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Ask Dr. Don
By
Don
Taylor,
Ph.D.,
CFA
•
Bankrate.com |
Student loan repayments
Dear Dr. Don,
I have $75,000 in student loans (at 8 percent
interest) from undergraduate and medical school studies. My grace
period ends next month, and then I will begin to pay these loans
using an income-sensitive government repayment program. My grandfather
has invested money for me, and now is giving me a gift of $8,000
to use for my education loans. Is it better to pay off the loans
immediately with that money, or to invest it at a higher interest
rate and pay later?
Aimee Analyze
Dear Aimee,
It sounds like your loans are on the income contingent repayment
plan. With this plan, the monthly payments are based on your income
and the total amount of Direct Loans borrowed. As your income rises
or falls each year, the monthly payments will be adjusted accordingly.
You have up to 25 years to repay, but any unpaid amount remaining
after 25 years will be discharged, with taxes due on the amount
discharged.
If you haven't already done so, you should consider
consolidating your student loans. Consolidating will simplify the
repayment process by having just one monthly payment, and may reduce
your monthly payments.
The Federal
Direct Consolidated Loans Information Center will help you decide
if consolidation is right for you. That site's Interactive
Loan Calculator can show you if there is a benefit to consolidating,
even on the income contingent repayment plan. You can even apply
online.
The interest rate on a consolidation loan is
determined by taking the weighted average of the interest rates
on your outstanding loans and rounding up to the nearest one-eighth
of a percentage point but not more than the rate cap of 8.25 percent.
So the consolidated loan rate will vary by student.
By applying for a consolidation loan while you're still in the grace
period, you may benefit from a lower fixed interest rate on a direct
consolidated loan. Consolidation may reduce the interest rate on
your loan(s) to about 6 percent. This recent Bankrate
story provides additional details on consolidating your student
loan.
Decide whether you want to consolidate your
loans before you decide whether to use your grandfather's gift to
pay down the loans. If it was your grandfather's intent for you
to use the money to pay down the loans, you should talk with him
about your plans before investing the money.
From a financial perspective, if you expect
to earn more from the investments on an after-tax basis than the
loan(s) cost you on an after-tax basis, then you expect to be better
off by investing the money.
Remember that expectations don't always pan
out. The Dow Jones Industrial Average is down 6.83 percent year-to-date
while the Standard & Poor's 500 index is down 12.28 percent.
Saving 6 percent on $8,000 in loans looks a lot better than losing
7.5 percent in the stock market.
Over time the stock market should provide an
average return, after taxes, higher than the after-tax cost of your
student loans. (See this
Bankrate article for more information on the deductibility of
student loan interest.)
-- Posted: Dec. 6, 2001
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