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Revisiting Paying Off Student Loans

Student loans have been on my mind ever since I read about the latest legislation dropping Stafford rates earlier this month [3].

Here’s a brief recap of where my student loans are now. I consolidated my Stafford loans years ago, locking in a very comfortable rate of 3.25%, and the balance currently stands at a little over $22,000. The loan had been in deferment as I completed my MBA at Johns Hopkins, which has stopped the clock the last few years, but with my graduation the interest has started to accrue again. We earn too much to be eligible for the student loan interest tax deduction [4] (certainly not a bad thing) and thus bear the full brunt of the 3.25% rate. Once again, I’m revisiting my student loan dilemma [5].

$22,000 in student loans at an effective tax rate of 3.25%. We also have a mortgage of around $220k at an effective tax rate of 4.3125% (the rate is 5.75% but it’s tax deductible, in the 25% tax bracket the effective rate is 4.3125%; we could consider only the deduction above the standard deduction for couples $10,900 but that begins to get overly complicated). Math says that if we were to pay down a debt, it would be my mortgage first because it’s at the higher tax rate. So I should never make more than the minimum payment on my student loan unless we have paid off the mortgage (which I envision is something that won’t happen for quite some time).

Proponents of Dave Ramsey’s Debt Snowball approach would say that you should pay off the student loan first because it’s the smaller amount (ahh, psychology). I personally don’t subscribe to that idea, I go by the Blueprint for Financial Prosperity Common Sense Payment Strategy [6] (okay I just made that up, it’s how most people who understand interest rates and math would pay down their debt, I just added some color). While I anticipated this result, it’s always good to revisit things as situations change.

So, the student loan is here to stay for the foreseeable future.