Evaluating Paying off Student Loan (another student loan post, long)

[mikeyKay]

I tried to "crunch the numbers" for paying off my student loan in one lump sum, or using monthly payments. I presently have the money to play it off tomorrow if I wanted to, but I wondered (on my own, and after reading some posts on this forum) if the money would be better invested. Here are the constants:

~$18,000 in student debt
5.3% interest rate
~$150 monthly payments
(days between payments)*(principal)*(5.3%/365.25) = amount paid to interest

Analysis:

My first problem was figuring out a way to analyze the system, and I still don't know if my method makes any sense. I broke it into 2 choices, I could either invest $18k and make my monthly payments to my loan, or payoff the $18k on the loan and invest my monthly payments. Does this make any sense?

Given the information it takes me 171 months to pay off the loan (14.25 years). After the 14.25 years, I dont think it matters what a paid for the loan (because in the end the loan will be nothing), the way to judge preformance is to see how much money I have invested. Again, I'm not sure if this makes sense. Soooo, after I plug some numbers into Excel, I get the following outcomes assuming various rates of return for the money invested:

% return__DON'T Payoff Loan______Payoff Loan
8%________52,064_______________51,707
9%________59,235_______________56,560
10%_______67,314_______________61,156
11%_______76,406_______________67,961

There are advantages and disadvantages to having a student loan outstanding, but in my opinion, it only makes sense to NOT payoff your loan if you can expect some nice returns on your investments.

Any feed back is much appreciated, as I am new to all this.

-mike

[buffett]

One other variable to consider is whether your income is low enough (65k?) to qualify for using the interest you pay on the loans as a tax deduction.

[James Boston]

I don't like this sort of thing. I'm not saying it won't pay off, just that it's better to eliminate the debt first.

The problem, IMO, with this is that it doesn't factor in risk or your personal financial situation. If you're very wealthy and could handle paying off all of your debts and still getting by, should that need ever arise, then it's workable.

I debated this with someone in OOT the other day. He was advising that first year college students should max out student loans and invest it because the S&P return average was higher than the interest on the loan, and the loan payments were deferred until after college. This, in no way, factors ability to make the payments when the time comes (not saying this applies to you). What if you took this approach a few years before 9/11 and the stock market cooling off. Alot of funds that still have avg 10% returns were down at that time. If you found yourself in a situation where you needed to eliminate that debt and not have that payment, you would have had to sell that assests at a loss.

This is a worst-case-scenario example, but it's worth mentioning.

[mikeyKay]

[ QUOTE ]
One other variable to consider is whether your income is low enough (65k?) to qualify for using the interest you pay on the loans as a tax deduction.

[/ QUOTE ]

i am not allowed to deduct the interest

[mikeyKay]

[ QUOTE ]
I don't like this sort of thing. I'm not saying it won't pay off, just that it's better to eliminate the debt first.

The problem, IMO, with this is that it doesn't factor in risk or your personal financial situation. If you're very wealthy and could handle paying off all of your debts and still getting by, should that need ever arise, then it's workable.

I debated this with someone in OOT the other day. He was advising that first year college students should max out student loans and invest it because the S&P return average was higher than the interest on the loan, and the loan payments were deferred until after college. This, in no way, factors ability to make the payments when the time comes (not saying this applies to you). What if you took this approach a few years before 9/11 and the stock market cooling off. Alot of funds that still have avg 10% returns were down at that time. If you found yourself in a situation where you needed to eliminate that debt and not have that payment, you would have had to sell that assests at a loss.

This is a worst-case-scenario example, but it's worth mentioning.

[/ QUOTE ]

i agree with you in that i beleive paying the loan off is the way to go. it seems like im not making enough money over 15 years to justify keeping the debt when i can pay it off.

keeping with your "worst case scenario" theme, if i pay off my loan, the worst thing that can happen is that i'm debt free. being debt free > maybe having an extra $4k 15 years from now. i mostly just wanted to see if i was missing something big in my analysis that would make me not want to pay off my loan.

-mike

[PokerBot123]

Will you average more then 5.3% revenue on money invested? That's what it comes down to isn't it. If so; how much extra revenue will you need to compensate for the risk you are taking.

[mikeyKay]

[ QUOTE ]
Will you average more then 5.3% revenue on money invested? That's what it comes down to isn't it. If so; how much extra revenue will you need to compensate for the risk you are taking.

[/ QUOTE ]

im not sure its that easy, due to the way interest gets compounded on my loan and how my payments have to go towards interest instead of principal. the way i set it up was the only way i could compare apples to apples. im not sure if there is a way to look at things by just looking at interest rates.

-mike

[Misfire]

Pay off 5% loan now = 5% return.
Risk = 0.

Keep 5% loan and invest in a 10% index = 5% return.
Risk > 0.

[Sniper]

fwiw... I do not recommend paying off low interest rate student loans, in one lump sum.

You are better off paying down your loan and building assets at the same time. As your salary/imcome increases, you can funnel extra money in both directions.

in other words, when debt=student loan, it is better to have... Assets: 18,000 & Debt: 18,000... than Assets: 0 & Debt: 0

[tiltaholic]

[ QUOTE ]
fwiw... I do not recommend paying off low interest rate student loans, in one lump sum.

You are better off paying down your loan and building assets at the same time. As your salary/imcome increases, you can funnel extra money in both directions.

in other words, when debt=student loan, it is better to have... Assets: 18,000 & Debt: 18,000... than Assets: 0 & Debt: 0

[/ QUOTE ]

can you elaborate on why this is the case?