The following is what I've written so far to examine and try to solve this dilemma I'm in of whether to put my extra money toward my student loan debt or invest it, which I'll be publishing on my site (but this is more for my own determination). I've done the best job I can quantifying the differences in interest and time frame. Given this data, is the answer clear? I've done some research on historical investment returns and some expected returns published on this page.
I'm especially confused about whether/how I would compare inflation—should I be comparing with real returns (inflation adjusted), or would this not matter for the sake of comparison since the money I'd be putting toward debt would be affected by inflation the same way....?
I would probably be investing in a passive mutual fund or ETF with mostly stocks and some bonds, maybe 70% stocks and 30% bonds (I'm 25).
Thanks in advance for any tips.
The decision of whether to pay off your student loans or use that money to invest for potentially greater overall returns could have an immense impact on your future financial state, and thus should not be taken lightly.
I myself am struggling to make this decision. Over the past 20 months I've managed to pay off ~23k of ~53k in federal student loan debt. I chose not to consolidate so I could strategically target the accounts off the ones with the highest interest rates first (opposite of the mega-popular debt snowball plan advocated by Dave Ramsey and his minions), which has saved me a lot of money.
But now that I have my two accounts with the highest interest (6.55% after a 0.25% autopay discount) paid off—for which it was a no-brainer to extinguish as quickly as possible—the interest rates of the remaining accounts seem comparable to returns on long-term investing.
Income and Expenses
My after-tax monthly income is ~$2,510, or ~$30,120k annually.
For the purpose of context, my monthly fixed expenses total $1208 ($710 in rent, $378 in student loan minimum payments, a $100 bus pass, and a $20 cellphone bill), and my variable expenses for necessities total ~$200 per month (~$100 in food and ~$100 in utilities). I'll assume a $100 average monthly expense for everything else (clothes, home items, going out to the movies, travel, etc.).
Thus, I have ~$1000 per month to do decide what to do with. (Health and dental insurance are paid in full by my employer, which is why those expenses are not factored in. Also, my food expenses are relatively low because I pick up food from my local food bank each week.)
Remaining Student Loan Balances
Here are my current student loan account balances and required monthly minimum payments. By paying just the minimum payment, I'd pay each off in 8.4 years, due to my originally choosing a 10-year repayment plan.
- $6530 at 4.41%, $77.10/month.
- $4900 at 4.41%, $57.93/month.
- $6,650 at 3.61%, $75.92/month.
- $4,980 at 3.61%, $56.88/month.
- $4,950 at 3.15%, $55.54/month.
- $4,870 at 3.15%, $54.61/month.
The minimum payments for my student loans total $378 per month.
I plugged these numbers along with my total budget for student loan payments (including the $378 in required minimum payments) to a handy calculator (http://undebt.it/debt-snowball-calculator.php) that determines when I'd be done paying off my loans and the total interest I'd accrue by applying my monthly payments using the debt avalanche method, i.e., applying all extra available money toward loans with the highest interest rate.
In that scenario, I'll be done paying off my student loans in May 2019, and my total interest cost would be $1,258. By paying just the minimums, I'd be student loan debt-free in October 2025 and my total interest would be $5,542—an additional $4,284.
Incidentally, if I used the popular (and much-loathed-by-myself) debt snowball method of applying all extra money toward the loans with the lowest total balance, I'd be done paying off the loans during the same month, but I would have paid an additional $111 in interest. I imagined the difference to be more extreme, but I'm not delusional enough to take that route (in other words, the irrational motivation of getting rid of accounts more quickly would not outweigh the cost of paying more in interest).
Payment of student loan interest may make one eligible for a deduction of taxable income. You may deduct a maximum of $2,500 of both required and additional interest payments. Your deduction eligibility is gradually reduced and eventually eliminated by phaseout as your modified adjusted gross income (MAGI) increases to the annual limit for your filing status.
Your MAGI is your adjusted gross income, your gross income minus certain deductions, with certain items that weren't used to calculate both your gross income and adjusted gross income added. Examples of things that may be added include tax-exempt interest, tax-exempt foreign-earned income, and deductions for IRA contributions and costs of higher education.
Your MAGI limit depends on your tax bracket. In my case, I'm in the 15% tax bracket and unmarried, making my limit is $80,000; with my measly salary I definitely don't have to worry about losing my eligibility for the deduction.
Let's take that additional $4,284 I'd be paying if I began paying just the monthly minimums across my loans. In that scenario, it would take me 101 months instead of the 24 months in the scenario in which I'd apply my spare $1,000 per month toward my student loans in the debt avalanche fashion; that's an additional 77 months (6.4 years). That's an extra $56 per month, or $667 per year, that I could deduct from my taxable income. Since I'm in the 15% tax bracket, that's an additional $100 in tax savings each year in excess of those of the 'all-in debt payoff' scenario. Since it would take me an additional 6.4 years, that would be $640 I could deduct from my total extra interest cost, making it $3,644.
The question now is: Would the returns of putting that extra $1,000 per month for those extra 77 months toward investing be worth more than that $3,644?
When comparing the overall return of paying off the loans and investing, the returns of paying off loans are relatively straightforward (my student loan interest rates are fixed, as are all of those for federal student loans—if mine were variable, things would be a lot more convoluted). In the the case of investing, these factors should be considered when estimating returns:
- What are the likely after-tax returns?
- What are the likely after-inflation returns of investing?
- What are the after-fee returns of investing?
For student loans, the amount I'm paying off will be affected by inflation, so for the purpose of this comparison, inflation is not influential. And obviously, fees don't apply, so that's a sole consideration of investing.