Question

Bob graduated from college two years ago with a degree in communications. He has a good job as a Communications Specialist making $50,000 a year. Because he took a basic financial class during his sophomore year of college, he understands the importance of creating a plan for his money. So he made it a priority to start saving, and he currently has a savings account of $5,000 built up. He’s motivated to continue putting away money for the future. However, he has $6,500 in school loans left to pay. He’s already paid off $8,500 since finishing college. Just like with his savings, he’s being aggressive and paying more than the minimum payments each month. Bob plans to be debt-free in 15 months.

1. Should he continue to pay extra on the student loan and get it paid off in his desired time frame? If he does this, he plans to continue contributing to his savings account at the same time.

2. Or, should he stop putting money into savings and put all of his extra cash toward the student loan? If he does this, how much more quickly will he have the student loan paid off?

3. Compare and contrast other options that Bob has available to him.

Answer 1

(1): In case Bob continues to pay extra on the student loan and get it paid off in his desired time frame and continue contributing to his savings account at the same time then he will achieve his goal of being debt free in the near future. Bob wants to be free from all debt within 15 months and by continuing to pay extra towards his student loan will help him achieve this goal. He should also look at establishing and building an emergency fund. This emergency fund should be different from the amount being saved in savings account. The emergency fund will enable him to meet unexpected situations like a health emergency, accident etc.

(2): No, Bob should not stop putting money into savings account. This is because the earlier you start saving the more will be the quantum of benefit that you will receive in future due to concepts like time value of money and compounding of money. His savings account will keep earning interest and the earlier he starts saving the longer will be the time duration for which his savings will earn interest. This will significantly increase the future value of his savings.

If Bob does stop putting money into savings and put all of his extra cash toward the student loan then he will be debt free before his desired goal of 15 months.$6500 has to be paid more and for a 15 month period this entails a monthly payment of 6500/15 = $433.33 per month. Bob can obviously pay the loan in 10 months by paying 6500/10 = $650 per month but this is not advisable.

(3): Other options that Bob can make use of is to contribute a part of his savings in equity market. As he must not be having an in-depth knowledge of the equity markets he can route his savings through mutual funds. Equity investments are risky but also offer potential high returns. As Bob is young he should seriously consider this option.