60 Second Guide to Getting Out of Dept | 60
Seconds Guide to Short Term Savings | Budgeting
101 | Getting Out of Dept | How
to Budget | Loans to Friends and
Family | Pay Off Student Loan
or Invest | Values Inventory
Worldly Investor News, 11/05/2001
by Gary Schatsky
(Editor's Note: Nationally recognized fee-only financial
advisor Gary Schatsky answers readers' questions about personal
finance three times a week. If you have a question
for Schatsky about investing, mortgages, taxes, retirement or any other
personal finance issue, drop him an e-mail at firstname.lastname@example.org.)
I have $48,563 dollars of student loans at 5.75%. With this
all-time low rate thanks to the feds, should I be paying
more towards the principle or should I be investing? I was
thinking of putting more in bond funds and other mutual funds
that could return higher interest. If I do invest extra monies
then would there ever be a time that I would put a lump of
those earning towards the loan?
Good question. The answer depends on a number of things,
not least of which is whether the interest on these student
loans are deductible from your taxes.
Clearly if the interest is not deductible paying off the
loans early will be an easy recommendation as earning a guaranteed
5 3/4% on an "after-tax" basis is hard to find
these days. If the interest is deductible the decision becomes
a little less clear.
Does the New Law Make it Deductible?
In order to see if the interest is deductible you first
have to understand the recent revisions to the tax law that
have expanded the number of people who can deduct the interest.
It should be noted that you don't have to itemize to take
this deduction, a great advantage to millions who don't have
enough deductions to itemize.
Starting in 2002 you can deduct all of the student loan
interest up to $2,500 per year if you are filing single and
have an adjusted gross income (AGI) of less than $50,000
($100,000 if you file jointly). This interest deduction is reduced as
your income increases with no interest deductible when your income reaches
$65,000 (or $130,000 if filing jointly).
More good news. The prior law also placed a time limit on
when you could you could deduct the interest - specifically
only for interest payments during the first 60 months that
interest payments were required. The new law eliminates any
If your loan is not deductible you have to be able to invest
the money and earn at least 5- 3/4%. Currently very few bond
funds or CD's are paying such rates unless they are low quality
bonds with significant credit risk. The only way to attempt
to beat 5 3/4% is by taking some market risk. Stocks certainly
should outperform 5 3/4% over the long term, but you may
not have the money "long-term" as you are forced
to make monthly payments.
In summary, if the interest isn't deductible pay off the
student loans. If it is, it's possible to outpace 5 3/4%
in the equity markets if you have the stomach and investment
time horizon. You might have the first but I am unsure about
In a more optimistic view of the times -- isn't it great
to be able to borrow at 5 3/4%?!