New Reader Question about debt …

I am always pleased to receive questions and comments from readers – and, new readers in particular. For example, recently I have been in e-mail conversation with David, a new reader, who asks:

After spending half of my day reading various posts and links I have a better idea of where I need to be.  I do have a question – I have student loans that I unfortunately locked at a 9.9% interest rate back in the mid 90’s.  I still carry about 30k and I make about a $330 payment a month.  What is the best strategy for those?  I can’t refi them.  I can pay them off “quickly” but the money that I would be lopping off that is taken away from my nest egg and emergency funds.  If I pay them off on their schedule, it will cost me around $79k in the long run. What would you suggest?

While I’m not qualified to – therefore, don’t – give give direct personal advice of the financial or any other kind, I can use this question as ‘inspiration’ for this, more general, post …

This is a common problem, facing most folk these day … not specifically the student loan, but debt in general. And my response is generally the same: it depends 🙂

And, the thing that it depends on is actually two things, not one:

1. Do you have ‘spare income’ or cash floating around that you COULD be applying to this loan?

If not, then you need to keep paying the loan according the schedule and doing your level best to find some additional money through increasing income (MM201) and/or better personal money management (MM101). But, if you do have some spare cash floating around then you need to ask yourself the following question …

2. Where else could you put the money that would return more than 9.9%?

This is really a simple question, so you don’t need to beat yourself up about the answer …

If you want to start a business that can return, say 50+% if it’s successful, then you may be better off keeping the loan in place – making just the required payments, for now – and putting your spare cash towards startup/working capital for your business.

But, if you are thinking (instead) of paying down your home loan, with its current interest rate of 6% (probably at least partly tax deductible) then I would suggest that you instead pay off the student loan.

And, if you had a car that you absolutely had to purchase and were thinking about financing it at, say, 11%, then I would instead suggest that you pay cash for the car and keep the student loan in place.

The decisions, to me, only become more ‘difficult’ if you have no clear idea of a better use for your money other than “Maybe investing in something one day” … in which case, I would take the ‘sure thing’ i.e. pay off the ‘student loan’ debt,


The available options are so close in interest rate earned or spent e.g. should I pay down the 9.9% student loan or buy some units in an Index Fund that should return a bit over 9.9% over the next 10 or 20 years …  in which case, I would again take the ‘sure thing’ i.e. pay off the ‘student loan’ debt.

Other than that, simply apply the principles in this recent post and you won’t go too far wrong …

BTW: don’t forget to compare interest earned and/or spent AFTER TAX. To me, a rough estimate (rather than paying for a consultation with your accountant UNLESS the decision is major or strategic) is probably usually good enough … but, when in doubt, work it out WITH YOUR ACCOUNTANT.

Oh and one more ‘trick’; if you have another asset that you can acquire new debt on to pay off the more expensive old debt, can/should you do it?

For example, if David has a house with ‘spare equity’ can/should David refi the house and pay off the student loan entirely. At an effective current (tax deductible) interest rate on the refi of, say, 6% (compared to a ‘locked in’ 9.9%) the answer is most likely a resounding YES, however, now we have to think about locking in and term:

The student loan is likely to be locked in to a repayment schedule that will see it paid off in just a few years, but a mortgage will probably be offered at 15 to 30 years to keep the repayment schedule low … if the purpose if simply to repay the student loan, then you should divert the money that you would be using on a monthly basis to repay the student loan to repaying the mortgage (i.e. pay off the mortgage with the original mortgage payments PLUS the former student loan payments).

Because the combined interest rate is now lower but your repayments are the same as before, you should actually be paying debt off at a slightly faster rate …

Of course, if you do have a hot new business or investment idea, then you may instead refi the house, pay off the student loan and apply any spare cash (over and above what the bank says that you HAVE to pay on the mortgage) to building that little ol’ warchest … but, this is an advanced – and more risky – Making Money 201 concept … only needed if your Number says so 🙂

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0 thoughts on “New Reader Question about debt …

  1. David,


    > I can’t refi them.

    You may not be able to refinance it directly- but if there is no prepayment penalty and you have good credit you may be able to get a separate loan with a better interest rate.

    I would check out peer to peer lending sites and see what kind of rate you could potentially get.

    I suspect your student loan interest is at least partially deductable. If you did your tax return using Turbo Tax or Tax Cut software you could just edit the return and see what difference entering 0 for the student loan interest makes on your taxes.

    -Rick Francis

  2. @ Rick – thanks for the tip; I didn’t know (a) about the potential tax deductibility of student loans in the US, and (b) your Turbo Tax ‘tip’ … this is why the internet is so powerful: it opens up the door to sharing knowledge.

  3. @Rick – yes the interest is tax deductable, but I was unaware of loans that are possible for balance transfers. My Loans are with Sallie Mae, so any suggestions or websites that you could start me off with, would be a greaat help.

    @AJC – much obliged for the “overall” advice. You make valid, common sense points that sometimes you need to see from someone else to help you make a decision. Thank you.

  4. AJC,
    An insightful post as always.

    Whenever I am posed with a problem like this, I quickly run some numbers. Based on the (partial) information that David provided (30K outstanding, 9.9% interest and $330 monthly payment), it seems that he still has around 14 years of payment remaining.

    Now if David has 30K which he can use towards paying this loan off, the two main options he’s posed with are a) Should he pay the loan off or b) Should he invest this 30K elsewhere.

    The obvious answer as you have also pointed out is to invest it if he can get a return of more than 9.9%. But if you run a few numbers, like I did, you’ll find that the number to beat is not 9.9 % but is only 4.5%.

    The point I’m trying to make is that on a loan, the principal (and the interest you pay on it) keeps on reducing every month as you make your monthly payments, while for an investment your principal (and hence the interest you earn on it) keeps growing. This means that you can actually beat your loan even with an investment that offers a much lower return than the interest rate on your loan.

    What are your thoughts on this?

  5. @ John – Absolutely correct if you compare a P&I to an ‘interest only’ … it should work both ways, though 🙂

  6. Hey Adrian,
    Great comments. I think in the next year or so we’re going to get a whole lot more of this.
    All the people who were looking to increase their capital by using DEBT are now looking to see how much of that capital they really own. That will drive them to their DEBT/EQUITY ratio. Problem with a student loan is that there is NO EQUITY which puts someone a long way behind the ‘eight ball’
    Interesting following your blog because it captures the heart beat of the personal investor who thought they were doing well and had hope for the future but now finds they never quite realised what they were getting into and are now saddled with DEBT

  7. @Adrian,
    Agree with you totally that the value for a student load is in FUTURE earning capability. The issue for a student is that capability does not necessarily mean results. The key is implementing what a student has learnt to bring in financial results. Otherwise the education is not worth anything financially and the student is left with a debt that needs to be paid back

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