I have $12 000 in student loan debt at 6.5% interest. Currently my payments are in the ballpark of $150 per month.

I have an automatic transfer to a high interest savings account with Tangerine set at $150 every two weeks as my paycheck comes in.

Is it a better idea to funnel all that money to the loan payment and save a bit of interest, or build my liquid savings and be able to kill the loan in one shot once I have enough saved? What factors play into this?

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    Do you have any emergency savings to handle situations where you need to buy new tires today? – mhoran_psprep Dec 5 at 18:00
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    “a high interest savings account with Tangerine” — is the interest rate less than 6.5%? – Paul D. Waite Dec 6 at 9:03
  • Emergency savings is at about $4000 – JacobPariseau Dec 6 at 14:41
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    High interest savings is significantly less than 6 percent – JacobPariseau Dec 6 at 14:41
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    Note that the 6.5% is tax deductible, so depending on your tax bracket your effective interest is actually lower than that. – IronSean Dec 6 at 20:23
up vote 25 down vote accepted

Minimizing the interest you pay is ideal, but funneling all money to debt repayment isn't wise unless you have some savings to act as a cushion in case of an emergency.

How much money you should reserve in case of emergency is debatable but 6-8 months worth of essential expenses is a common goal. Do some research on emergency funds and evaluate your situation to come up with a number you feel comfortable with, save that, and then go to town on paying off that student loan as fast as possible via extra payments each month.

Saving up and then paying off in a lump sum instead of paying extra every month will cost you the difference between the annual 6.5% and your saving account interest rate between now and the payoff date.

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    The advertised rate for a Tangerine High-Interest Savings account is 1.25%. – Nelson Dec 6 at 2:45
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    @Nelson Not quite what one imagines when they hear "high interest savings," ay? Better than many accounts, sadly. So it basically costs 5.25% to keep liquidity (cash in bank) rather than paying extra on the loan. – Hart CO Dec 6 at 4:11

Is it a better idea to funnel all that money to the loan payment and save a bit of interest,

Yes.

or build my liquid savings and be able to kill the loan in one shot once I have enough saved? What factors play into this?

Letting the money sit in savings to earn less interest than your loan is accruing is not a good idea.

Ideally, you'd go with a mix of these strategies. Once you have savings sufficient to absorb an emergency, you should start funneling as much as you can toward that debt. The canned advice is generally $1,000 of emergency fund, but if you may need to move apartments and pay a security deposit or some such you may want to adjust that higher; but once you have your emergency fund established you prioritize the loan. AND emergency funds go in stable, liquid vehicles; savings account or maybe a CD. This money does not get put at risk to try to eek out a better return.


6 months of expenses makes a lot of sense. In a bind, you have 6 months of buffer to find a new position and settle in maybe even pay a headhunter to place you. You can make decisions based on the best decision rather than a need. At it's core, money gives you control of your decision making. This level of buffer is very important for breadwinners with mouths to feed.

I don't really know why I feel compelled to write this today, but here we go. To start, I'm a millennial. So don't read this as coming from a crotchety old baby-boomer who doesn't understand today's world. School was the easy part. If you're a young recent graduate.... go work. The start-up you worked for missed a funding round, neat, go find another one. Get on fiverr. Get on elance. Cold call businesses. A young person can find work. You might not like it, it might not be what you think you want to do. But you don't have an established career, you have only yourself to feed and clothe. Don't let yourself start carving out a rut of comfort. If it takes you 6 months to find work you are doing something wrong. Not work you want, not work you think is in your chosen career trajectory, just work. Put a grand in the bank that doesn't get touched unless the alternative is you missing work tomorrow.

Lets ignore the principle potion of your loan payments which do also zap your cash flow. $12,000 at 6.5% is $65 of interest each month. Put this in terms of the time you have to spend working for someone else, to pay yet another someone else. Based on national averages (about $72k per year of income taxed at an average effective rate of 13.5%) that's about 1.6 hours of net pay per month. Why does someone else already own that effort? Stop committing your future efforts to other people. Money is control. If you owe people money, guess who has the control... I guarantee it would be more fun to set that $65 on fire at the end of the month than it is to send it to the person you owe it to. That's control. That's what you want.

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    I'd recommend immediately qualify the resounding "Yes" immediately, with an "if you have an emergency fund". – Matthieu M. Dec 6 at 16:48
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    It's a this or that question. Is option A better than option B, yes. I get in to the emergency fund later. Also, there are multiple schools of thought related to size of emergency fund or simply having some debt capacity available to you rather than holding cash as your emergency fund; if this were credit card debt that might be an alternative to holding cash. I'm comfortable with the answer as it is. – quid Dec 6 at 18:05
  • I wouldn't use a dollar number as the "canned advice." I'd use "six months of rent plus minimal groceries plus utilities, however much that works out to in your local market." In some parts of the country, $1k easily covers that, but in others... – Kevin Dec 6 at 22:57

By this calculation, paying off your loan at the minimum rate will take almost 9 years, and you'll be paying $3,771 in interest. Tangerine bank offers a 3% interest rate for the first 6 months, and 1.5% thereafter; over 9 years, that averages to (about) 1.75%, and you'll have earned $2,714.41, so over that time period you will have a total profit of 2714 - 3771 = $-1057. If you instead pay $450 per month, you'll have paid off your loan in 2.4 years, and only have paid $995 in interest to your lender.

While I absolutely agree with other posters here, that you definitely some sort of financial cushion (enough to cover your cost of living for at minimum 3 months, but depends on your circumstances), in general, you should pay off your debts before beginning to accumulate wealth, otherwise you will have a very difficult time coming out ahead, long-term.

You should try to build up some savings so you can cope with emergencies. Your car breaks down, a medical bill, etc.

I often hear that you should have 6 months pay in savings for emergencies. So if you're making an average American salary of $50,000 or so, you should have $25,000 in savings? I think that's way excessive. On the other hand, many Americans have essentially zero savings. In my humble opinion, for most people you should have several thousand for unexpected expenses and if possible 2 or 3 months pay to tide you over if you lose your job.

After that, pay off debts as quickly as possibly. There is no advantage to keeping money in a savings account paying 1/2 % to save up for a lump sum payoff, while you are paying 6 or 8 or 30% on a loan. You're losing money every day that that money sits in your savings account.

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    Usually mentioned is 3-6 months living expenses for a emergency fund in something easily convertible to cash, within a day or so. 6 months pay should be more than living expenses. – sjakubowski Dec 5 at 23:03
  • Personally I think 3 months pay for the possibility of losing my job is realistic. I'd presumably cut my spending so 3 months pay should last 5 or 6 months. Let's see, right now I have 5 months worth of take-home pay in investment accounts that I could cash out within a couple of days, but in my mind that's a combination of emergency fund and extra retirement money. – Jay Dec 6 at 17:49
  • I don't worry too much about "convertible to cash within a day or so". If I needed money today, I'd just put it on a credit card until I could get the money out of my investment accounts. When I was in my 20s my credit limit was $300 and that wasn't practical, but today the combined credit limit on my cards is ridiculous, over $80,000, so that's not an issue. (I don't know why the banks give me such a credit limit. I don't know how I'd ever repay it if I really maxed them all out. I woudln't loan me that kind of money. But whatever.) – Jay Dec 6 at 17:52

As others have mentioned, you should ensure that you have a cushion of living expenses, typically 3-6 months. This is so that if you lose your job you'll be able to get by while you're looking for a new job.

After that, you should consider your debt. Debt is OK if you can funnel your free cash into investments that earn a higher rate. And in fact, over the long term the stock market has returned around 10%, so 6.5% debt is not so bad.

However, this assumes that you have enough money lying around to invest, and you'll be able to leave it invested for decades. If you're still living on meagre income, you probably can't sock away a significant amount of your money. In the short term the stock market can be very volatile (take a look at the charts for the past few days for an extreme example). It's an unfortunate truism that you generally need to be comfortable in your finances before you can make much more money in the stock market. If you're only earning savings account interest, you're better off paying off the loan as quickly as possible.

You probably can't afford to pay it off in one lump sum, but most loans allow you to increase your payments, which will reduce the term of the loan. Do a budget and figure out how much of your paycheck you need to live on normally, and pay most of the rest towards the loan.

  • Is there any reason it would benefit me to increase my payment rate as opposed to just throwing excess income at it each paycheck? The latter seems more flexible and also keeps my payment low in case of emergency – JacobPariseau Dec 6 at 22:12
  • They're essentially the same thing, just different ways of achieving it. Doing it automatically makes it harder to forget. – Barmar Dec 6 at 22:17

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