Pay everything now or gradually?

Question

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.

Answer 1

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.

Answer 2

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)

Answer 3

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.

Answer 4

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.

Answer 5

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?

Answer 6

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.