Paying off loans quickly in near future versus saving/investing

[xilex]

Hello all, I've seen the articles about how to manage money between loans and investing. I've also tried some of the online calculators that try to give you input whether paying off loans is a better outcome than investing, but here is my question.

I will be attending next year. Currently, as a fellow, after the standard Roth deduction, maxing out other employer-offered retirement accounts, making about $2000/month student loan payments, I have about 3000-5000 of leftover income. My student loans total approximately 130000 at 6.8% interest rate; I haven't refinanced because I am wary about losing whatever 'benefits' the federal loans offer. I plan to, on an attending salary, to hopefully have the loans paid off within two years. Current loan repayment plan is on IBR, minimum payment approximately 600/month.

My question is, since investing is a long-term effort, and I have a plan (hopefully) to pay off loans quickly in the near future, should I divert my remaining income towards investments (index funds in taxable account) or put it all in student loans? I lose out on compounding returns over time (tens of years), which I see as more advantageous than the interest of 6.8% over two-three years (about 27000 of interest). Thanks.

[Hatton]

Make sure you have adequate disability and emergency fund.  That being said I would split the difference 1000 to a taxable account and 1000 to paying off the loans

[xilex]

hatton1 wrote:

Make sure you have adequate disability and emergency fund.  That being said I would split the difference 1000 to a taxable account and 1000 to paying off the loans

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Thanks. Got those two taken care of right now. Any rationale behind splitting it up 50/50?

[Zaphod]

What benefits do the federal programs have that you cant give up? Seriously, I would assign a cost to each of the benefits and see if its better than the 1/3 to 1/2 of the interest rate you could get which is substantial.

I would certainly focus on filling up your tax deferred accounts while at a lower income. Investing is longer term so yes, imo, it does make more sense to focus on that over student loans (after refi, your rates are awful). However, your balance isnt particularly large so I imagine it will be gone shortly anyway.

[xilex]

Zaphod wrote:

What benefits do the federal programs have that you cant give up? Seriously, I would assign a cost to each of the benefits and see if its better than the 1/3 to 1/2 of the interest rate you could get which is substantial.

I would certainly focus on filling up your tax deferred accounts while at a lower income. Investing is longer term so yes, imo, it does make more sense to focus on that over student loans (after refi, your rates are awful). However, your balance isnt particularly large so I imagine it will be gone shortly anyway.

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I guess these are the two benefits below (taken from SoFi).

DEFERMENT/FORBEARANCE

In many cases, you can put your federal loans on hold due to financial hardship. Deferment allows you to do so without accruing interest in the case of subsidized loans, but unsubsidized loans continue to accrue interest while in deferment. Loans in forbearance also accrue interest. It’s important to understand that accrued interest is capitalized, or added to the loan’s principal, when repayment begins. Some private lenders do offer forbearance, so if this is an important feature for you, check with the lender about their policies before refinancing.

SPECIAL REPAYMENT PLANS

Federal loans offer extended, graduated and income-driven repayment plans (such as Pay As You Earn, or PAYE), while most private lenders only allow a standard repayment plan. It’s important to note that paying less than the standard amount typically means spending more on total interest over the life of the loan.

Just in case it takes a little longer than normal to find a job, though I'm not sure how high the chance of that happening will be.

[lucas]

If you're going to stick with the 6.8%, I would pay that off completely before delving into a taxable account.  After taxes, the risk/reward on the taxable account is not worth it when you get a guaranteed "return" of 6.8% on the loan.

 

[xilex]

lucas wrote:

If you’re going to stick with the 6.8%, I would pay that off completely before delving into a taxable account.  After taxes, the risk/reward on the taxable account is not worth it when you get a guaranteed “return” of 6.8% on the loan.

 

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I understand your point. I brought up the point, however, about having loans at 6.8% for two years versus investing over 20-30 years in a taxable. I don't have a good way to quantify that to see what is better.

[Zaphod]

xilex wrote:

lucas wrote:

If you’re going to stick with the 6.8%, I would pay that off completely before delving into a taxable account.  After taxes, the risk/reward on the taxable account is not worth it when you get a guaranteed “return” of 6.8% on the loan.

 

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I understand your point. I brought up the point, however, about having loans at 6.8% for two years versus investing over 20-30 years in a taxable. I don’t have a good way to quantify that to see what is better.

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taxable still wins. You're comparing simple to compound interest and a bounded vs. unbounded term with your debt dying a smidgen every year due to inflation. Its really an unfair fight. Its actually a simple to find out amount, you know the exact finance charges associated with your loans so that is your holding costs for those, all in. The only thing you can work with in investing is historical numbers +/- some discounting factor, etc...Basic premise aside from compound interest rates can be smaller than simple and come out far far ahead, is that the nominal loan payment will stay the same but due to inflation will actually be a smaller payment over time. As opposed to the investment which has historically increased purchasing power/out paced inflation over 20-30+ years. May not happen in the beginning years, but the longer out you go the more likely and locked in it becomes. Doesnt make it the right choice for you but mathematically its pretty obvious. Same thing applies to mortgage prepayment only much worse since rates are super low and tax advantaged.

 

The deferment forbearance is nice, but low probability. As is the repayment options, and in reality quite a few private lenders have similar options.

[Hatton]

I think that you are doing great.  I think you get the psychological benefit of paying off your debt plus starting to accumulate a taxable account.  The point is you will have a head start on FI through the value of compound interest.  I think it is possible to work on both debt reduction and starting a taxable account which will give you enormous flexibility if you get burned out and want to retire early.

[The White Coat Investor]

6.8% guaranteed is a pretty attractive risk free return. I'd do that before investing in taxable, assuming you're not going for forgiveness.

[jhwkr542]

 

Zaphod wrote:

taxable still wins. You’re comparing simple to compound interest and a bounded vs. unbounded term with your debt dying a smidgen every year due to inflation. Its really an unfair fight. Its actually a simple to find out amount, you know the exact finance charges associated with your loans so that is your holding costs for those, all in. The only thing you can work with in investing is historical numbers +/- some discounting factor, etc…Basic premise aside from compound interest rates can be smaller than simple and come out far far ahead, is that the nominal loan payment will stay the same but due to inflation will actually be a smaller payment over time. As opposed to the investment which has historically increased purchasing power/out paced inflation over 20-30+ years. May not happen in the beginning years, but the longer out you go the more likely and locked in it becomes. Doesnt make it the right choice for you but mathematically its pretty obvious. Same thing applies to mortgage prepayment only much worse since rates are super low and tax advantaged.

 

The deferment forbearance is nice, but low probability. As is the repayment options, and in reality quite a few private lenders have similar options.

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While all correct, the 6.8% comes with zero risk.  The markets may be down the next 2 years, may be up, may be flat.  6.8% guaranteed simple interest isn't bad.  You'd be gambling that the markets will return better in the 2 years.  Plus the peace of mind of having loans gone sooner and increased cashflow is not insignificant.

I'd refinance the loans and pay them down.  If you think your job will be safe for another 2 years, there'd be very low risk of needing the federal benefits.  Use Earnest if you're worried, which will let you change your repayment as you go if something happens.

[xilex]

jhwkr542 wrote:

 

While all correct, the 6.8% comes with zero risk.  The markets may be down the next 2 years, may be up, may be flat.  6.8% guaranteed simple interest isn’t bad.  You’d be gambling that the markets will return better in the 2 years.  Plus the peace of mind of having loans gone sooner and increased cashflow is not insignificant.

I’d refinance the loans and pay them down.  If you think your job will be safe for another 2 years, there’d be very low risk of needing the federal benefits.  Use Earnest if you’re worried, which will let you change your repayment as you go if something happens.

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Zaphod wrote:

taxable still wins. You’re comparing simple to compound interest and a bounded vs. unbounded term with your debt dying a smidgen every year due to inflation. Its really an unfair fight. Its actually a simple to find out amount, you know the exact finance charges associated with your loans so that is your holding costs for those, all in. The only thing you can work with in investing is historical numbers +/- some discounting factor, etc…Basic premise aside from compound interest rates can be smaller than simple and come out far far ahead, is that the nominal loan payment will stay the same but due to inflation will actually be a smaller payment over time. As opposed to the investment which has historically increased purchasing power/out paced inflation over 20-30+ years. May not happen in the beginning years, but the longer out you go the more likely and locked in it becomes. Doesnt make it the right choice for you but mathematically its pretty obvious. Same thing applies to mortgage prepayment only much worse since rates are super low and tax advantaged.

The deferment forbearance is nice, but low probability. As is the repayment options, and in reality quite a few private lenders have similar options.

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"taxable still wins" meaning putting money into investments now will have a potentially greater return years from now?

jhwkr542: I'm not looking at the market in two years, I'm looking at the 20 year growth with contributions lost during this year and a little less over the next two years (the earliest years for compounding).

[Zaphod]

jhwkr542 wrote:

 

Zaphod wrote:

taxable still wins. You’re comparing simple to compound interest and a bounded vs. unbounded term with your debt dying a smidgen every year due to inflation. Its really an unfair fight. Its actually a simple to find out amount, you know the exact finance charges associated with your loans so that is your holding costs for those, all in. The only thing you can work with in investing is historical numbers +/- some discounting factor, etc…Basic premise aside from compound interest rates can be smaller than simple and come out far far ahead, is that the nominal loan payment will stay the same but due to inflation will actually be a smaller payment over time. As opposed to the investment which has historically increased purchasing power/out paced inflation over 20-30+ years. May not happen in the beginning years, but the longer out you go the more likely and locked in it becomes. Doesnt make it the right choice for you but mathematically its pretty obvious. Same thing applies to mortgage prepayment only much worse since rates are super low and tax advantaged.

 

The deferment forbearance is nice, but low probability. As is the repayment options, and in reality quite a few private lenders have similar options.

Click to expand…

 

While all correct, the 6.8% comes with zero risk.  The markets may be down the next 2 years, may be up, may be flat.  6.8% guaranteed simple interest isn’t bad.  You’d be gambling that the markets will return better in the 2 years.  Plus the peace of mind of having loans gone sooner and increased cashflow is not insignificant.

I’d refinance the loans and pay them down.  If you think your job will be safe for another 2 years, there’d be very low risk of needing the federal benefits.  Use Earnest if you’re worried, which will let you change your repayment as you go if something happens.

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Never said it made it the right decision. There are lots of other reasons besides peace of mind that paying off the loan is nice as well (and its not a large sum so its not that it wouldnt be easy), freedom, options, etc... You always have options with a taxable account, if you change your mind on debt vs. investing you can always just pay it off instead.

However, you cant look at it in the next 2 years kind of thing, that is entirely the wrong short term type of thinking. If you were really analyzing it in this matter, you would only be justified if greater terminal wealth was the goal, 20 or 30 years later. Not 2, or even 5-10. Its a much more long term time/inflation arbitrage than some quick get rich scheme.

[Zaphod]

xilex wrote:

jhwkr542 wrote:

 

While all correct, the 6.8% comes with zero risk.  The markets may be down the next 2 years, may be up, may be flat.  6.8% guaranteed simple interest isn’t bad.  You’d be gambling that the markets will return better in the 2 years.  Plus the peace of mind of having loans gone sooner and increased cashflow is not insignificant.

I’d refinance the loans and pay them down.  If you think your job will be safe for another 2 years, there’d be very low risk of needing the federal benefits.  Use Earnest if you’re worried, which will let you change your repayment as you go if something happens.

Click to expand…

Zaphod wrote:

taxable still wins. You’re comparing simple to compound interest and a bounded vs. unbounded term with your debt dying a smidgen every year due to inflation. Its really an unfair fight. Its actually a simple to find out amount, you know the exact finance charges associated with your loans so that is your holding costs for those, all in. The only thing you can work with in investing is historical numbers +/- some discounting factor, etc…Basic premise aside from compound interest rates can be smaller than simple and come out far far ahead, is that the nominal loan payment will stay the same but due to inflation will actually be a smaller payment over time. As opposed to the investment which has historically increased purchasing power/out paced inflation over 20-30+ years. May not happen in the beginning years, but the longer out you go the more likely and locked in it becomes. Doesnt make it the right choice for you but mathematically its pretty obvious. Same thing applies to mortgage prepayment only much worse since rates are super low and tax advantaged.

The deferment forbearance is nice, but low probability. As is the repayment options, and in reality quite a few private lenders have similar options.

Click to expand…

“taxable still wins” meaning putting money into investments now will have a potentially greater return years from now?

jhwkr542: I’m not looking at the market in two years, I’m looking at the 20 year growth with contributions lost during this year and a little less over the next two years (the earliest years for compounding).

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Yes. That is true from a terminal wealth perspective. I have attached a couple graphs that demonstrate what inflation will do to todays 100 dollars and then what investing it has been historically and then for rolling 30 year periods since 1928. I would refinance those loans to a better rate unless you really think you wont be able to get a job.

For the inflation graph you can see that each year your loan/mortgage payment gets cheaper in real dollars and anything you would be investing is buying less. For the investing graph you will see average, median, min and max values of return in the greater market. Minimum after 30 years was something like 851%. So by putting your loan payments as a priority instead of investing you are essentially prioritizing saving yourself from having to make a 50% off payment sometime in the future and avoiding growth of those dollars by 8.5x.

Hopefully at some point you have enough money coming in you dont really have to feel like you need to make a choice, and thats likely if you live like a resident for the first few years. I would prioritize (and am) building up a nice nest egg, emergency fund, etc...in the beginning and not hurting liquidity/cash flow at the beginning. After a few years of doing that you probably will be able to crush the loans if you wanted, buy the doctors house, etc...

[jhwkr542]

So by this logic, op should pay as little towards loans as possible and invest the rest...?