College Loans

First off I want to apologize to my readers because these first blog topics will jump around a bit. I am attempting to summarize and remember 16 months of conversations from when I first began my financial journey in February of 2009.

After I had designed the basics of my financial picture I was sitting high. Just look at what a DINK (Dual Income with No Kids) can do. Our checking account was flush, we had settled after a couple of months after moving from San Antonio, and we were both gainfully employed for the foreseeable future.

Investments or Debts?

The first discussion I started having with family (primarily my brother Walter who you will likely see as a reoccurring character in these blogs) and friends was on investing. Do I dump my cash into the market, do I just put it into my Bank of America (BoA) savings account, do I buy Certificate of Deposits (CDs), or some other new and exciting investment option.

It was during these conversations I called upon a college buddy who now resides in OK. He had gone into the banking industry, and like me had started his post-college financial journey. He had a question that changed my perspective 180 degrees. “Tell me about your college loans…” This question literally exposed that giant pink elephant that was hiding behind the only chair in the room. I just took for granted that the loans I signed off on at the beginning of every semester were going to require being paid off. The other reason this was a novel concept to me at the time was that I was still technically in school as my graduate program requires that you complete a year residency requirement before being granted your Masters. So I was employed making good money and was still technically a student paying tuition and completing papers.

College Loans

So the question “Tell me about your college loans…” caught me by surprise. I immediately found some old letters I had stashed away in old college papers that were from my college loan financiers (turned out to be ACS-Education which I later learned is a part of BoA I believe) and began doing my research and was surprised by what I found. I had three types of loans that broke down as such:

  15-Apr-09
  Balance
Subsidized $8,500.00
Subsidized $16,824.40
Unsub @ 6.8% $26,332.05
total $51,656.45

As you can see our “investment” questions quickly got diverted into debt pay down discussions though at the end of the day paying down a debt becomes a type of investing.

College Loan Details

The first major understanding of my particular college loan situation was the discovery of what a subsidized and unsubsidized loan can mean over the course of just a year. The way my loans broke down for the educational components they subsidized is as follows:

Undergraduate Studies – Subsidized loans at 3.745 Variable Rate (Not a worry since Uncle Sam is paying the interest until June of 2010)

Graduate Year 1 and 2 – Subsidized loans at 6.80% Fixed Rate (Not a worry since Uncle Sam is paying interest until June 2010) Was also the MAX amount in unsubsidized loans I could take my two graduate years

Graduate Year 1 and 2 – Unsubsidized loans at 6.80% Fixed Rate (Eureka! We have found our investment vehicle for the next several years!)

The Plan

Now armed with a true sense of our financial household and a new long-term tenant in our bank account I did the math. What to do…what to do… Mr. Dave Ramsey would say go crazy and pay that stuff off now! Other schools of thought say pay the minimum payments (tax benefit up to $2,500 of the interest you pay towards your student loans) and 10 years later have a small party to celebrate.

Quick tangent: The tax “benefit” of having a college loan – Ok, so this “benefit” is tricky if you do not frame it correctly. Walter has done a great job about helping me keep this in perspective and, in turn, realize a college loan is not worth the “benefit” for purely the “benefit’s” sake. I am going to do some quick math, but bear with me.

College Loan
Loan Amount $10,000
Interest Rate 10%
Interest Paid $1,000
Tax Benefit $250.00
(Assuming 25% Tax Bracket)
Still Paid Out-of-Pocket $750.00

Now comes the question. “Warren, why would you pay someone $750 so that Uncle Sam will pay $250. If I had no loans and that $1,000 in interest became income the following table comes into play.


College Loan Income
Loan Amount $10,000  
Interest Rate 10%
Interest Paid $1,000
Gross Income $1,000
Tax Benefit $250.00
(Assuming 25% Tax Bracket)
Tax Paid $250
Still Paid Out-of-Pocket $750.00
Money in Checking $750

I end up having that $750 now in my pocket to spend on fast cars, women, and diapers and all the other fun stuff that 25 year old men buy.

** Note I am not a CPA. Please do not take the above tables as fact, but merely a demonstration of a concept to the best of my ability at this time.

So the million dollar question…Can I make a higher return on investment (ROI) in the market or should I pay off student loans. In essence, can I make more than 6.8% after taxes in the market or should I stay with the guaranteed 6.8% return on my money and pay down those loans. I decided to go a mix bag and do a bit of investing and a bit of student loan pay down. Before I even made my first payment to my student loans that unsubsidized portion had accumulated over $1,000 in interest in just 12 months. So the first $1,000 we paid did absolutely nothing to the principle of the loan… That had to be one of the saddest payments I had ever made to anything… but that is a heck of a lot better than have a $3,000-$4,000 hill to climb once my student loan grace period ended in June of 2010.

Second Tangent: Why are my student loans at a higher interest rate than what I can go out and buy a mortgage for? When I can go get a 4.5% mortgage and have a 6.8% interest rate on my student loans it seems like somewhere the equation got backwards… If only I was 4 years younger and got out of college when rates were still in the 3% range for student loans.

The Plan in Action

Below you will find two graphs showing our progress on both fronts. While I did not go full Dave Ramsey and dedicate every dollar after a $1,000 emergency fund, we were still able to make SIGNIFICANT progress on paying down debt. In turn, we have also created a nice bank account of cash assets that gives us the option to potentially buy a house after our next employment placement, pay for any birth/baby related expenses, and have the peace of mind knowing that we can pay our bills for at least three months if a true emergency came up.


 

Advertisements

About odysseustoday

25 year old man starting his financial journey.
This entry was posted in Education, Finances, Financial Tools, Resources, Student Loans and tagged , , , . Bookmark the permalink.

One Response to College Loans

  1. B Yehl says:

    I would like to see you address the concept of a “tithe” and how you and your wife give back a portion of your money to God.

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s