Should Dr. PayItBack Pay It Back?

Last November, I made the decision to pay off my wife’s remaining student loans. While it is always satisfying to get rid of debt, this wasn’t an entirely straightforward decision given how low the interest rate was. The loans had been refinanced to a variable rate, which at the time was sitting at a paltry 0.59%. I did the math and calculated that if the conditions of that moment continued, I could be expected to lose out on $4,244 in investment gains over three years by paying them off early. An expected loss of <$1,500 per year was little enough to be outweighed by the guaranteed peace of mind and cashflow of getting rid of the debt.

As it turned out, the timing could hardly have been better. The stock market would peak just two months later, and as of this moment it sits at over 14% down from its level when I made this decision.

I had invested that $17,000 in the market rather than paying off the loans, I would be down $2,500 and the loan would still be there. Now, there are still over two years for the market to recover within the original term of the loan; in fact if I were a betting man, it will still come back strong enough to have been the better mathematical choice. But there is no guarantee of that.

Now I find myself with similar thoughts regarding my own medical school loans — our last outstanding debt besides our mortgage — so I figured I would run a similar set of calculations.

My loan balance sits at $67,630.80 with 23 months of its original term remaining. The interest rate is 2.32% but it is variable, which means it will go up or down with its benchmark rate (currently the 30-day LIBOR). My minimum payment is $3,008.88.

The maximum additional monthly amount that I could comfortably put toward the loan is $10,000, for a total monthly payment of ~$13,000. This would see the loan fully paid off by early February 2023, or 6 months. This money doesn’t come out of nowhere; it’s the amount I am currently putting into our taxable brokerage. If I put these numbers into a compound interest calculator, it tells me that this plan would save me on the order $1,170 in interest. This of course assumes that variable interest rate will not go significantly up or down. I think most folks would agree at this point that further increases are more likely than not, but none of us really know.

If instead I continued investing the $10,000 per month, the returns become much less certain. Assuming 6 months of $10,000/month investment, if we take a modest expected return for the stock market of 8%, I would expect to see gains of $8,760 on that amount over 23 months. The difference between these two values is $7,590, which is the expected opportunity cost of paying off my loans.

This is obviously not the only possible scenario. Let’s take a rosy future, in the top percentile of current expectations, where the market has reached new highs by this time next year. This would imply an annual return of about 17%, and gains of $20,080 or total opportunity cost of $18,910. That’s a solid chunk of change!

On the other hand, things could stay relatively flat. An annual market return of 2% gets us gains of $2,080 and an opportunity cost of just $910. As you can see, there is an order of magnitude of difference depending on your starting assumptions.

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With the most likely numbers, it’s hard to justify an early payoff just yet. The math can and will change based on my loan interest rate and the current market dynamics, so this will continue to be something I keep an eye on.