Welcome to the fifth edition of “What Would You Do?”! If you have a question and would like to know what others would do please contact me and I’ll keep it in mind for future editions of “What Would You Do?”. Recently I’ve asked Should I Buy a Smartphone, Should I Buy the NeatDesk or NeatReceipts Scanner, What Would You Do With $1,000,000, and Should I Pay Off My Car Loan! Now on to today’s What Would You Do…
My girlfriend has a few different student loans as I discussed in our debt paydown strategy. They are at different interest rates and to complicate things further some have fixed rates and others have variable rates. There was a clear choice as to which loan she should pay off first. She is currently working on paying off an 8.25% variable interest rate loan that originally had a pretty hefty balance. After she pays that loan off things are going to get tricky.
The Loans and Other Necessary Information
After my girlfriend pays off her 8.25% loan she will still have three fixed rate loans at an interest rate of 6.8%. These loans have a current balance of right around $20,000. She will have a variable rate loan, currently at 5.75% (based on the prime rate), with a current balance of approximately $23,000. Finally she has another variable rate loan, currently at 4.75% (based on the prime rate), with a current balance of approximately $8,000 left on it.
I personally have been saving money to help her pay these loans off. Once we get married one day I’ll take that money and apply it to her loan balances. By that time her 8.25% loan should be paid off but the question remains… which loan should she attack next?
The variable rates will change based on the current interest rate environment. For this exercise let’s assume that the rates are the same as they are today. We hope to have these paid off before the end of 2015 and the Fed (the agency that controls interest rates in the United States) seems to indicate they won’t be raising interest rates before then anyway so hopefully that is a safe assumption.
What Would You Do?
As we see it there are two options for us. We are aware of Dave Ramsey’s debt snowball method (pay the smallest balance off first) and the debt avalanche method (pay off the highest interest rate first). We aren’t a fan of the snowball method because we’d like to pay the least amount of interest possible. This would suggest we use the avalanche method and attack the 6.8% fixed rate loans next, then go on to the 5.75% and 4.75% variable loans.
On the other side, we are aware that the economy might get better faster (we can hope right?) or maybe inflation will start to grow out of control. In that case the Fed might start raising interest rates rather quickly which would lead to an increased interest rate on her variable rate student loans. If we can’t pay the variable rate loans off quickly after rates start going up we could end up paying a lot more in interest. These loans don’t have small balances that can be paid off in a month or two.
The other option (as we see it) is to pay off the variable rate loans (5.75% and 4.75%) before the fixed rates (6.8%) loans. While we might pay a bit more in interest this way there would be less uncertainty in total interest paid. Once the variable rate loans are paid off the most interest we could ever pay is 6.8% regardless of the Fed does to interest rates in the future.
Now that you know the options we have considered what would you do? Is there an option we have missed? Would you pay off the fixed rate loans first or knock out the variable rate loans? Let me know in the comments below and be as specific as possible. We’d love to get as many opinions as we can so we make sure we didn’t miss anything.