Ask Money

Fund an IRA or target student loans

Chris Farrell Dec 21, 2010

Question: I recently decided to put away a little extra money every week from the income I have left over after contributing the max to my 401k, making a contribution to my emergency cash fund and paying my monthly student loan. I initially intended to put this extra $100/week into the principal of my higher interest private loans (total private loans of approx $88,000 with a variable rate ranging from 4% to 5%). But it occurred to me that it might make more sense to place those extra funds into an IRA. For what it’s worth, I only started contributing to a 401k this year and I am 32 with no kids or house and no other retirement savings or debt. Thoughts on what my financial priority should be? Thank you! Faith, Brooklyn, NY

Answer: I would attack the private loans since you’re contributing the maximum into your 401(k) plan at work and adding to your emergency stash. An IRA is always nice, but it seems to me the best use of your extra money right now is targeting the debt.

You have a lot of debt to pay back. But the extra $100 a week toward principal will have a snowball effect. The impact will be slow at first, yet it will gather momentum with time. Paying down the loan quicker is also the equivalent of earning a 4% to 5% return on your money.

You’ll also be reducing a future risk: Higher interest rates. These are variable rate loans and interest rates are likely to rise with stronger economic growth. Of course, over the past three years rates have gone down and stayed down. Still, odds are rates will climb somewhat when the economy stirs and the employment rate goes up.

The risk to your future cash flow is there. It’s another reason to target the debt and eventually get rid of it.

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