Pay off student loan or save?
This article is part of the Ask the M-Network series. Leah submitted a question and asked:
I’m 28. I have 9% of my income going into a 401k, no credit card debt, a paid-off 9-year-old car, and 5 months expenses in savings (some of that earmarked for the next new-to-me car). I also have a student loan of $11K at 2.5% interest. I want to start aggressively paying down the student loan, but because of the low interest rate my boyfriend is urging me to put that money in savings instead to earn interest and act as a larger emergency/irregular expenses fund. Am I better off holding on to the cash, or getting rid of the debt?
Update: I received the following reply from Leah after posting this article:
I wanted to thank you and your colleagues and readers for your advice on my question regarding saving vs. paying off student loan debt. It was really helpful to get advice from people who share my financial values and who understand the psychological value of being debt-free! I’ve decided to split my efforts between saving towards my next car and aggressively paying down the student loan.
I also really wanted to express my gratitude for the change in perspective this experience has offered me. The changes that have the most effect on our lives are not events, but changes in perspective. For the last 4 years I’ve felt like I’m really struggling to accomplish my financial goals without getting very far. Putting together a summary of my financial position and hearing all of your opinions on it – I finally feel like I’m succeeding. It’s time to feel the power of my accomplishments.
Patrick from Cash Money Life
Several months ago when banks were paying 3% interest or more, I might have agreed with your boyfriend. But right now you have a very solid emergency fund and savings accounts aren’t paying very high interest. You would probably need to invest in CD’s to earn a 3% interest rate (if you can find those rates). The problem with CDs is that your money is tied up longer and you won’t have quick access to it. Based on your situation, I would probably repay the loans as quickly as possible, and for two reasons:
Repaying the debt makes sense financially. Since the interest in your emergency fund is paying less than the interest on your student loans, repaying those loans becomes a more attractive option.
Repaying the debt makes sense psychologically. Getting out from under the weight of debt is a huge psychological boost. It truly is like a weight being lifted off your back. Eliminating debt is one of the main principles Dave Ramsey teaches in his Financial Peace University. He believes you shouldn’t take on any unnecessary debt, and that you should work to eliminate any debt you have. You are in a financial position to eliminate the last remaining debt you have, which will free up additional money for other uses.
Overall, your financial position is moving in the right direction and I wish you the best.
Plonkee from Plonkee Money
If you can find a savings account that pays more than 2.5% interest then you might be better off financiallly by saving the money. On the other hand, you might benefit from a slightly larger emergency fund / savings as at the moment it’s taking people typically several months to find a new job when they’ve been laid off. Added to which, it’s not clear when your car is going to bite the dust.
Failing all those scenarios, paying off the loan is a better use of the money than just dumping it in a low interest savings account where the money has no particular purpose. Personally, I choose to invest extra money rather than pay off my student loan which is about the same size and interest rate as yours. But that brings up a whole raft of other questions about risk and asset allocation.
At the end of the day, regardless of what your boyfriend thinks you should do whatever sensible thing makes you most comfortable. You have already demonstrated that are perfectly capable of managing your own finances. You can make a good choice here too.
Pinyo from Moolanomy
I think you are doing great financially. The good news is that you are deciding between two good options, and you can’t go wrong choosing either one. If you want to pay down the student loan you should definitely do it. Dave Ramsey recommended paying off your debt first to million of people and they are doing just fine.
On a personal note, I agree with your boyfriend, because long-term investing will more than likely give you a better return on investment than paying down your 2.5% student loan. For example, you can increase your 401k contribution, or start contributing to Roth IRA. However, I wouldn’t simply put the money in a savings account right now due to the low interest rate. If you’re not going to put it in tax-advantaged vehicles like 401k or Roth IRA, you’re will be better off paying the student loan.
Paidtwice from I’ve Paid For This Twice Already”¦
Wow! It is like my life except you’re in a way better position! :)
I say pay off the debt. A savings account right now earns paltry interest. As long as savings accounts are earning so low, I would be aggressively getting rid of your financial obligation. You have a good sized emergency fund already.
When savings rates are high again if you still have the debt you could reconsider. Paying off debt rocks :)
Readers, what do you think? What would you recommend? Disagree with any of the replies?