A General 401k/Loan Repayment Finances Question

[neverrain]

So I have been reading that there is slightly more importance placed on paying off student loans (in good standing).  Currently, here is where I am.  I need to make a decision on this today so I ca make the change to my 401k if needed.

1.  Currently contributing 8% of my paycheck to my 401k.  My company matches 4%.

2.  Remaining DoE loan is at about ~$10k @ 2.5% interest.  Currently making $80 payments a month.

If I remove my contribution temporarily to my 401k, I can get close to $1k/month payments on the loan and have it gone in about a year.  I looked into it an the annual return rate on my 401k is just under 5% (which seems low to me).

Is it smart financially to hold off on my 401k for about a year to pay down and remove this loan?

In case it matter, I am 31 years old.  I realize at 50 it may be a worse idea.

[Revelate]

No, paying off an installment loan isn't a huge factor except for DTI calculations on a mortgage or auto loan.

Keep contributing to that 401K, that annual rate of return is compounded, so money you put in now, counts for quite a bit more than money you put in 10 years from now.  Never give up a long-term benefit for short-term satisfaction financially, and arguably you may be doing yourself more harm even from a FICO perspective within the next decade by paying that student loan off early.  I'm not seeing really any short-term upside other than pride/emotional benefit of getting it paid off.  So you'll be there in 1.5 or 2 years instead of 1, it doesn't matter rationally.

[neverrain]

What kind of harm are you referring to on the FICO standpoint?

Also, I was considering only matching up to 4% and placing the other 4% into another investment.  Maybe a Roth IRA or some type of investment account?

[Revelate]

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@neverrain wrote:

What kind of harm are you referring to on the FICO standpoint?

Also, I was considering only matching up to 4% and placing the other 4% into another investment.  Maybe a Roth IRA or some type of investment account?

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Roth IRA vs. 401K is mostly a question of whether you think you'll be making more money after you start taking distributions from your 401K / Roth IRA, or less.  If you're going to be in a lower tax bracket, 401K makes more sense; however, if you're going to be a higher one, Roth does.  There's some additional things which are a *lot* more complicated (such as what you can do with a 401K vs. a Roth IRA) but that's the basics of it as 401K contributions are pre-tax (and incidently lower your current tax burden, which might be huge if you're at a bracket border under the current tax code), and Roth IRA ones are post-tax.  

I can't give better advice than that without a lot more data points, and I'm not an expert anyway.

The harm is simply this, and it's minor: the longer your installment loans tick out, the better that looks for your AAoA as far as the FICO algoritm is concerned... and there's a lot of anecdotal evidence on this forum which suggests that paying off an installment loan is a small benefit if any from a score perspective.  Anyway, AAoA issues might be minor damage, but it's there... whereas paying off is probably score neutral, so I consider that to be harming one's score.  Don't know where you're at but it would truly suck for me if I hit 639 on a mortgage application someday, so I play for maximization over a longer time-horizon and others will probably offer different opinions.

[neverrain]

Yea that makes sense regarding the FICO thing.  The account has really only been open for about a year anyway.  I think my intention would be more for just having one less thing to worry about.

Thanks for the inut.

[Anonymous]

When you say they match 4%, is it 50% of up to 4%?

Regardless, I would ALWAYS put in up to what the company matches. Iit's an INSTANT 50% return on invetsment*, and nothing else can match that rate of return!!!!!

(*you have to factor in vesting, of course, if you plan on leaving or getting fired...)

After that, I'm a fan of paying off anything that has a high interest rate next, usually credit cards. Then, I agree with Revelate that there's no hurry to pay down the loans. 5% return isn't awful, but consider that will be componded over the next 35 years... The student loans will be paid off within a few.

[AndySoCal]

I would not change the 401K contribution. Your student loan interest rate is lower than your 401K  rate of return on investments. 

[neverrain]

My company matches 100% up to 4% of my paycheck I guess is another way of saying it.

Aside from just paying down the loans and getting rid of them, I still need to build up an emergency fund for at least 3 months.  I have no real credit card debt to worry about, it's mostly paid in full every month.  I just want to be debt free completly so I can save and buy toys when I feel inclned.

[Anonymous]

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@neverrain wrote:

My company matches 100% up to 4% of my paycheck I guess is another way of saying it.

Aside from just paying down the loans and getting rid of them, I still need to build up an emergency fund for at least 3 months.  I have no real credit card debt to worry about, it's mostly paid in full every month.  I just want to be debt free completly so I can save and buy toys when I feel inclned.

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100% of 4% is a sweet deal, I'm very jealous! I would make sure it's not 50% of 8% though, there is a difference.

As for the emergency fund vs student loans vs 401k, etc... At your age (and my age), I think savings tend to be over-emphasized in importance. I'm not saying it's not important, but I will say that equally important is managing revolving credit. I think of revolving credit purely as a cash flow tool, meaning if you go though a few months with reduced (or zero) income, or higher expenses, you can re-allocate that gap across the following months.

Basically, I'd consider available revolving credit as a part (A part) of your savings, if that makes sense. You actual liquid savings is ideally enough to cover all of your installments and revolving minimum payments (plus rent, etc), but at ~30 I wouldn't say you must have 3 or 6 months of net income saved.

Family + spouse + house alters the equation, of course.

[neverrain]

I'm sure it is 100% of 4%.  At the moment, the 8% I am putting in works to a little over $400/month, and I can see the $200ish they put in.  Yea, I know it's a pretty sweet deal.

As for the emergency fund, I was figuring enough to cover all our bills (I live with my gf) in full for 3-6 month.  I would rather stay away from credit cards unless absolutely necessary.  Between the 2 of us we probably have close to 20k in available credit, but rent and utilities can't be paid with that, so liquid cash is more preferable to me for an emergency fund.  I guess YMMV applies here.