Dear Debt Adviser,
My question is regarding school debt. I am seven years into a 25-year Stafford loan. I pay $244 a month, and the interest rate is fixed at 3.13 percent. I have saved well beyond a six-month cash reserve, but I'm curious if it makes sense to pay off this loan early. My other debt is a 15-year fixed mortgage at 3.5 percent and a zero percent car loan with 23 months left. Is it smart to dump such a large amount of cash to pay off a low-interest loan? Thank you.
Great job so far! You have successfully managed your money to the point that you are in a positive cash-flow position and have a substantial emergency savings account in place. You are now ready for phase two of financial success. Based on the information you have given me, my answer to your question is no, I don't think you should pay off your low-interest student loan. I believe you can put your money to work for you in better ways. Here's how.
Because your debts are manageable and at appropriate terms, I believe you should leave them alone and set some more advanced financial goals and work on funding them. Short- to medium- term goals are those that take from less than a year to three years to fund. Long-term goals are those that take more than three years to fund.
Short- to medium-term goals could be saving for the next car, a wedding, a vacation, graduate school and so on. Long-term goals could be retirement. Don't make the mistake of thinking of retirement as an old person's game. You can be financially independent to do whatever you want, when you want. Isn't that more interesting?
I asked financial planning expert Marcy Person at Person Wealth Management Solutions for her thoughts, and she suggested that you use some of your surplus income to fund or increase the contributions to your 401(k), if you have one at work. This is especially valuable for you if your employer has a matching program, or if you are in a high tax bracket or in need of deductions. If taxes aren't an issue, she suggests a Roth individual retirement account or a Roth 401(k) as great alternatives, and the younger you are, the better.
Since you have enough income to service your debt, and the rate is fixed at 3.13 percent, she also advises that investing the cash would be a better choice than paying off the loan over time. "Although the short-term returns may not always appear to exceed the cost of borrowing, the long-term result of investing in a tax-deferred investment will usually far exceed the current low cost on the loan," Person says.
I also want you to start funding other, more fun financial goals. Things that come to mind are summer trips, a big down payment on your next new car, a hot tub for the backyard, you get the idea. Also, I'd be in favor of revisiting your emergency savings account and adding to it until you reach one year of living expenses. Six months seems like a long time, but the job market is not so hot right now and a search can take much longer. So if you can buy some extra time with a bigger account, that's a good thing.
If you still have some money to burn after you have developed a plan to fund your new goals, consider beginning an investment program. A good financial planner will help you determine how and what investments might best work into your goals and long-term plans.
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