Tying to an article earlier that my colleague PK wrote, personal finance seems to have taken a dive in popularity in more recent years. As a writer for a confessedly self-aware personal finance crowd, this assertion may seem irrelevant, surprising, or, at worst, alarming. As a young college graduate, many of my fellow coworkers (as well as I) have student loans as one of their more significant financial obligations on top of car loans and (soon) mortgages. Some plan on paying down their student loans as fast as possible to deleverage themselves and then start saving for a home. I am of a different and not necessarily correct opinion: to hold onto the student loans for as long as possible due to their incredibly low interest rate and tax-deductibility for incomes up to $60,000 (partial deductions up to $75,000).
Sallie Mae, especially when compared to the more newsworthy GSEs such as Fannie Mae and Freddie Mac, has fared rather decently through the recession. The government-sponsored loan originator has had its down years and their Q2 earnings or lack thereof leaves much to be desired. Still, student loans is considered to be a relatively safe investment, one that is sponsored by the government itself with subsidies to Stafford and Perkins loans for certain conforming loans while a student is still attending school. This guarantees a four-year ROI on many of these investments for the originators, who can sell the loans for a profit at the end of the guaranteed return to loan servicers are a slight discount. Individual firms such as Discover, PNC Bank, Citigroup and Wells Fargo also have large books of student loan originations which have fared them well (relatively) through the recession. But due to the recent Great Recession, many young graduates are supremely interested in divesting themselves of student loans (not necessarily incorrectly) at the expense of other perhaps more prudent investments. A massive focus on deleveraging is one of the symptoms of the increase in savings ratethe country has seen since 2007.
Student Loans are a huge concern for recent grads (David Goehring)
First, the basics. Student Loan interest is tax-deductible even if you don’t itemize, up to $2,500 a year. For those in the 25% tax bracket, that is an extra $625 back a year. If you maintain a salary less than $60,000 the interest is 100% tax-deductible, and there is reason to believe that a significant portion (I would estimate at least 75% of recent graduates, due to a starting average salary of $50,034) fall under this threshold. If this is the case, the already low interest rate is essentially only three-quarters its actual value. Anybody arguing for paying down student loans will agree that it is a lesser priority to pay down than higher interest loans such as Credit Cards. And, at that, if you pay down your student loans it is most important to pay down those with the highest interest rate first. After paying down credit card debt, where the savings should go next is perhaps most important. It has been argued here (and here) and many other places that the Roth IRA is one of the best forms of investment vehicle for tax avoidance, but it has a cap every year, currently at $5,000 ($6,000 for those over 50, who I hope do not still have student loans). This means that if you are not capping out your Roth IRA investment for the year, you will not be able to make up the contributions, which is exacerbated by the fact that there is an income cap on Roth IRA contributions of $122,000 for individuals and $179,000 for couples. With the tax benefit from holding student loans as well as the massive tax benefit from investing in a Roth IRA, it seems foolhardy to me to pay student loans off before starting a Roth IRA. The only exception I see is the need to access the money before 59, but hopefully there are other available investment vehicles capable of providing those funds.
Employees with an employer match in a 401k should also make sure to contribute to this to at least the cap of the employer match before paying down student loans. The contributions are tax-free and the additional investment from the employer match is an additional form of income. After this, the choice between paying down student loans versus other forms of investment if more nit-picky, but there should be no reason to invest in your own tax-favorable, low-interest debt before making sure to maximize retirement vehicles and paying down high-interest credit card debt.
Cheers,
Cameron Daniels
