Why I’m in no hurry to pay off my student loans
March 4th, 2008 | Budgeting
When people hear the amount of student loans that my wife and I carry, their jaws drop. All told, our student loan debt is about $40,000. With minimum payments, we have carrying costs that total nearly $400 a month. And yet, even with this mountain of debt and burdensome monthly payments, I’m in no rush to pay it off.
When my wife and I graduated (2004 and 2005), interest rates for student loans were at their lowest amount in years. Originally, my loans were around 3.5%, while my wife’s were at 3.75%. We both consolidated our loans (under different companies, since we weren’t married at the time) with companies that offered to drop our interest rates an additional percentage point if we allowed them to automatically withdraw payments from our checking accounts. What does this mean? It means we owe $40,000 at less than 3% interest.
Now here comes the kicker. Inflation is nearly 4.5% and rising. Because the rate of inflation is above the rate of our loans, the difference between the two is essentially extra money in our pockets. Every month that inflation stays above 2.75% (the highest rate we’re paying on our loans) inflation is outpacing the accruing interest on our balance. For example, let’s say you owe a $100.00 balance in the month of December 2007 at 3% interest. That balance would have accrued about $0.76 in interest for a total of $100.76. But inflation, at a rate of 4.28% between December 2007 and January 2008, would have effectively reduced that balance to roughly $99.51 in January 2008 dollars. What does that mean? Over time, inflation is negating accrued interest and even paying down the balance.
Of course, our plan to have inflation help us pay down our student loans at a minimum rate is completely dependent on our own salaries increasing to match inflation. After all, our buying power gets decreased every time inflation goes up. Realistically, we may not get raises high enough to compensate for this as we wind into a recession. But thankfully, the U.S. government has given my wife and I an additional benefit for taking out student loans: The interest is tax deductible.
Ka-ching.
It seems like the difference between inflation (4.28%) and your interest rate (2.75%) is pretty minimal. On your example you gain $1.25 per month. Is that worth having a $40,000 debt in the back fo your mind all the time? I know it makes mathematical sense to not pay it down - but sometimes peace of mind makes more sense than math.
I think $40,000 combined school loans is pretty awesome. I know my mom alone had about $150,000. I have none, but that is also why it’s taking me 20 years to get my degree.
Well, that and laziness.
Mom’s last blog post..The finances behind being a stay-at-home-mom.
Thanks for the comments, everyone. JB, in my example I used a loan with a $100 balance. If apply it to a $40,000 balance like my wife and I have, and the economics suddenly look much more appealing.
Oh OK Seb - I misunderstood. Thanks for clearing that up!
JB’s last blog post..Accounts In Collections - When To Pay Off?
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just remember that deducting the interest is not a given. If you A. Don’t itemize your deductions, the deduction is worthless. and B. If you make too much money you’re not allowed to deduct it.
I love the rest of the advice though.
Actually, you don’t have to itemize deductions to take the student loan interest deduction. There’s a separate category for it on the 1040A.
I’m with Seb on this one. I was lucky enough to consolidate at a good time, and have a 2.75% interest rate on my $30K student loan. My plan is to pay off all credit cards and my higher interest variable-rate private student loan, sock away a nice chunk of change, maximize my retirement savings, and then will maybe think about the larger student loan. But I don’t worry about that one too much, just pay the minimum each month. I also like that it can still go into deferral, should I want to return to school.
What with low interest balance transfers on credit cards and good credit rating (and using a credit union) getting me a lower interest car loan, my student loans have the highest interest rate of any of my debt. That’s where all my focus is going to paying it off right now. I’ll have taken 3 years to pay off around $18000 in student loans. Then to the car. Then to the credit cards (which have the smallest balance by far anyway).
[…] presents Why I?m in no hurry to pay off my student loans posted at Pinching Copper. All told, our student loan debt is about $40,000. With minimum payments, […]