Just got a pile of cash; should I pay off student loans?

[cautious]

I just obtained ~$150,000 from a one-time event. Now I'm trying to figure out what to do with this money. I have no debts except for a $50,000 federal graduate student loan at 6.8%. My income otherwise is $50,000/year.

I plan to invest a substantial portion of this money in ETFs, largely index funds such as SPY but also some higher risk ETFs (not leveraged, just more segment-focused).

I've read up on advice about student loans, but my federal graduate student loan interest rate (6.8%) seems to be quite a bit higher than what most people here have discussed, so I'd like to ask for your thoughts on what I should do with regard to my student loans. Should I accelerate the payment by some fraction, or should I just pay them all off? The minimum payment is ~$600/month.

Thanks!

 

[REWahoo]

By paying off your loan you will be "earning" a risk-free 6.8% per year on the $50k loan amount, and that's hard to compete with from an investment/risk standpoint. I say pay it off and be debt-free.

 

[Webzter]

Seems like freeing up $600/month on a salary of $50k/year would create a lot of flexibility with regards to other opportunities that might arise.... and at nearly 7% interest, I'd be keen on refinancing that or paying it off outright. This is especially true given the difficulty of discharging student loans if it ever came to having to declare bankruptcy.

 

[cautious]

Thanks to both of you for the helpful advice. If the interest rate were lower, I might try to beat it, but I really have no expectations of beating 6.8% (especially since I have to pay off loans with after-tax money...) so I think I might just go for it. I'm still open for contrary opinions if anyone has their reasons. Thanks!

 

[aaronc879]

I would definitly pay off the loans in full. Are you a home owner? If you aren't and you expect to stay in the same area for several years, then i'd use some of it for a 20% down payment. Otherwise, I don't think you can go wrong investing it long-term in index funds like you already suggested.

 

[Webzter]

I'm still open for contrary opinions if anyone has their reasons. Thanks!

Parties where your friends are complaining about student loan payments will be awkward. You can't exactly commiserate with them and you'll be a social pariah if you say "well, I owed $50k but I was tired of paying it so I wrote a check for the full amount."

You'll miss out on deducting the interest on your taxes.... if you manage to get over the standard deduction and itemize, that is.

You'll no longer have the benefit of using the department of ed's awesome, blazing fast, state of the art website to service your loan.

Owing money to the government means you'll always have someone that cares [-]looking out for you[/-] willing to hunt you down no matter where you move.

An extra $600 a month can go straight to someone's head. That's a loaded mid-size sedan payment right there. You could afford to order of the McD's dollar menu 600 times more per month! Who can handle choices like that?!?

 

[cautious]

@Webzter: Playing both sides now, ehh? The social and intellectual benefits that you've pointed out actually far outweight the financial gain of paying this off early, I've now concluded!

 

[ERD50]

I'm still open for contrary opinions if anyone has their reasons. Thanks!

OK, I'll throw out one, but by no means take this as a recc one way or the other - it's just ONE consideration:

As I understand it, student loans are forgiven at death. So one factor in your decision, to make this more apples-apples, would be to consider the added cost of $50,000 of life insurance. Because paying off the loan and passing would leave your estate $50,000 poorer. The life insurance would null that out.

Probably a small factor, and maybe only a paper calculation if you have no one to leave money to. Overall, at 6.8%, I'd lean to paying it off since you would still have the $100,000 in liquidity. And I'm one of the apparent minority on this forum who has no fear of moderate amounts of debt, as long as the rates are low and liquidity is not compromised.

-ERD50

 

[Meadbh]

And I'm one of the apparent minority on this forum who has no fear of moderate amounts of debt, as long as the rates are low and liquidity is not compromised.

I'm one of those who is not afraid of "good" debt. "Good" debt will make you money in the future. Is your student loan "good" debt? IMHO it was "good" when you took out the loans as it enabled you to complete your education. If your education is now completed, that debt has no future value. This is a great opportunity to say goodbye to it.

 

[cautious]

@ERD50: thanks for the additional consideration. I'm under 30 and single, so the life insurance wouldn't benefit any real dependents.

@Meadbh: technically I still have a bit of time left before I complete the degree; my situation is highly unusual. I can't quite see how the question of whether or not my education is completed changes the calculus. I agree with the gist of your statement but am not sure if I'm missing some material difference here.

 

[Texas Proud]

OK, I'll throw out one, but by no means take this as a recc one way or the other - it's just ONE consideration:

As I understand it, student loans are forgiven at death. So one factor in your decision, to make this more apples-apples, would be to consider the added cost of $50,000 of life insurance. Because paying off the loan and passing would leave your estate $50,000 poorer. The life insurance would null that out.

Probably a small factor, and maybe only a paper calculation if you have no one to leave money to. Overall, at 6.8%, I'd lean to paying it off since you would still have the $100,000 in liquidity. And I'm one of the apparent minority on this forum who has no fear of moderate amounts of debt, as long as the rates are low and liquidity is not compromised.

-ERD50

I don't mind a moderate amount of debt....

I got zero percent for furniture purchase for 4 years...

I got 4.?% for a car loan for 6 years...

I got 4.5% for a house loand for 30 years...


The only negative was that my credit rating took a big hit when all three of these were taken out within one year... my average length of open accounts dropped a lot... but, it has been going back up so no long term problem...

 

[Texas Proud]

To the OP...

I am one that trys and balances the interest rate with the other options... to me 6+% interest is pretty high for me as debt... sure, I might be able to make more investing the money, but as pointed out by someone else it is not risk free... paying off this debt is a risk free 6.8% return...

If I could get the debt refinanced to the low 4s... or even in the 3s, I would keep the debt and invest my money in stock funds...

 

[Webzter]

And I'm one of the apparent minority on this forum who has no fear of moderate amounts of debt, as long as the rates are low and liquidity is not compromised.

-ERD50

Well, really, that was the basis for my rec to pay it off. On a $50k salary, a $600/month loan payment is a significant cashflow hit. And, since you can't wipe out a student loan in bankruptcy*, it's sort of "there" no matter what.

If it were a lower interest rate, or a smaller percentage of monthly pay, I'd likely advise differently (although, in full disclosure, we paid off the remaining $3k we owed on student loans even though the $116/month it freed up was not significant)

* from my limited look at it and limited understanding of bankruptcy law

 

[cautious]

@Texas Proud: Makes sense. I wouldn't take out a 6.8% loan to invest in the stock market, but I might do so with a 3% loan.

 

[FreeAtLast]

I would pay it off. You took out the loan because you did not have the money for the education at the time. Now things have changed.

My daughter had almost that amount in student loans. Now she has under 20k which we together will pay off within about a year.

It is a good feeling to be working down the balance.

 

[FUEGO]

I would pay it off. I am carrying much more student loan debt than that, but mine is at 0.75% fixed for 30 years. At 6.8% you are getting a risk free 6.8% return. Double what you would get from a bond fund right now, and not too much lower than what some say you'll get from stocks long term.

 

[Bestwifeever]

Eh, you're young, pay off the student loan--you'll still have $100K to invest and plenty of time to sock away/invest the equivalent loan payments (i.e., you'll recoup that $50K in no time, it's hoped). If you were almost at retirement and living off your investments, keeping the cash might make sense, but imho not at your age.

 

[cautious]

It looks like the winner is paying off my debt. Thanks for the input, everyone!

 

[powerplay]

I think using some of the money to pay off the debt is the best idea. You will then be debt free!

 

[Meadbh]

@Meadbh: technically I still have a bit of time left before I complete the degree; my situation is highly unusual. I can't quite see how the question of whether or not my education is completed changes the calculus. I agree with the gist of your statement but am not sure if I'm missing some material difference here.

It's about utility.

X years ago you really needed an education, and you didn't have any money. Therefore the utility of borrowing the money at 6.8% interest was high.

Now you've got the education, and you have money, too! Today, would it be worth your while to borrow money at 6.8% to get the education that you already have? I think not.

Pay off the loan and you will start your career debt free. That has a high utility for someone hoping to ER some day!

 

[Walt34]

I'd pay it off and be done with it for the purely emotional reason that I loathe owing money and making payments.

It has more to do with a sense of independence than anything else because my future options and opportunities are then limited by the amount of debt and the interest I've committed to pay on it.

And it's nice to know that I don't owe nobody nuttin'.

 

[steelyman]

Once I got out of graduate school and landed a job, I attacked credit card debt, car loan, and student loans. I got them paid off within a year or so and the feeling thereafter, once all were paid off, was excellent. If nothing else, you feel like you just gave yourself a big raise since there are no longer any payments. And that raise can go towards saving for ER if you like.

 

[Jay_Gatsby]

Before you pay off your debt, you should really look at refinancing it at a lower interest rate. If I recall current student loan rates correctly, you could probably cut your interest rate in half, if not less. Paying 3.4% would be a great deal less tempting to pay off with cash that could be put to work (or invested in blue chip stocks with dividend yields that are around that percentage).

 

[cautious]

@F. Scott Fitzgerald: The counterpoint I've been looking for! I'll ask my school's financial office re: refinancing at a lower rate before I make the jump. Thank you.

 

[scrabbler1]

To the OP...

I am one that trys and balances the interest rate with the other options... to me 6+% interest is pretty high for me as debt... sure, I might be able to make more investing the money, but as pointed out by someone else it is not risk free... paying off this debt is a risk free 6.8% return...

If I could get the debt refinanced to the low 4s... or even in the 3s, I would keep the debt and invest my money in stock funds...

This was always my mindset when it came to figuring out whether to pay off debt or not, as well as whether to incur any new debt.

On a much smaller scale compared to the OP, I had an unexpected windfall in the first few months after I graduated from college in 1985. I had student loans of only $8,100 (still a fair sum back then) but somehow discovered I still had about $5,000 in an old custodial bank account I had forgotten about. Before the 6-month grace period expired to begin repaying the loan, I paid off $5,000 of the loan to not only lower my interest expense (the loan was about 8% and the interest was still tax-deductibe althouth the 1986 Tax Reform Act would soon phase that out) but to also lower the amount of the monthly payment.

I was still building up my own savings which were in a simple bank account at the time (I was not yet into serious investing yet, so an implied "return" of 8% looked really good!).

But getting more than halfway to paying off the loan was crucial in the middle of 1987 when I was able to pay the rest of it (less than $3,000) off, something I would not have been able to do if the outstanding balance had been higher. By then, I had already learned that the interest deduction was being phased out.