Let’s say you have a $25,000 student loan (what a coincidence, I have a nearly $25,000 student loan!) on which you’re paying about 3% interest, if you consolidated about two years ago, and you’re only sending in the minimum payments because you’re coming out ahead when you deposit the rest in a 5.15% Emigrant Direct account. This is exactly what I’d be doing if my loans weren’t in deferment because of my continuing education. (feel free to substitute car loan for student loan in the example, any low interest loan will suffice)
The only problem with that thinking is that while you are you coming out ahead by 2.15% (a little more considering the interest deduction), the difference between the 5.15% savings account and the 3% student loan interest, you’re actually falling behind from a purchasing power perspective because inflation is higher than 2.15%!
Now, if we were discussing this, you’d say that if you paid out the entirety of the loan as quickly as you could, you’d in fact be making 0% on that money because you would no longer possess it. That is true, however, by accelerating your payments you are setting yourself up to be debt free in the future and thus able to freely invest what you would’ve had to earmark for student loan payments. [Also remember that this superficial analysis ignores all other factors because we often can’t make large payments on our student/car loans because we have other financial obligations like mortgages/rent, food, emergency funds, etc. that take precedence, but for the sake of argument from a strictly mathematical perspective I ask that you leap with me.]
So, how is this different than the 0% balance transfer arbitrages that many personal finance bloggers (including myself) have started? How does a 3% car loan differ than a 0% credit card loan outside of the interest rate? The difference is the 0% balance transfer is the source of the interest bearing funds whereas with a car loan the source of the interest bearing funds are your own savings. 0% balance transfer money is a bonus.
I’m eager to hear everyone’s thoughts on this because for the longest time I was of the mindset that you should just pay the minimums, deposit the rest, and collect your difference in interest because you’re making more than 0% on your money. The floor of what you should demand on your money should be the inflation rate, which is much more than 0%.