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my question is: Should my wife and I prepay my private variable-rate student loans, given our particular financial profile? Or are there higher priorities to address with any extra cash we have at the end of the month?

Here is the rundown.

Ages: Me mid-thirties; my wife mid-twenties.

Place: US city with a high cost of living and very high real estate prices.

Expected 2010 total gross income: ~$160K

Assets:

  • ~$50K in cash in checking/savings
  • ~$35K cash in an emergency fund
  • ~$120K equity in a home (we bought in '09 after the crash; prices are relatively stable here)
  • ~$22K in 401(k) and Roth IRA accounts
  • ~$20K resale value of a car we own outright

Loans:

  • ~$415K left to pay on 30-year fixed rate mortgage @ 5.125%
  • ~$40K in private student loans from my MBA; variable rate, currently @2.25%
  • ~$55K in federal student loans from my MBA; fixed rate @ 2.35%
  • (Zero consumer debt)

Now that I feel we have enough cash saved in an emergency account, it's time to turn to other priorities. I can really feel the weight of those private student loans, and though the interest rate on them is low now, I'm concerned it could go up soon. Obviously we are way behind on retirement savings too, and we'd also love to save some cash for a planned new addition to our family sometime in the next couple years...

Just don't know which financial priority to place my focus on next. Is is smart to really focus on killing those private student loans? THANK YOU for any thoughts or advice you have!

Jon C.

  • What's the monthly payment on the Student Loans? – Chris Cudmore Mar 29 '11 at 13:35
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    I fear that this question is a bit localized (to one individual's situation) and should be generalized a bit, so that it is useful to a larger audience. – George Marian Mar 29 '11 at 20:45
  • Hi Chris, the monthly payment on my private variable rate student loans is ~$315 and the payment on my federal fixed rate loans is ~$270. – user3148 Mar 30 '11 at 3:23
  • BTW, I really appreciate everyone's comments so far, and encourage any others to chime in with their advice. The comments so far have been encouraging for me, because I have lately been feeling a little discouraged that my wife and I are lagging on retirement saving. Also, the unbelievably high cost of childcare in the city where we live has really daunted us, when we consider the prospect of becoming parents. Anyway, thanks again for the encouragement and helpful advice! – user3148 Mar 30 '11 at 3:32
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See my recent answer to a similar question on prepaying a mortgage versus investing in IRA.

The issue here is similar: you want to compare the relative rates of funding your retirement account versus paying down your debt. If you can invest at a better rate than you are paying on your debt, with similar risk, then you should invest. Otherwise, pay down your debt.

The big difference with your situation is that you have a variable rate loan, so there's a significant risk that the rate on it will go up.

If I was in your shoes, I would do the following:

  1. Fully fund both Roth IRAs ($10k). You won't get another chance to fund these again, and as you mention, you're a little behind on retirement savings.
  2. Make sure you're capturing any employer match in your 401k. This is free money, take it!
  3. As mbhunter suggests, shop around to see if a refi on your mortgage makes sense. This could use up a bunch of cash. Obviously, you wouldn't want to get cash to prepay your student loan -- the rate would be higher. If your mortgage is held by a bank (hasn't been sold) you might try just calling your bank to see if they can rewrite your note -- the fees and hassle for this are lower, even though you might not get the best rate available.
  4. Use a chunk of remaining cash to may a lump sum payment on the variable rate loan ($20-30k, whatever you're comfortable with).
  5. Set a payment schedule to get that loan paid off as soon as possible -- but giving priority to the Roth IRAs if the schedule goes into next year.
  6. Don't prepay the fixed rate loan, especially if rates go up. When rates rise to the point where you can invest in CDs paying more than 2.35%, you'd be silly to make any prepayments.

But that's me. If you're more debt-averse, you may decide to prepay that fixed rate loan too.

2

You're in good shape as long as your income stays.

Your only variable-rate debt now is your private student loan. I think you'd be wise to pay that down first, and you sense that already.

Worst-case, in the event of a bankruptcy, student loans usually cannot be discharged, so that isn't a way out.

Once that loan is gone, apply what you were paying to your other student loan to knock that out.

You might investigate refinancing your home (to another 30-year fixed). You may be able to shave a half-percent off if your credit is stellar. Given the size of the mortgage, this could be several thousand out of pocket, so consider that when figuring out potential payback time.

Consider using any "free time" to starting up a side business (I'm assuming you both have day jobs but that may not be a correct assumption). Start with what you know well. You and your wife are experts in something, and have passion about something. Go with that. Use the extra income from that to either pay down your debts faster, or just reinvest in the business so that you can offset the income on your taxes.

Again, you're in good shape. Just do what you can to protect and grow your income streams.

2

You're doing great.

I'd suggest trying get putting 5-10% towards your retirement and the balance to the student loans. You are a little weak in retirement savings, but you have $550k house with 20% equity that you bought at the bottom of the market. That's a smart investment IMO, and in my mind compensates somewhat for your low 401k balance.

If I were you, I would retire the student loans ASAP to reduce the money that you have to shell out each month. That way, you have the option of scaling back you or your wife's work somewhat to avoid paying thousands for child care. In my mind, less debt == more options, and I like options.

  • +1 for the less debt == more options. If you like the flexibility, think about paying off those student loans first (obviously the variable one sooner). – Andy Wiesendanger Mar 30 '11 at 20:14
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Based on your numbers, it sounds like you've got 12 years left in the private student loan, which just seems to be an annoyance to me. You have the cash to pay it off, but that may not be the optimal solution.

You've got $85k in cash! That's way too much.

So your options are: -Invest 40k -Pay 2.25% loan off -Prepay mortgage 40k

Play around with this link: mortgage calculator

Paying the student loan, and applying the $315 to the monthly mortgage reduces your mortgage by 8 years. It also reduces the nag factor of the student loan.

Prepaying the mortgage (one time) reduces it by 6 years. (But, that reduces the total cost of the mortgage over it's lifetime the most)

Prepaying the mortgage and re-amortizing it over thirty years (at the same rate) reduces your mortgage payment by $210, which you could apply to the student loan, but you'd need to come up with an extra $105 a month.

  • +1 for the calculator and banging out some numbers. Its good to see options to make better decisions. – Andy Wiesendanger Mar 30 '11 at 20:15
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Just for another opinion, radio host Clark Howard would suggest killing the private student loans as quickly as possible. The only reason is the industry around private student loans has fewer rules as to how they interact with you, and they have historically been very unpleasant if you have to deal with them in bad financial times.

As a safety net, get rid of the private student loans as your main focus while you have the money and rates are low. Not for financial reasons per se, but for peace of mind.

The other advice in this question are great, but nobody mentioned the potential dark side of private student loans.

0

Don't frett to much about your retirement savings just put something towards it each year. You could be dead in ten years.

You should always try to clear out debt when you can. But don't wipe yourself out! Expedite the repayment process.

  • dying isn't cheap in most cases. – MrChrister Apr 2 '11 at 16:50

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