Should I use most of my savings to pay off my student loans?
I have a large amount of student loan debt (around $64,000) but no other debt. I also have a good deal of savings and recently received a windfall. I now have enough to pay off my student loans and still have around $12,000 left over as my emergency fund, but I'm worried because I'm self-employed and I can never be sure of my income. Also, my husband and I are trying for a kid and that would add a whole new bunch of expenses to the list. Is it a bad idea to wipe out most of my savings, but be debt free?
Given your circumstances paying off all of your student debt now would be unwise. A better approach would be to pay off any high-interest low-balance student loans. Hold on to most of your cash in a high yield online FDIC insured savings account for the time being until your financial future appears more predictable.
And congratulations on what is in effect the defeasance of your student debt.
I agree with my colleagues that there is no one right answer to your question about paying down student loan debt.
If you go by "the book," you would set aside 6-12 months of expenses between you and your husband. You would then add the amount of out-of-pocket expenses for the possible birth of your child to get the amount that you should keep in cash (or a high interest savings account as has been suggested).
Let's say your expenses are $8,000 a month, for example, and it will cost you $5,000 out of pocket to have your baby. You should leave $53,000 ($8,000 x 6 months + $5,000) in a high-interest savings account and use the remaining $23,000 to pay down student loan debt.
Why six months contingency fund instead of 12 months? With a two-income family, we recommend six months of contingency because with one income still accruing (assuming it's about 1/2 the household income), the contingency fund should last about 12 months.
I hope this helps you with your decision. Good luck with your family!
So (simplifying a bit, obviously): You have cash of $76,000 in the bank and a loan of $64,000. That is, as of today you have a net worth of $12,000. If you use cash to pay off your loans, you will have a $12,000 net worth. So this decision is not about improving your situation immediately; it's really about flexibility.
Since you are self-employed and look forward to a lengthy interruption while you care for a baby (another long topic so I won't start), you need financial flexibility. You don't want to run out of money for day-to-day expenses. Kids can be expensive little things. For this reason I would not pay off the loan.
But, you should invest your $76,000 to earn a decent return. You can get 5.5% - 6% if you buy (for example) a preferred-stock or long term bond fund. The fund will fluctuate in price but not wildly, I don't think. This return should offset the interest cost on the loan. (I wish you had told us what it was).
This is both a financial and emotional decision. Emotionally, it can feel good to wipe out a bunch of debt. However, it might not be the best financial decision. Here are some things to consider:
1) Do you have a budget? If not, start there. Analyze your current expected income for the year plus your husband's income and see if there's extra cash flow at the end of each month.
2) What's the interest rate on the student loan debt? Compare to the interest rate you can earn by investing in the stock market (through mutual funds or exchange-traded funds).
3) If you had no more student loan debt, how much additional cash flow does that free up each month to put towards the emergency fund (or even an opportunity fund -- to have a baby, perhaps)?
There's no perfect answer. As a mom of three boys, I know that kids cost a lot. If you and your husband both plan to work outside the home after a baby, you'll need a new budget that factors in childcare costs.
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