Should I pay off my student debt in one chunk?
June 7, 2018 7:26 AM   Subscribe

Should I get rid of all my debt and savings in one fell swoop?

I have about $10,000 in student debt that I have been paying off very slowly for the past 3 years at about $85/ month. The interest rate now that I am not in school is 3.95%. I make $45,000 a year before taxes ( in Quebec) and am single. I have a good credit score, but it could be better. I have about $15,000 in my savings account. My rent is $700/ month. I am thinking of trying to buy a condo in the next couple of years. Is it more beneficial for me to pay off all my debt now and continue putting away money every month? (My goal is to put at least $500 into savings every month.) Or should I keep my nest egg and invest it, and continue paying my debt off bit by bit, but possibly at a higher monthly rate?
posted by winterportage to Work & Money (29 answers total)
 
I would definitely keep your nest egg, you just can't predict what life will throw your way! If you are able to increase the number of payments on the debt that might be a nice middle ground.
posted by machinecraig at 7:33 AM on June 7, 2018 [3 favorites]


Traditionally student loan debt is pretty cheap money, though 3.95% isn't that low in the current market (is it?).

Even so, cash on hand wins. I see no compelling reason to pay this off at the expense of 2/3 of your nest egg.
posted by uberchet at 7:41 AM on June 7, 2018


At that low an interest rate, the debt is costing you about $40 a month (assuming that 10K is what you have left to pay). So if you pay $85/month, half of that is going to interest. You definitely want to start paying off faster, but I agree with machinecraig that you shouldn't get rid of your nest egg. On the other hand, there's not a lot of point in trying to save (at 1% interest, maybe) while paying out 4% per month. So I would take that $500 and use it to pay off the loan — it should take less than two years. At the end you'll be debt-free AND still have your nest egg.
posted by ubiquity at 7:41 AM on June 7, 2018 [15 favorites]


don't spend your nest egg.

you get a decent tax break on the interest paid each year towards your student loan debt. you can arrange to pay it off at a faster rate (say $150/month) and that'll get rid of the debt years sooner. make sure you're clear that you want the extra payment applied to the principal otherwise lenders are sometimes intentionally obtuse about what they do with it.
posted by noloveforned at 7:42 AM on June 7, 2018 [1 favorite]


Why in the world would you stay in debt longer? Put that $85 a month you have been paying into your house savings. Ignore all the people encouraging you to stay in debt. They clearly do not understand first step to be financially secure is to not owe money. Also don't invest money you'll need in the short term. Put money in a high interest savings account like synchrony or CDs.
posted by KMoney at 7:43 AM on June 7, 2018 [20 favorites]


I vote with KMoney. Pay it off.

We went through the same analysis when we were young, and wrote a big check to pay off the loans. The delta between potential investment returns for $10,000 (7% is a benchmark, but that's over a long term and your question is more immediate and who knows what the market will do in these weird times) and potential interest rates (4%, and maybe going up) is small enough that you can fairly disregard it. And the psychic benefit of shedding that debt was HUGE.

If you are in a position that you can pay them off, and still have $5000 in the bank and $500/month to save, go for it.
posted by AgentRocket at 7:56 AM on June 7, 2018 [4 favorites]


Response by poster: Forgot to mention I have my savings in a Tax Free Savings Account (TSFA) with no fees and 1.10% interest, in case that changes anything
posted by winterportage at 8:03 AM on June 7, 2018


You need to maintain an emergency fund. With an income of $45K, $15K is probably more than you need. Three months' worth of expenses is a common suggestion, though it really depends on your risk tolerance. But your emergency money should be in a very liquid form, because you need to be able to rely on its being there when you need it, not wiped out in a market crash. Online savings is best. But because the return is relatively low, you shouldn't have money sitting around there beyond what you've calculated is your necessary emergency fund.

You also need to be investing regularly for retirement in a tax-advantaged account like an RRSP or similar--I'm not an expert on Canadian retirement, but I think it's like the U.S. in that you only have the opportunity to invest a certain amount per year pretax. You can never have too much money in retirement, and smaller savings now will have the benefit of growing for years.

When you are going for a mortgage, the lender will include your student loan payments in its calculation of how much you can afford to borrow. Therefore, you will be able to get (and to afford) a better place if your loans are all paid off. Also, it's better to have no debt if you can avoid it, just as a general matter of life flexibility. So if I were you, I'd take the excess of the $15K over what I decided I needed as an emergency fund and put that in a lump sum towards those loans. Then I'd put $375 (out of $500) into an RRSP or similar (check the details on this; as I said, I'm not an expert, you don't want to exceed any yearly limits) and the other $125 towards the loan (make sure to figure out what the requirement is for having the payments applied to principal, not interest) until the loan is gone. Then I'd start saving for a condo. I know this will take a little longer for you to get a condo, but you'll be doing so on a much sounder financial basis.
posted by praemunire at 8:05 AM on June 7, 2018


Response by poster: Oh yeah I have also $1000 in an RRSP right now too.
posted by winterportage at 8:10 AM on June 7, 2018


I sometimes get stuck in decisions like this, where each path seems to have equal pros/cons, and sometimes I just shruggo and split the difference. You could pay off half your loans, have much lower payments for the rest of them, and still keep half your savings. If in six months to a year you feel like you'd rather just pay off the rest, you still have the money.
posted by nakedmolerats at 8:17 AM on June 7, 2018 [6 favorites]


I would pay $5k off and keep $10k as a financial buffer then pay off the rest of the loan at $250+$84 a month with $250 going to savings. You'll pay off your loan and replenish your buffer in under 2 years.

If the choice is between investing and paying off the loan, I'd pay off the loan. Any investment that has a greater payoff than the interest on your loans isn't going to be very liquid - so not great as an emergency fund.
posted by missmagenta at 8:17 AM on June 7, 2018 [8 favorites]


If you put your money into a simple index fund (or whatever), you will outperform %3.95 handily.

Invest the money, use the dividends to pay the loan payment, and make ~6% on top of that.
posted by cmoj at 8:19 AM on June 7, 2018 [3 favorites]


Figure out how much money you need to continue your current lifestyle for six months. Keep that much, and pay down the debt with the rest. Continue paying down the debt as fast as you can without dipping into that six month buffer until the debt is paid off in full.
posted by davejay at 8:25 AM on June 7, 2018 [2 favorites]


They clearly do not understand first step to be financially secure is to not owe money.
Depends on the interest rate you are paying and the rate you can get from your savings. As mentioned above, 4 percent isn't that low but it is probably much lower than the OP would pay on a credit card if they were forced to use one in an emergency. 15K is more than 3 month's living expenses (it is about 4 months of pre-tax salary, but expenses should be less than salary). Maybe it is 6 months of expenses and some people feel more comfortable with that in the bank. I agree with paying a smaller chunk now once you determine your desired emergency fund amount and then paying more on the debt each month.
posted by soelo at 8:29 AM on June 7, 2018 [2 favorites]


In your situation, and just looking at the debt and savings: I would pay off the debt ASAP, using current income and temporarily suspending your savings efforts. And I would not be leaving the TFSA money sitting in a 1.1% interest-bearing vehicle - I'd be investing it more aggressively using a self-directed brokerage account set up through your bank or an online broker. You are young, you should be taking advantage of the magic of compound interest in your Tax-Free Savings Account; top that up first to the absolute max before you start putting more money into RRSP accounts which you will eventually pay tax on when you draw them down. I sure wish I had the option of a TFSA when I was your age!
posted by Mary Ellen Carter at 8:34 AM on June 7, 2018


If you put your money into a simple index fund (or whatever), you will outperform %3.95 handily.

Invest the money, use the dividends to pay the loan payment, and make ~6% on top of that.


Most of what we're talking about here really is a matter of judgment, weighing risks that we can't perfectly predict, factoring in personal tolerances and goals, but I want to underline the flaw in this line of thinking, because many people don't realize the risk involved until it bites them on the nose.

It is true that the historical record suggests that on average a low-fee index fund should have a higher return than 4%. However, if it were that simple, the world would be a different place. Those returns are on average and over time. Returns on equity investments are not guaranteed. And the market can be highly volatile over the short term. In the long term, thinking about retirement in forty years, you can be less concerned about volatility. But if you put your money into the market in 2007, you would not have seen a return of 6% that year, and you would not be getting much in the way of returned income to make your student loan payments. You should never, ever assume a return above the risk-free rate in the short term. OP's time horizon is relatively short, as he would like to buy a house in the relative near future, which means he is fairly vulnerable to market swings. The proposal that he rely on returns from the market to make his student loan payments would put him on basically the shortest time horizon of all. Therefore he needs to take some care to avoid volatility and should not be making blithe assumptions about market performance.
posted by praemunire at 8:39 AM on June 7, 2018 [3 favorites]


I would increase the payment, because I dislike debt. I would also increase contributions to retirement, and keep the savings available for emergencies. Cars die suddenly, companies do mass layoffs, stuff happens, and having emergency savings can be a lifeline.
posted by theora55 at 8:55 AM on June 7, 2018 [1 favorite]


Any other monthly payments toward debt? If not, would a steady, current student loan payment history have a positive impact on your mortgage application?
posted by Iris Gambol at 9:10 AM on June 7, 2018 [1 favorite]


Hit post too soon. Being debt-free feels great, but "I have a good credit score, but it could be better" may mean that by continuing to make payments (in larger increments, and applied toward the principal; definitely keep a healthy nest egg), you'll ultimately improve that score, and be in a better position come home-buying time.
posted by Iris Gambol at 9:15 AM on June 7, 2018


Best answer: Here is what my wife and I did in Ontario to buy our first home that I think may work from you:

- Move money up to your RRSP limit per year into an RRSP so you can get a higher return than a savings account;
- Build your RRSP up to $25,000; and
- When you're going to buy your first condo, take out a $25,000 interest-free loan as a first-time homebuyer from your RRSP. Your payback period if 15 years so you have lots of time to pay it back.

This benefits you a couple of ways - one, it reduces your immediate tax burden offering you more money in the short-term (we often rolled our RRSP tax savings back into our RRSP), and two, it lets you come up with a down-payment by borrowing against yourself interest-free. It allowed us to buy our home without putting a single dollar down of cash in our pockets (minus transaction expenses.)

To be honest, once you have the downpayment if your debt payments are $85/month, you will have no issues qualifying for a mortgage with the level of debt you're in and the income you are at. I would keep that debt on the books and focus on a downpayment if this is indeed your primary goal - yes, it sucks to pay interest and owe anyone money, but taking your $15,000 and paying debt down actually doesn't help you with the primary sticking point you will have for a home at the moment - a downpayment.
posted by notorious medium at 9:15 AM on June 7, 2018 [2 favorites]


No. If you die tomorrow or any time before the end of your loan terms you'll have wasted as your money paying off some business who doesn't really need it.
posted by GoblinHoney at 9:19 AM on June 7, 2018 [1 favorite]


I tend to think that with savings of only 5k more than your debt it's a mistake to compare the interest rate on your current debt to the interest you're making from savings; compare it instead to the interest rate you'd incur on whatever form of debt you'd have to take out if an emergency occurred and you had to re-borrow the money. Lack of cash on hand to address situations like car breakdowns, appliance failures etc is how a lot of people end up in unnecessary poverty spirals. A $5k emergency fund may or may not be sufficient depending on your lifestyle and support system, but I'd think hard about contingencies before making this decision. Also, as noted above, if you want to buy property, you're going to need cash on hand.
posted by lwb at 10:17 AM on June 7, 2018 [4 favorites]


Best answer: I'm struggling with this myself - almost exact same situation. (10k student loan debt, low interest rate, the ability to pay it off, low interest in savings...). Luckily, I am married to a finance guy. I am not a finance person, I'm a go-with-my-gut person. We disagree on this.

Finance Guy sez: keep the debt. At $149.52/month and 2.65% interest it's not worth paying off. Keep the nest egg in case you need to have cash on hand, and let the $149.52/month keep going for the next 5 years until it is paid off. The $35/month of interest is no big deal.

Go-with-my-Gut Person (me) sez: Pay it off. It'll be such a relief to have it off of my shoulders. No more literal or psychological debt! One less thing to worry about every month! The feeling of finally being free of that debt will be awesome. Plus, no more $35/month going to interest. I also have other ways of accessing cash on hand in case I need it immediately, though (house disaster savings acct) and my credit score is excellent.

Basically, I'm probably going to pay it off despite what Finance Guy sez because it's my debt and it weighs on my shoulders. And then that $149.52/month (the number is clearly burned into my mind after so many years of seeing that amount go out) will go into savings.

Let us know what you decide. I've been stalling on making that final payment and perhaps your decision will be what finally spurs me on to doing it.
posted by Elly Vortex at 10:37 AM on June 7, 2018


You don't need to choose between debt repayment and savings.

-Keep an emergency fund big enough to cover all your normal expenses for 3-6 months if you get laid off, etc. This might be 15k or more or (probably) less, depending on your expenses and risk tolerance. This is NOT to be invested. You can't risk the market being down when you really need the money. Keep it in a high interest savings account, or short-term GICs.

-Don't save money for a house before you pay off that debt. The "savings" from owning a house (may not actually exist, depends on rent vs mortgage +taxes in your area) are likely to be outweighed by your interest fees from the debt. Pay that 500 towards your debt instead and it'll be paid off in no time. Then you'll be able to save for the house much faster.

-I don't know what your fixed expenses look like, but with only 700$ rent I suspect you can trim your budget enough to save more than 500$ a month on 45k/year. Look into frugal tips, etc.

-Do extensive research before deciding to buy a condo. I know so many people who regret it. The resale value is often much lower than you might think, for example, and condo fees may be higher than expected as well.

-1000 is a teensy drop in the bucket for retirement. You need to build retirement savings into your budget, separately from paying off debt and saving for a house. I would personally (and did myself) pay off debt first, then focus on catching up for retirement, unless you have the option of a pension or matching RRSP contributions from your employer (in which case always take advantage of it, it's free money). Then worry about saving for a house after you've caught up to where your retirement savings should be for your age.
posted by randomnity at 12:27 PM on June 7, 2018


Response by poster: Thanks for all the answers guys!!! Psychologically, having debt doesn't bother me at all, since I borrowed it from the government ( funny how that is...). Getting rid of my nest egg would hurt so much more ! But I will definitely consider increasing my monthly payments. My instinct of needing a down payment matches with what notorious medium says. I never knew I could take out a loan from my own RRSP. I will definitely look into that. Thanks again!!!
posted by winterportage at 1:00 PM on June 7, 2018


I am in Ontario, been looking for a condo in months.
I would say forget about the condo, even if you have 30,000 you can't even afford a decent condo.

If you want somewhere decent 50K down it's min, and 2K in morage monthly :)
posted by dadaxiang1204 at 1:01 PM on June 7, 2018 [1 favorite]


I would pay the debt off. An emergency that actually requires you to come up with more than 5K immediately is pretty low odds — it could happen, but it’s not likely. Which means that the odds that you’re going to need to go back into debt at a higher rate if you pay off your debt and reduce your savings to 5K are also very low.

At that point, paying interest, even if it’s not all that high, is just throwing money down a well. If you pay off the debt and put your current amount of your loan payments back into savings, your savings will have recovered in no time.
posted by LizardBreath at 4:42 AM on June 8, 2018 [1 favorite]


Also, and this is psychology, not finance so your mileage may vary. But if you’re like me, you’re going to feel a lot more comfortably well off with 15k in the bank and a 10k debt than you are with 5K and no debt — cash on hand that you can spend at will feels more significant than an under-control debt, even though you have the same net worth either way. If you’re trying to save for future goals, feeling poorer is more motivating than feeling comfortably well-off.
posted by LizardBreath at 5:00 AM on June 8, 2018 [1 favorite]


If you invest your $15K well, you're return should be more than the 3.95% interest rate you're paying on your student loan. That means, keep up your monthly payments and you end up ahead of where you would have been if you paid off your loan in one chunk.

Also, paying down debit on time helps your credit score.
posted by Taken Outtacontext at 1:07 PM on June 8, 2018


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