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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2020-09-25

3 Financial Goals to Achieve Before Marriage – And Some That Can Wait

Marriage is both a personal and financial turning point that opens up a new world of financial opportunities and struggles. However, with proper planning, you can minimize the challenges and make the most of financial opportunities. Check out these financial goals to achieve before marriage, as well as a couple of others that you’ve still got time to work toward:

Financial Goals to Achieve Before Marriage

The Emergency Fund

For many couples, the COVID-19 pandemic has made the importance of emergency funds exceptionally clear. Especially as you enter into your first few years of marriage, it’s important to build a strong financial foundation so you’re prepared for unexpected expenses, from home repairs to medical bills. Financial hardship is a leading cause of divorce, and in these uncertain times, an emergency fund can help to weather the storm. In addition, an emergency fund provides a way to ease financial anxiety and distress even when times aren’t tough. When you know you’re prepared with emergency savings, there’s no need to panic if the unexpected happens.

Setting a Monthly Budget

Even if you aren’t getting married, creating a budget is a great financial step, and is something you should do right away. Work with your partner to outline your regular expenses, as well as any expenses that may arise in your first year of marriage. Make sure you provide yourself with some flexibility in your savings and begin building an emergency fund if you haven’t already. There are several useful tools that can help you keep track of your budget, including apps like Mint. You can also employ a budgeting strategy to keep your saving and spending on track. Several popular budgeting methods include the 50/20/30 rule, the Zero based budget and the cash envelope system. Not only will a budget be good for your finances, but it will be good for your marriage, as well.

Setting Goals for the Future

Yes, setting goals is a goal. You and your future spouse should lay out financial goals before getting married. It’s important to be on the same page when it comes to debt repayment, housing plans, savings goals and other major financial milestones. Plus, it’s good to know what your spouse is looking for, and a good plan helps to avoid financial stress that can really harm a marriage.

More Flexible Financial Goals

Making a Down Payment

While it’s great to start saving for a down payment before marriage, it’s not necessary to be entirely ready to buy a home before tying the knot. Especially if you’ve already established good money management habits, you can always continue working toward this financial goal as a married couple. Even if you don’t have the money for a down payment right away, you can easily establish a strategy to save toward a down payment. Experts recommend planning on putting a minimum of 10% down for your down payment and the more you can save, the better. Stay focused and keep saving. You’ll have that down payment in no time.

Becoming Debt-Free

Some couples choose to pay their student debt off before getting married, however, student debt is another financial goal you can afford to wait on, especially if you consider refinancing. After your wedding, you may choose to prioritize other expenses that come with building a life together, like a new car or home, before tackling the remainder of your student debt. That said, you certainly don’t want to forget about your student loans. By refinancing your student loans, you could earn greater financial flexibility by lowering your interest rate or changing your student loan repayment term. Refinancing can provide you with the options you need to achieve financial goals with your new spouse.

Tips for Tackling Student Debt

As a general rule, it’s best to first tackle whichever debt is incurring the most interest. Debts with high interest rates can easily spiral out of control, and while it may not be essential to totally eliminate your student debt before your marriage, it is advisable to develop a plan to do so. The good news is, you can employ several strategies to make paying off debt a less intimidating ordeal. Two of the most popular repayment strategies are the debt snowball and the debt avalanche. These two plans take opposite approaches. While the debt avalanche calls for dealing with the highest interest debt first, the debt snowball calls for dealing with the lowest amount of debt first and using the momentum to pay off debts one by one. The right method for you depends on your situation, but both can be incredibly effective if used correctly. Again, it’s worth noting that it isn’t necessary to have your debt entirely paid off before getting married, but you should develop a plan for paying it off before you say “I do.” A marriage is a big change, but it doesn’t have to be stressful. By taking the time to have fun and create a few financial goals, you’ll set yourself up for success even before tying the knot. If you’re getting married soon, you also might be interested in budgeting for your wedding. Check out our guide here.

person making pros and cons list for refinancing private student loans

2020-09-25

10 Pros and Cons of Refinancing Private Student Loans

This year we have seen record low refinancing rates for student loans. If you have private student loans and have been thinking about whether you should refinance them, we hope this post will help you make a decision. We will run through the essentials and the pros and cons of refinancing your private student loans.

6 Benefits of Refinancing Private Student Loans

Private student loans are loans borrowed through banks, credit unions or other private lenders and can consist of original private loans or a loan that you already refinanced. When you refinance, there are many benefits you can experience. Here are the pros of refinancing your private student loans:

1. Obtain a Lower Interest Rate

When you refinance a private loan, you are paying the loan off with the new loan you borrow. The new loan can have a lower interest rate than the rate you previously had on your old loan. A lower interest rate can lead to thousands of dollars in savings depending on the amount of the loan, your old interest rate and your new rate. A lower rate can help reduce your monthly payment and save you money in interest cost over the loan term.

2. Make Your Repayment More Manageable

If your monthly payment is becoming difficult to pay, refinancing is a good way to help make your payment more manageable. This can be done by obtaining a lower interest rate, as previously mentioned, that can help lower your payment. You can also lengthen the loan term when you refinance. When you extend the loan term it makes the monthly payment lower, but will increase the amount of interest charges you will pay.

3. Pay Debt Off Faster

Ready to pay your loan off faster? This can be achieved through refinancing in multiple ways. If you have 10 years remaining on your loan term and refinance to a 7 year loan term or shorter , you will have a higher payment but will have the loan paid off 3 years earlier. Another way to pay off your loan faster is if you refinance and obtain a lower interest rate, your payment will be lower monthly. But if you continue to pay your old monthly payment or more towards the new loan you will be able to knock out your debt quicker.

4. Release a Cosigner

When you refinance your private student loan you can use the opportunity to release a cosigner from your previous loan. As long as you have a strong credit history and credit score, along with stable income, you can qualify for the new loan on your own. To qualify for the best interest rates available most lenders look for a credit score at least in the high 700s. At ELFI a minimum credit score of 680 is needed for refinancing.*

5. Combine Multiple Loans

If you have multiple student loans, refinancing is a great way to simplify your finances. You are able to pay off all the previous loans and focus on paying off just one loan. It’s also easier to keep track of your due date so you never miss a payment. Having only one loan may also help keep you motivated on your debt paying journey instead of seeing multiple student loan debts you have to pay.

6. Choose a Different Lender

If you are not happy with your current student loan lender, refinancing allows you to change to a different refinancing lender by refinancing with whichever lender is the best fit for you. So if you have questions about your loan but can never seem to get answers from your lender, refinancing can help you fix that. At ELFI we pride ourselves on providing a simple and easy process for refinancing along with award-winning customer service loan advisors.

However, just like there are benefits to refinancing private student loans, there are also some cons to consider.

1. Lose Benefits with Your Current Lender

If you refinance your student loan with a different lender, you may lose benefits you have with your current lender. Some benefits that lenders may provide are an interest rate deduction for setting up auto-pay for your payment, forbearance options, or career coaching. Before you look to refinance with a different lender, weigh whether a new interest rate from a different lender outweighs any benefits you may be giving up.

2. Get a Higher Interest Rate

If you are refinancing to extend your loan term to make the payment more manageable, you may end up with a higher interest rate then the previous rate you had. This would make refinancing your loan more costly in the long term because of the additional interest you will end up paying. In order to avoid this, make sure to get personalized rate quotes from multiple lenders so you know your options and how it will affect your monthly payment and the total amount of interest you will pay.

3. Raise Monthly Payments

When you refinance you have the ability to choose a new loan term. Selecting a shorter loan term then the amount of time you had left on your loan can increase your monthly payments. Typically refinancing lenders provide loan terms of 5, 7, 10, 15, or 20 years. If you had 8 years remaining on the loan you want to refinance and select a loan term of 7 years you may see an increase in your monthly payment unless you are qualifying for a significantly lower interest rate.

4. May Extend Time to Repay

When selecting your loan term when you refinance, if you choose a longer loan term then the amount of time you had remaining on your loan, you will be stuck paying the debt off longer. However, this can be beneficial if you need to lower your payment to fit within your current budget. You can also combat this issue by paying more than the required monthly payment when you can afford it, to help pay the loan off quicker.

The Bottom Line

Every financial situation is unique so it’s best to determine what is right for your circumstances. When you weigh the pros and cons of refinancing private student loans, you will most likely find it is advantageous for you because of all the different potential benefits.

*Subject to credit approval. Terms and conditions apply. Notice About Third Party Websites: 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.