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Debt repayment advice for Sam
Sam of FinancialSamurai.com asked:
So here’s the question that perhaps you and the readers could pitch in and share their thoughts. I’ve currently got about $30,000 in consolidated student loan at a rate of 2.68%. I decided to do an extended repayment period (20 years), given the rate was so low, and savings on CDs and interest rates were around 4-6%, hence a positive carry. Recently, however, the best 5-yr CD rates are at only 2.5-2.75%. I’ve got to pay taxes on the savings interest income of course, and at the same time, I can’t deduct the interest payments on my student loan because of income limit restrictions (thanks big government!). To add another wrinkle to the dilemma, I’ve got a rental property mortgage at 5.25%, which I’m chipping away at so I can pay it off in full in 15 years (in 8 years), instead of 30 years. I’ve got no other consumer debt. And currently, my “Freedom Fund” listed on my site, which is cash, is up to $95,500. Psychologically, paying off the student loan will provide mental relief, a benefit that’s hard to value. I’m just worried that if I pay it all off, or a large slug, that money will be inaccessible forever. Where else can I borrow money at 2.68%? What would you and the readers do?
- Pay off the student loan in full given savings rates are at parity?
- Attack the student loan with extra principal payments every month or year? If so, by what amount a month/year?
- Let it be, and focus on paying off the higher interest rental property loan at 5.25%, even though it’s a much bigger loan, and I won’t get the same sense of accomplishment?
- Do nothing and sing kumbaya?
Thanks for your thoughts!
Pay off student loan debt, rental mortgage debt, or save?
Should Sam pay off his entire student loan debt? Should he put the Freedom Fund toward the higher rate rental mortgage? Should he sit on the savings and continue to faithfully chip away at both debts while building savings?
Here is what I would do Sam:
Although rates are low on the student loans… debt is still debt. If you reduce your debt you always win because it is guaranteed to pay returns by reducing your cost of living. Another reason debt should go is because concerning ourselves too much with rates can blind us to the fact that carrying debt means we are actually presuming upon our future ability to earn.
Assuming your entire $95,500 is all in liquid savings I would order your above options as follows:
- Pay off entire student loan debt and be done with it once and for all.
- Keep enough of the Freedom Fund aside for a solid 6 month emergency fund… say $20k – $25k according to your monthly budget.
- Use the remainder of the Freedom Fund to fully fund your 401k and/or IRA (if you have not already done so.)
- Once your retirement accounts are fully funded, use any remaining amounts to further pay down your rental mortgage early.
So as an example, if I had the $95,500 I would put $20,000 into my high yield savings account emergency fund. I would then contribute $16,500 to my 401k, $16,500 in my wife’s 403b, and another $5,000 to my Roth IRA, and $5,000 to her Roth IRA. Once all this was accomplished I would use the remaining $32,500 to further reduce the rental mortgage.
Whatever you decide to do… if you ever start stressing, just sing kumbaya. 😉
What do you think Sam should do?
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