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Pay Down Student Loan Debt or Invest In a Traditional 401(k)?

April 22, 2019

Student loan debt in the United States has amounted to $1.5 trillion according to the Federal Reserve. This large student loan debt burden has affected many young people who are looking to start families and create a life for themselves. Despite this tough obstacle, many young people still have excess savings and need to determine what to do with these savings. Should they take their savings and invest in a traditional 401(k) or use that savings to pay down their student loan debt? We’re going to share different situations all spanning 10 years that involve paying down student loan debt and investing in a traditional 401(k) plan.

 

 

Let’s say you have a taxable income of $150,000 and file taxes jointly with a spouse. Under the new 2018 tax brackets, your effective federal tax rate is 16.59%.  Let’s also assume you have $70,000 of student loan debt with 10 years left at a 7% interest rate. Your monthly student loan payment would be about $812.76 assuming you’re making the same payment amount every month.  What should you do? Pay down the student loan or invest in a traditional 401(k) account?

 

 

Income: $150,000

Effective Tax Rate: 16.59%

Student Loan Debt: $70,000

Monthly Payment: $812.76

Term: 10 years

Interest Rate: 7%

 

Scenario 1 – Paying Down Debt Student Loans Then Investing

Let’s start off by taking a look at how you can pay this debt down faster. Did you know that if you pay an extra $100 a month in addition to your regular student loan monthly payment, you’ll save $4,464.13 in interest paid? Not only will you save money by paying extra every month, but you’ll cut down the overall repayment period by a year and a half. Yes, you’ll be debt-free a year and a half earlier than you thought!

 

$812.76 + $100 = $912.76 Monthly Payment

 

After being debt free sooner than expected, you may decide to start investing in your 401(k). If you put all of the money you were paying from your student loan into your 401(k), you’d contribute $1,094.31 monthly.

 

You may be wondering how you can contribute more money towards your 401(k) than your student loan payment. The answer lies in taxes.

 

Student loan payments are made with post-tax income. 401(k) contributions are made with pre-tax income. Since a traditional 401(k) account uses pre-tax income, you are able to contribute more towards your 401(k) than you would have your student loan debt with the same income. Though you don’t pay taxes on 401(k) contributions, ordinary income tax will be applied on 401(k) distributions.

 

$912.76 / (1-16.59%) = $1.094.31 Monthly Contribution

 

After a year and half of contributing $1,094.31 per month, compounded monthly, at an assumed 7% rate of return, you would have $20,826.09. The investment amount of $20,826.09 combined with the student loan interest savings of $4,464.13 would give you a total 10-year net value of $25,290.23.

 

Scenario 2 – Investing While Paying Down Student Loan Debt

 

If you have a higher priority of saving for retirement than paying off your student loan debt, you may want a different option. Let’s see what would happen if you decided to put that extra $100 a month into a tax-deferred 401(k) account. The $100 would be contributed to your 401(k) account instead of your student loan debt balance, but you would continue to make monthly student loan debt payments. Due to the pre-tax nature of a 401(k), your contribution of $100 post-tax would become $119.89 pre-tax.

 

$100 / (1-16.59%) = $119.89 Monthly Contribution

 

With an assumed 7% rate of return, compounded monthly, on your 401(k), you will have approximately $20,872.19 in your 401(k) after 10 years.

 

Scenario 3 – Employer Contributions 401(k)

 

Some employers will match your 401(k) contributions up to a certain percentage of your income. This could be a real game-changer. Turning down your employer’s 401(k) match is like throwing away free money. If you have student loan debt, but your employer offers a match, consider contributing to receive the maximum employer match. If you contribute $119.89 a month with an employer match while making your normal student loan payments, your money can really grow.  If your employer matches the 401(k) contribution dollar for dollar, you will double your investment of $20,872.19 from Scenario 2 to $41,744.37 in your 401(k) account after 10 years.

 

Contributions to a traditional 401(k) are made prior to your income being taxed. The withdrawals on a traditional 401(k) are taxed. The tax rate that is applied to your withdrawals depends on your tax bracket in retirement.  As the average person’s career develops, they typically continue to increase their salary and move into a higher tax bracket. Upon retirement, they will see a decrease in income and move to a lower tax bracket. This means your 401(k) withdrawals could be taxed in a lower tax bracket if done while in retirement, instead of in your working years. Note that this will only be the case if your retirement income is less than your working income.

 

 

Scenario 1 – Paying Down Then Investing

Scenario 2 – Investing While Paying Down Debt

Scenario 3 – Employer Contribution 401k

 

As you can see from the chart above, investing while paying down student loan debt or paying down debt than investing produces almost the same total net value. One debt pays down and investment strategy might perform better than the other depending on the return in the 401(k) account. It’s important to keep in mind that the returns on a 401(k) account are never guaranteed

 

The real deciding factor on whether to invest or pay down your student loan debt will be if an employer offers a 401(k) match. Matching contributions from your employer will make investing significantly more attractive than paying down debt. If an employer match to your 401(k) is available, it’s wise to take advantage of it.

 

Your comfort level with your student loan debt can be a large factor in your decision to invest in a traditional 401(k) account or to pay down debt. Knowing whether you are more interested in being debt free or being prepared for retirement can help you make a decision. Let’s look at how student loan refinancing can help you amplify your student loan debt pay down and investment strategy.

 

In Scenarios 1, 2, and 3, the big question was whether you should use the additional $100 a month to pay down student loan debt or invest in a 401(k). What if you wanted to spend that $100 a month instead? Is it possible to find a way to save on student loan debt while spending that extra $100 a month? You’re in luck! This can be done with student loan refinancing.

 

Scenario 4 – Refinancing Student Loan Debt

By refinancing your student loan debt, you should be able to decrease the high-interest rate of your student loan. In addition, you should be able to save money over the life of the loan and in some cases monthly.

 

The total interest you would have to pay on your student loans of $70,000 at 7% interest over 10 years is $27,531.12. If you qualify to refinance your student loan debt to a 5% interest rate, the total interest you would pay is $19,095.03. This would mean that refinancing your student loans would be saving you $8,436.09 in interest over the life of the loan or $70.30 a month.  When comparing your new 5% interest rate to your previous interest rate of 7%, not only would you be saving over the life of the loan, but reducing your monthly payment!

 

$8,436.09 / 120 = $70.30 Monthly Interest Savings

 

Learn More About Student Loan Refinancing

 

 

Scenario 5 – Refinancing and Paying Down Debt Then Investing

 

Now, what happens if you refinance your student loan debt, pay down the debt, and then start investing? Refinancing your student loan debt will cut your interest rate, saving you $70.30 a month, making your monthly student loan payment now $742.46 instead of $812.76 per month. By taking the additional $100 a month and the $70.30 in student loan savings from refinancing and applying them to your monthly student loan payment, you will be debt free two years and three months sooner than expected. Two years and three months are earlier compared to the one and a half years from Scenario 1. Just a reminder, in Scenario 1, there an additional $100 a month put towards your student loan debt. With refinancing and making the same monthly payment as Scenario 1, you will save $13,017.87 in interest over your original loan.

 

$742.46 + $70.30 + $100 = $912.76 Monthly Payment

 

Now that you’re debt free, you can use the money that would have been used for your student loan payment to contribute to your 401(k). Since 401(k) contributions are done with pre-tax income, you will be able to contribute a pre-tax amount of $912.76, which is $1094.31.

 

$912.76 / (1-16.59%) = $1.094.31 Monthly Contribution

 

After two years and three months of contributing $1,094.31 per month, compounded monthly, at an assumed 7% rate of return, you would have $32,085.89. The investment amount of $32,085.09 combined with the student loan interest savings of $13,017.87 would give you a total 10-year net value of $45,103.76.

 

Scenario 6 – Refinancing and Investing While Paying Down Debt

 

Now let’s try refinancing while you simultaneously pay down debt and invest. In this scenario, you will cut down the interest rate on your student loan debt from 7% to 5% by refinancing. You’ll be contributing the pre-tax amount of the extra $100 a month and $70.30 a month in interest savings towards your 401(k). You will end up contributing a total of $204.17 a month to your 401(k) account.

 

($100 + $70.30) / (1-16.59%) = $204.17 Monthly Contribution

 

With an assumed 7% rate of return, compounded monthly, you will have approximately $35,544.87 in your 401(k) after 10 years. Combined with the interest savings of $8,436.09, you will have a total net value of $43,980.96.

 

 

 

Scenario 1 – Paying Down Then Investing

Scenario 2 – Investing While Paying Down Debt

Scenario 4 – Refinancing Student Loan Debt

Scenario 5 – Refinancing and Paying Down Debt Then Investing

Scenario 6 – Refinancing and Investing While Paying Down Debt

 

As you can see from the chart above, just from refinancing your student loan debt, you can save money and increase your total net value. If you take it one step further and supplement your debt pay down and investment strategy with student loan refinancing, you would approximately double your total net value! By taking advantage of student loan refinancing, you will be able to supercharge your debt pay down and investment strategy. For those who are just trying to save money on student loans or have more money to invest in their 401(k), student loan refinancing is the way to go.

 

Check Out Our Guide to Student Loan Refinancing

 

NOTICE: Education Loan Finance by SouthEast Bank is not authorized to provide tax advice or financial advice. If you need tax advice or financial advice contacts a professional. All statements regarding 401(k) contributions assume that you have a 401(k) plan and that you are able to contribute those amounts without contributing more than the current federal law limits.

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Education Loan Finance by SouthEast Bank is not responsible for and has no control over the subject matter, content, information, or graphics of the websites that have links here. The portal and news features are being provided by an outside source – The bank is not responsible for the content. Please contact us with any concerns or comments.

 

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2019-09-22
5 Common Questions About Student Loan Refinancing

Deciding to refinance your student loans is a big step in your financial journey. As with any big step, there are often questions that arise. We’re sharing some of the most common questions our Personal Loan Advisors hear from borrowers looking to refinance their student loans. 

1. Will my refinanced student loan have a variable or fixed interest rate?

Either! Education Loan Finance offers both fixed and variable interest rates, giving you the freedom to choose.  Fixed interest rates will not change from year to year, but variable interest rates will fluctuate based on the
LIBOR index and may increase or decrease over the life of the loan. Read our blog about variable and fixed interest rates to learn more.  

2. How long will the application process take?

You’ll be done before you know it! The application process is quick and easy. After providing some information about yourself and your student loans, you’ll upload documents and submit the application. If you refinance your student loans with ELFI, you’ll receive a Personal Loan Advisor who will be your point of contact throughout the process – one person who’ll be with you step-by-step.

3. Can I consolidate both federal and private student loans?

Yes! ELFI allows you to consolidate federal student loans as well as private student loans from multiple lenders. As long as they are student loans, ELFI can consolidate them. However, only student loan debt can be consolidated – no other consumer debt, such as credit card, auto, or mortgage can be included, even if it was used to pay education expenses. 

4. Can I consolidate my student loans with my spouse’s student loans?

While spouses are eligible to serve as a cosigner on an application, we cannot consolidate student loan debt among multiple borrowers – even if they are hitched! 

5. Will the application process affect my credit score?

We’ll run a “soft credit inquiry” during the pre-qualification phase of refinancing in order to provide you with preliminary rates that you may qualify for. A Soft credit inquiry won’t affect your credit score. However, once you choose your loan product and submit your application, we’ll need to view your full credit report – this will show up as a hard credit inquiry. These inquiries are common among student loan refinancing lenders.   Hopefully this short Q&A gave you some helpful insight about what to expect when refinancing your student loans. If you have questions about the student loan refinancing process, you can check out our full list of frequently asked questions or contact ELFI at 1-844-601-3534 to speak with a Personal Loan Advisor. 

Learn More About Student Loan Refinancing

  Subject to credit approval. Terms and conditions apply. NOTICE: Third Party Web Sites Education Loan Finance by SouthEast Bank is not responsible for and has no control over the subject matter, content, information, or graphics of the websites that have links here. The portal and news features are being provided by an outside source – The bank is not responsible for the content. Please contact us with any concerns or comments.
Happy couple working on budget
2019-09-20
How to Know When It’s Time to Refinance Your Student Loans

There are plenty of milestones in life that give us reason to celebrate– high school graduation, marriage, the birth of child, paying off student loans. Yes, seeing your debt decrease and your savings increase for many people are a time worth remembering. And truth be told, being further out of debt can make those other milestones much more enjoyable. This blog is designed to help you reach that debt-free milestone quicker by refinancing your student loans. After all, getting them under control and adjusting the repayment terms to something more favorable could help make a dent. Here’s how to know it’s time to refinance your student loans:

You Earn Good Money

No one wants to see their hard-earning income fly out the window. If we’re talking about milestones, we would argue that the 15th and 30th of the month are recurring ones that give us plenty of joy, albeit short-lived. When we see money deposited we want to hold on to it and protect it. However, your debt doesn’t go away. Even though you’re earning good money you will have to face the music and pay off the education that helped get you to the position you’re in. Refinancing your student loans often means a better interest rate and the option to choose a better term.

You’re Credit-Worthy

Many people simply aren’t aware that federal interest rates are not dependent on your financial circumstances. There are a few factors involved, but the credit history of the borrower isn’t one of them. If you’ve been on-time with your credit card, mortgage, car loan, or any other debt, and maintained a good balance between the money you earn versus what you owe in debt, you’ve likely got a high credit score. When you refinance your student loans with a private lender that credit score helps determine your interest rate, and that in return can help save some money.

You Love One Payment

One of the added benefits of refinancing your student loans often means consolidating your loans. While it’s true you can still refinance partial loans, lumping them all together with a nice bow on top not only helps you feel empowered to pay them off, but also reduces the likelihood you’ll miss a payment due to the sheer number of them floating around out there.

You’re incentivized at Work

A growing number of companies are taking a long, hard look at the benefits they offer their employees. Gone are the days of sticking with one job from graduation to retirement. Today, it’s all about working for an employer that offers great benefits, compensation and work/life balance. And because of that, repayment part of an employee’s student loan obligations are becoming the norm. If you’re in this category, it may be wise to refinance your student loans, consolidate them, and watch your employer help pay down your debt. If you can check these boxes chances are you’re ready to refinance your student loans and are one step closer to that all-important milestone of getting out of debt. Speak with one of our Personal Loan Advisors to help walk you through the process.   Subject to credit approval. Terms and conditions apply.   NOTICE: Third Party Web Sites Education Loan Finance by SouthEast Bank is not responsible for and has no control over the subject matter, content, information, or graphics of the web sites that have links here. The portal and news features are being provided by an outside source – The bank is not responsible for the content. Please contact us with any concerns or comments.
2019-09-16
What I Would Have Told Myself in College: Barbara Thomas

  Barbara Thomas, Executive Vice President of Education Loan Finance (ELFI) provides some financial advice to college students based on her own experiences in college.   Hello, I’m Barbara Thomas. For most, like me, my college days were a great experience that lead to incredible personal growth. I had a marvelous sense of freedom and made many new friends. However, I have spent much time reflecting on what I would do differently if I could begin my college life all over again, given what I know now. Hindsight is a wonderful thing, isn’t it? So here’s my advice to all of you who are preparing to enter college, or are currently in your freshman or sophomore years.

Choose an Affordable College

When looking for the right college, don’t get beguiled by a famous name and a beautiful campus. And, while a state-of-the-art fitness center or an Olympic-size swimming pool might be important if you’re an athlete, most of the time you will be paying for them in higher college fees. Instead, make sure to keep your eyes on finances, as affordability should be a top concern. Considering the fact that many students end up taking on sizeable student loan debt, keep in mind that you (most likely) won’t be living on that beautiful campus in your late 20s or 30s.

Rethink Your Path to the Best Education.

Just because a college is more expensive, doesn’t
necessarily mean that it’s better than one that costs less. You should look upon college as an investment in your future. Consider what the return on investment (ROI) from your college education will look like. In other words, analyze which college is likely to provide you with the most bang for your buck. Here’s a report from U.S. News & World Report that gives you the ROI of different colleges.

Look at Alternatives to a Four-Year College.

If you find out that college is not the best path for you, it can turn out to be an expensive mistake. Keep in mind that dropping out of college won’t make your student loans disappear. So before you enroll in a college, consider these alternatives:
  • Take a gap year to earn money to put toward going to college and give yourself more time to decide what you want to do.
  • Consider attending a trade school to learn a valuable skill with high earnings potential.
  • Spend two years at a community college. Attending a community college can help you save on tuition. However, if you plan to transfer to a college of your choice, be sure to do some checking. Find out how many transfer students are accepted and how many of your community college credits can be used.
Do your research and crunch the numbers to make sure you’re making the best choice.

Earn More While in School

A survey of millennials found that earning money while in college was the number one thing that participants wished they had done (or done more of). This reflects the increasing financial cost that goes along with obtaining a college degree. The College Board estimated that in 2017 (updated figures are available), the average student loan debt upon graduation was $28,500. Keep in mind that a heavy debt load is going to affect your financial future – your ability to buy a home, start a family, and save for retirement. Apart from financial considerations, there is no better way to acquire real job skills than to hold down a job and learn about its demands firsthand. Employers know this, which is why previous work experience is the most popular measure to assess job candidates, even those straight out of college.

Research Ways To Lower Your Monthly Student Loan Payments

So, you’ve done everything right - you chose the higher education path that was right for you, and you have landed an interesting job. Now, what about those student loan payments? Are they weighing you down and preventing you from leading the life that you had envisioned after college? ELFI has a solution to your problem – it’s called refinancing. You can close out your original loan and take out a new one with a lower interest rate and/or a longer term. This can significantly lower your monthly loan payments. Get in touch with us to see how we can help you!  

Learn More About Student Loan Refinancing With ELFI

  Terms and conditions apply. Subject to credit approval.