A Letter to a Client

Note: This is an actual letter I wrote to someone who was thinking about how to handle some various debts. After stripping out anything that could be used to identify the individual I thought the letter could still be generally helpful to others. So here it goes.

If you have $50,000 in student loan debt and you defer it for 1 year you would owe $52,850. If you deferred for 2 years, you’d owe $55,700. And if you deferred for 3 years you’d owe $58,550.

Now at the end of three years, you still need to begin to pay back the $58,550 so the bank would set up an amortization schedule. Typically a student loan is amortized over 10 years. At that rate, you would then pay back (on an original borrowed amount of $50,000) $76,949.

That’s $27,000 in interest over 10 years. Note that’s assuming you are able to pay $641 a month that would be called for in a 10-year loan amortized at 5.7%. If you found that monthly payment daunting and wanted to lower it, the situation gets only gets worse. Say you needed to get the payment down to around $500 monthly. Well, in that case, you’d have to get the terms extended to 14 years. And assuming the bank doesn’t increase the rate, which may or may not be the case since a longer term loan carries more risk, you would pay $507 monthly but your total payback over the 14 year period would be $85,118 so you’d add on another $8000 In interest.

What’s the big deal you ask? Well in your case, lets say you could pay off your student loan with proceeds from your house sale. Now, being unencumbered by the monthly loan payment, you could invest that same amount. So, instead of paying down debt for 14 years and having nothing to show for it other than no longer having the debt, you could invest the $507 monthly. Assuming a 7% avg annual return, you will have accumulated roughly $142,000 at the end of 14 years.

In simple terms, the deferment and subsequent amortization don’t cost you $35,000, they cost you and your family $142,000. Now think about that for a second. That's enough to pay for college (a few years early) along with some other stuff – in cash. Let’s talk about this and the insurance part, which I haven’t gotten into here, soon.