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Thinking about loan payments

Chris Farrell Nov 18, 2011

Question: I have a student loan that is on an extended payment plan with a variable rate that is tied to prime. Currently, the rate is 2.11%. I have money available that I could put toward the loan, but at this interest rate, it seems advisable to invest the money. However, at some point down the road when the rates go back up, I may wish that I had paid off the loan early. Do you have any advice as to the best approach for paying off such a variable rate loan? Wendell, Rochester, NY

Answer: I like the way you’re thinking about the issue. You’re right. The low rate on your variable loan means you have the financial flexibility to invest elsewhere, rather than in accelerating payments. But there remains the risk embedded in any variable rate loan: Eventually the rate could go higher.

I think the way to answer the question is to step back and look at your whole balance sheet. One set of questions would look at how flush your emergency savings is. Should you focus on topping it off or do you have enough in there?

Another issue is whether you face any major known expenses, such as a new boiler or a rebuilt engine?

I would also ask how much risk is there elsewhere in your finances, such as credit card debt, a variable rate mortgage or the like.

My baseline or fallback position is that it’s always a good idea to eliminate a debt burden unless you truly have a better use of the money. Those better alternatives can include a flush emergency fund, an investment you’re attracted to right now, a big expense you know is coming (even if the timing is uncertain), and a high-interest-rate credit card debt.  

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