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I have around $45,800 is my bank account and have the following three loans:

  • Loan 1: $6,114 with 6.8% interest rate
  • Loan 2: $14,649.21 with 6.8% interest rate
  • Loan 3: $2,927.25 with 5.750%

Should I pay everything off now leaving around $23,680 in my bank account or make a payment each month such that I pay off everything in a year? Currently I am paying around $3400 a month on the loan with the highest amount (Loan 2). Should I keep doing this and then pay of Loan 1 and then Loan 3? Or just pay everything now?

Added: Monthly income around $6800, no rent expenses, only some utility and food expenses. No contribution to 401k and am not sure whether to pay like 80% of it now and invest rest in index funds? Also these are student loans. Also I am in the USA.

Added: I ended paying them off.

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    "these are my only expenses" You don't buy groceries, pay utility bills, etc.? This matters because if your other expenses are zero, there is no reason for you to keep this money sitting there while you're paying interest. – void_ptr Nov 28 '19 at 3:06
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    Do you want to pay more money or less money? – user253751 Nov 28 '19 at 10:31
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    What are your monthly income and your total monthly expenses? You don't have rent to pay? The situation is not quite the same of you have 0 income and have rent to pay every month or if you earn thousands and have no rent to pay. Also, you may need to look up and fees for early repayments (though it would be quite rare that those fees outweigh the benefits of the early repayment). – jcaron Nov 28 '19 at 13:13
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    Do the loans allow for early payment? Some banks in some countries have loans, if you pay back early you need to reimburse the bank for lost interest. – lalala Nov 28 '19 at 14:05
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    Just curious as to why you would think it's just as good to pay it off gradually? – Aequitas Nov 29 '19 at 1:49
51

To put this into perspective, you are paying ~$1500 interest annually (gradually decreasing), or $132 monthly.

All the while, you have money sitting in your bank account doing seemingly nothing.

Looks to me you're off to a good start being debt-free at this point, while still keeping a healthy chunk of cash in your bank account.

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    So pay everything now? – questionguy Nov 28 '19 at 4:33
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    @questionguy given how much you have in savings... emphatically yes. Now, if you only had $24,000 in your bank account, the answer would be different. (The answer then would be to pay off Loan 2 and then it's monthly payments for Loan 1.) But... you've got $46K in savings, so pay it all off now. – RonJohn Nov 28 '19 at 4:56
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    @questionguy You don't intend to invest a sizable chunk of your cash right? Because if you can invest like 30K and by investing 30K you are able to earn more than 1500$ per year than it would be better for you to not pay the loans and just invest the money. If you don't intend to invest that money or are sure that you will not be able to earn more than 1500$ per year from your investment than, as this answer points out, there is no reason for you to keep that amount of cash idle and pay interest on your loan – Giacomo Alzetta Nov 28 '19 at 16:13
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    @GiacomoAlzetta: Ok so basically pay everything now? I am not really contributing anything to a 401k plan. Plus if I invested anything in index funds, for example, I wouldn't get anything in return right (or very little)? – questionguy Nov 28 '19 at 17:03
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    @void_ptr: Ended paying them off. – questionguy Nov 28 '19 at 23:01
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Reasons to not close your debt:

  1. You can make more than 6.8% return somewhere else
  2. You fear an unexpected expense in which you need temporary cash

Reasons to close your debt:

  1. Even if you believe you can make more than 6.8%, nothing is guaranteed and you end up losing money on interest.
  2. Debt is leverage. That extra $20k is not yours. If you lose it, the bank takes what you have.

If I were you I would close the debt. Debt is basically playing with the banks money, BUT if you lose it then they take what you have.

Another benefit of being debt free is the emotional relief of not owing money. I think the improved state of mind may actually improve your success in life. (better decisions from having a clearer mind)

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    Ended paying them off. – questionguy Nov 28 '19 at 23:00
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    The only place I'm aware of where the average person can safely make 6.8% return is via a 401K match. That doesn't apply to OP, but it sometimes applies when a person has a choice between paying down a debt or paying into a 401K. – Brian Nov 29 '19 at 14:22
  • Did the fact that these were student loans matter? Student loans I think are a tax write-off as well, (up to an amount??) so it may have been best to write off the max amount every year. Not very knowledgeable about this though! – Mars Dec 3 '19 at 5:12
  • Did a quick check... interest paid on student loans is tax deductible, up to $2500. So I think effectively, that 6.8% would be reduced by 22% = 5.3%. Increases the odds that the 401K is a higher return than paying off the loans – Mars Dec 3 '19 at 5:18
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Short answer: Pay off all the loan. Always check out the possible early loan payoff penalty and find a way around it.

Assume you are living in the USA, the saving account is paying you less than 1% interest for the cash inside the bank account. Unless the loan is part of your business that gives you a monthly positive cash flow against the interest paid, otherwise it is like holding $23,690.46 and allow it to dissipate $1563 every year.

You may argue that holding the extra $23K may allow you to enter the market during a crash and let you buy stocks that will double or triple the money. However, this is a risky take since nobody can predict the future. Because :

  1. Nobody knows when the market will crash.
  2. One must make sure income doesn't cut off when the market crash. Because the debt still follows you.
  3. Federal Reserve Board may reduce the interest rates when the market slump.

IMHO, the dilemma is due to how one handles their mental accounting . In fact, I have made a similar mistake before, by putting too much weight on the cash for unforeseen gain and neglect the high loan interest rates. Richard Thaler behavior economics book : Misbehaving, have a few chapters mentioned how mental accounting affect our decision making.

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    The early payment penalty is an important aspect for the OP. They should include that in the calculations (how much costs keeping the loans vs. how much costs it to pay them off). Maybe one or two of these loans don't have such a penalty - in this case they should probably be preferred when paying off. – glglgl Nov 28 '19 at 9:34
  • @mootmoot: So I shouldn't invest anything in index funds? Just pay it all off at once? – questionguy Nov 28 '19 at 21:31
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    @mootmoot: Ended paying them off. – questionguy Nov 28 '19 at 23:00
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    @questionguy index ETF is a long term game. The 10%~15 % average returns only emerge in the long run like 10~15 years. – mootmoot Nov 29 '19 at 8:58
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    @mootmoot "The 10%~15 % average returns only emerge in the long run like 10~15 years."... and there is no guarantee for it, not even for a more realistic 6%, not even if you consider a time span of 30 years... – matheburg Nov 30 '19 at 20:29
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Pay them off now.

Paying off your loans is a guaranteed 6.8% return on your money. Consider it this way: would you take out another loan at that rate now so you could do something else with the money? I highly doubt it. The stock market has returned more than that historically on average, but not enough more and not reliably enough to make it worth borrowing money at that kind of rate, in my opinion.

With your income, expenses, and savings, there is zero reason for you to be in debt like this. Pay it off and start putting money into a retirement account right now. You're in a great position to set yourself up financially for the rest of your life by getting out of debt and getting a jump on your retirement savings. Don't squander it.

Some comments have mentioned checking for a penalty for paying the loan off early, which is a good idea, but I highly doubt there is one based on the info you've given.

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  • Ended paying them off. – questionguy Nov 28 '19 at 23:00
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Another aspect worth mentioning: taxes.

Without taxes, paying off a loan at 6.8% is equivalent to earning 6.8% on a guaranteed investment.

However, earnings on an investment are taxable in most jurisdictions, but there is no tax due on the money you save by paying off a loan early.

If you're in the 20% marginal tax bracket, then saving 6.8% on a loan is equivalent to about 8.5% pre-tax. Where can you earn 8.5% today, guaranteed?

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  • I get what you're trying to say, but this doesn't make much sense. You might want to try rewording it and maybe using some numbers – Mars Nov 29 '19 at 0:31
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    Makes perfect sense to me. – Lightness Races in Orbit Nov 29 '19 at 17:37
  • @LightnessRaceswithMonica Must just be my ignorance then--I can't follow any of it. Why is paying off a loan at 6.8% equivalent to earning 6.8% guaranteed investment? I think d3jones means to say that paying off a loan at 6.8% balances out if you have an equivalent investment at 6.8%. (And if you think of it that way, you can follow--a 6.8% loan doesn't actually balance out with a 6.8% investment because of tax on the investment). – Mars Dec 3 '19 at 5:09
  • Also, if we're talking about taxes, these were student loans and thus the interest paid is tax deductible. I think the effective rate would drop 6.8% → 5.3%. Lastly, I think OP would be in the 15% tax bracket, meaning you only need ~6% to break even. – Mars Dec 3 '19 at 5:22
  • @Mars Yes, that's what the answer is saying. So you did get it. :) – Lightness Races in Orbit Dec 3 '19 at 11:56
0

Max out your 401k

Having paid off this debt, now, max out that 401k. Not to the match; all the way. And get $20k in there for 2019 still! Because you don't want to eat up your 2020 contrib limits, so you can max it out in 2020 also.

I gather your low expenses are because you still live with your parents, which I imagine puts you on your 20s. This is an age when

  • it stands to have the most positive impact due to compounding
  • but the 401K seems to not matter at all since retirement is so very far away

A 401k for a young person should be invested roughly like a university invests their endowment. When that happens, big armwave here, it will roughly double per 7 years. (not quite. It doesn't double every 7 years, it might lose value or it might gain 4x, due to volatility. Over 30+ years it averages out to doubling every 7 years.) That means twice as much money for retirement if you do it now, instead of 7 years hence when you start thinking about such things.

Since you have already paid taxes on this money, you might as well go Roth 401K if it's available to you. Lots of people will tell you it doesn't matter mathematically if you do everything right, but there are significant non-math reasons to favor Roth. Also, you can fully fund a Roth IRA in addition to your 401k using what is called the "Roth Backdoor" -- contribute to a non-deductible traditional IRA (not taking the tax deduction) then immediately convert to Roth. IRS and Congress acknowledge that this tactic is legal.

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