:10 PM on April 11, 2014

I'd recommend filling your IRA for 2013 at least, since you have until April 15th to do so.
posted by the man of twists and turns at 12:15 PM on April 11, 2014

The first question is just the payments:
The advantage to paying off the loans altogether right this minute is that you then can have lower monthly income because you're not going to be making payments. Since you're interested in becoming semi-nomadic, that might be awesome.
Paying double payments right now so that you owe less later probably doesn't get you anything in these terms; if you pay off $44k of your $45k loans, you still have a payment due next month. (probably; you'd have to check your servicer's terms to see if they'd credit those pre-payments toward future payment schedule)
The main disadvantage is that the money is then gone, and you can't it as a down payment on another house or to pay for unexpected expenses, or to buy groceries when you're unemployed.
The secondary disadvantage is that paying off the loan over time could leave you with money left over.

Then you consider the interest: 1.85% is really low to be paying on a loan - congratulations on that. That means that this year, the amount of interest we're talking about is $832 (and it'll become less per year over time as the principal decreases). You could put your $45k into the best savings account you can find, at about 0.8% interest, automate your payments to student loans, and be effectively cut your interest rate again (1.85-0.8=1.05%), but have access to the remainder of the cash any time you need it. Alternately, you could find an index fund (look for a bank with low fees and a good internet transfer policy, or the whole proposal loses steam; I like Vanguard) that on average yields 4-5% per year. So in 12 months, your $45k would become $47025, except you'd be pulling out 12 months of loan payments, $832 of which would be interest paid. But you'd be net ~$1200 in interest gains as compared to just paying the loans off right this minute and never worrying about it again. Assuming the stock market cooperates and gives you 4-5%, and assuming you've successfully automated transfers from the fund to your bank account and from your bank account to the loan servicer. Basically, if you have the mental energy to set this up right now, you'll be able to basically ignore it for years until the loan is paid off, and you'll mysteriously still have a mutual fund worth several thousand dollars, even though you only set aside the $45k loan value, and you've been paying interest to the loan guys the whole time.

(alternately consider spending $3000 in Thailand, putting $42k into the fund to pay off the loans, and having that miraculously be enough)
posted by aimedwander at 1:01 PM on April 11, 2014 [1 favorite]

How secure is your job? How big is your emergency fund? If there's a chance you could be unemployed, increasing your emergency fund set aside that will let you keep paying your expenses, including student loans, is a good idea.

If you already have a good emergency fund and are secure in your job so you can keep paying your student loans, I would suggest using the extra money to max out your IRA. 1.85% is just so low - and it's effectively even a bit lower with the tax deduction - that you could financially benefit a lot more but investing the money and letting it grow for your retirement.
posted by medusa at 3:25 PM on April 11, 2014

If you didn't have the cash or the debt, would you borrow it?

Pay off the debt, and enjoy your debt free existence, unless you'll need cash for a down payment for a new (which you can't borrow).
posted by bensherman at 5:58 PM on April 11, 2014

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