Question about student loan repayment

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Question about student loan repayment

Postby Joanna » Tue Aug 14, 2007 6:17 pm

I am almost done paying off the last of my credit card. I estimate I will have it paid off in two months at most. I am very responsible with it, but had some expenses related to moving home from overseas and to getting my professional certification processed after graduate school (many fees!) So I had it up at $5000 at one point, and now it is nearly paid off.

My only other debt is my student loan. It is a line of credit that is paid back at a special student rate of 3%. It is currently costing a little under $100 a month. According to my statements, I have not really paid back any of the principal yet. It looks like they will just keep collecting at 3% indefinitely.

So I am wondering if there is any benefit to paying it off sooner. I would really like to be able to start saving in an RRSP a little, or perhaps buy a condo or home. Once I get a permanent teaching contract, my salary will go up quite a bit from the hodgepodge of part-time stuff I am doing right now.

So, is it better to pay off the student loan? Or should I just keep it since any other loans I might get (e.g. a mortgage) will not be at the low rate of this one? And I do need to start putting away for retirement as I am 30 now and have never done that yet...

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Postby plonkee » Wed Aug 15, 2007 4:30 am

I think that you should start putting away for retirement before anything else.

I have a student loan at about the same rate, and I pay the minimum possible and save / invest elsewhere. If you can get a savings account or you can invest for returns greater than 3% then doing so is financially the better move.

Assuming you currently have an emergency fund, I'd suggest starting an RRSP and then a savings account (>3% interest) and leaving the student loan. If the debt bothers you, you'll be able to pay it off out of accumulated savings quicker than by making increased payments.
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Postby Kate » Wed Aug 15, 2007 5:31 pm

I'm conservative by nature and i don't like debt, so I'd be paying off the student loan, but that's really an emotional reaction, not a financial one. Your question is similar to the "should I invest in my RRSP or pay down my mortgage" question. Many experts say to invest in RRSP's and then use the tax refund to pay down your mortgage. You could do the same thing here.

Another consideration though is your marginal tax rate. If you don't have much income yet, an RRSP is less worthwhile. The earnings would still compound tax free, but you wouldn't get much of a tax break on the contibution. You're better to save the contribution room to use when your tax rate is higher.

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Postby sjpeer » Wed Aug 15, 2007 9:02 pm

I subscribe to the Dave Ramsey framework which is:
1. Save $1,000 in a short-term emergency fund.
2. Pay off all debt except your mortgage.
3. Save 3-6 months of expenses for a long-term emergency fund.
4. Save 15% of your income for retirement.
...there are a few more steps but these apply to your question.

The idea is that you work on each step, one step at a time until it is achieved, then move on to the next step. This approach gives you a lot of focus and helps you reach your goals at an accelerated pace rather than constantly changing your approach and making emotional decisions.

According to these steps, you should pay off your student loan first. Mathematically it may not be optimal, but do you really want to keep paying $1,200 a year with the principle staying the same? There's a tremendous emotional benefit to paying off your debt as well.

This advice is also a little different because it recommends paying off all debt before starting to save for retirement. Again, the purpose is to help you focus your efforts. I have a couple of articles on my blog about Dave Ramsey, saving for an emergency fund, etc. Feel free to check them out (link below).

Hope this helps.
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Postby jdroth » Thu Aug 16, 2007 7:21 am

My impression is that this is yet another instance where you ought to <b>do what works for you</b>. How does the studen loan make you feel? Is it a burden? Or is it just a minor nuisance? What's the balance? How quickly could you pay it off if you applied your energy to it?

If the loan is a burden, then follow sjpeer's advice, and take the Dave Ramsey approach. But if the loan doesn't worry you much, and you have confidence that you'll tackle it in due time, then by all means begin saving for retirement. An early start on retirement is <i>huge</i>.

I'm willing to bet, though, that the best answer is to do a little of both. :)

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