Like many Americans, I accumulated student loan debt during college. While it’s been years since I was in school and the balance has diminished, it’s still non-zero today. I could have dispatched them years ago but didn’t. However, now I’m giving some serious thought to it in order to simplify my personal finances.
Comparing Interest Rates On Other Debt
The first reason why I haven’t dispatched them is the interest rate is extremely low. After I graduated from school, I consolidate all of my loans together at 3.125%. Setting up direct withdrawal reduced that rate by .25%. After making on-time payments for 36 months (hard to miss with direct withdrawal!), another 1% was dropped. Final interest rate: 1.875%.
Compare that to the 4% rate on my mortgage. Math tells me that I’m better off paying any extra money towards the debt with the larger interest rate. How much? By my math, it’s about $430.
But it’s more complicated. If I put the lump sum towards my mortgage, I’d have $245 less in mortgage interest when I itemize deductions on my taxes. With my marginal tax rate of 22%, that’s about $54 of tax savings I’d miss. And that’s just one year alone. Next year I’d save $33, and the year after $12, after which the student loans will be paid off.
On the other hand, my student loan interest is no longer deductible on my taxes because my income is higher than the limit.
So that $430 savings is now only $331.
Is it really worth the hassle of another monthly bill for the next 36 months?
High Yield Savings Accounts
The other interest rate arbitrage angle is high interest savings accounts. Until recently, one account I have paid more than 2.25% interest. In recent months that has fallen to around 1.6%, but for a while, I was better off putting any extra principal in the savings account instead of towards the student loan. Okay, not exactly better since the savings account earnings are taxed at my marginal rate of 22%, but a small price to pay for optionality.
But again, is it really worth the hassle of another monthly bill?
All Debt is Not Equal
Looking at the different types of debt, student loan debt is one of the most unforgiving. Bankruptcy can’t banish it like credit card debt, and foreclosure isn’t an option either. Default on your loans and you’ll see your wages garnished to pay off your loans. Is it really worth keeping this kind of debt around if you can get rid of it?
Personal Finance Simplification
Perhaps the primary reason why I want to get rid of this debt is to simplify my personal finances. True, with auto-pay shuffling the money around, it’s not likely that I’ll miss a payment and the only annoyance is the monthly email reminding me about the debit and the paper statement which I’m unable to turn off. First world problems, I know. But every bit of simplification helps me focus on things I’d rather be focusing on.
So, what do you think? Should I pay off my student loan debt early? I’d love to your thoughts.