Q: I graduated college last year and have a school loan for $28,000 at 11 percent interest, for 10 years. I have been paying that one off for a year now, usually adding some extra money for principal each month.
With the home I recently purchased, I have a $130,000 loan at 6.75 percent interest, for 30 years. I have been adding some extra money for principal each month.
Which is the better loan to pre-pay? Also, I have around $25,000 in a savings account in my credit union, but I’m not sure what to do with. Should I invest in the stock market? What about paying off my student loan? Any suggestions?
A: You have plenty of options and for someone who just graduated from college, a strong financial future. Here are a few things to do:
First, see if you can get the interest rate on your school loan lowered. If yours is a government-sponsored loan, you may be able to cut your loan’s interest rate dramatically, perhaps in half. If so, that will change the game for you.
If, for whatever reason, the loan’s rate cannot be reduced, take $11,000 out of your savings account — where it is earning virtually nothing — and pay off a chunk of your school loan. That cash will effectively earn the 11 percent interest rate the loan carries.
Keep $10,000 in cash for emergencies. That can stay in your money market account, or in a short-term CD. You won’t get much more interest, but it’s something.
Do you have a Roth IRA? Are you eligible for one? If so, use the remaining $4,000 to open up a Roth for yourself and your spouse. Once you open it up, I’d put the cash into an S&P 500 fund. Vanguard offers some inexpensive index funds, so start there. You can check out www.morningstar.com for more mutual fund ideas.
As for your savings, you should open up a brokerage account (preferably where you open up your Roth IRA) and start plowing half of your available cash into an index fund or try something else. The idea is that regularly you add to that cash and over time, it will grow.
Use the remaining cash per month to prepay your school loan. Once you’re done paying off your school loan, you can start prepaying your home loan again. Remember, always pay off your highest, non-deductible debt first.
Feb. 28, 2001.