|Student Loan A||-0.37||Investments||11,668.70|
|Student Loan B||-5500||Cash||9,046.11|
|Student Loan C||-5500|
Upon graduating college, I had $14,500 worth of student loans to pay off. I’ve already paid off one $3.5K loan leaving me with around $11K left to pay. Although being in debt is typically bad, student loan debt is sometimes considered “good debt” because of the relatively low interest rates and tax deductions that come along with paying interest.
For example, if, at the end of the year I paid $2,000 in interest on my student loans, I could take a deduction on my tax return for $2,000. This would result in me saving money on taxes. If I was in the 25% tax bracket, I would end up saving about $500.
A close up on the loans
- Loan B: $5500 loan @ 4.660% interest.
- Loan C: $5500 loan @ 4.290% interest.
However the interest rates shown above are deceptive. After taking into account the tax savings that I would incur from paying the student loans slowly over time, the effective interest rate is actually closer to 2.95%. Let me show you why:
To make things more simple, I’m going to combine my two loans into one loan. Since Loan B and Loan C have the same principal, I can just take the average of both the interest rates to have find the effective interest rate. Thus, I effectively have
- Loan D: $11000 loan @ 4.475% interest.
My top tax bracket federal is 25%, and my California State tax bracket is 9.3%. Thus, my combined top tax bracket is 35.3% What this means is that for every additional dollar I earn, I pay 35.3 cents to the government. This means that every dollar I deduct from my taxable income saves me 35.3 cents. Applying this logic to the student loan interest means that I’m saving 35.3% of whatever interest I pay on my loans (since the interest is tax deductible). Thus:
- My effective interest rate = 4.475 * (1-0.353) = 2.895325
I’m only paying 2.9%* interest on my student loans!
*This scenario only applies fully if the total interest you are paying on your loans is less than $2500 for the given year.
One shot kill
Unlike most people, I have the opportunity to kill my loans with 1 single payment.
- I’m not efficiently allocating my capital. I could earn more money by investing rather than paying off my loans.
- I’m losing out on an excellent credit building opportunity.
- Paying off the loans now will make it so that I have to spend more time saving money for a property/house.
- I would end up paying the government significantly more in taxes
- I’ll be 100% out of debt and have zero liabilities
- Increased cash flow due to no monthly loan payments
The reason behind my choice
Looking at this situation rationally, the Cons outweigh the Pros on my decision to kill my student loans. Physically speaking, I lose much more by paying them off all at once than by slowly paying them off as time goes on. However, I plan on making the irrational choice, and choosing to slay my debt despite the financial inefficiencies associated with doing so.
My reason? It’s quite petty – I don’t want to play the student loan game. I don’t want to deal with a monthly responsibility to pay off debt. So, I’m going to ruthlessly kill them in 1 shot and destroy my liability.
I may very well regret this decision going forward with my 99K challenge. But, I’ll take it as a handicap (albeit however small), as after all, I never did ask for an easy life.