Student Loan vs. Mortgage

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by on November 4, 2010 at 9:46 pm

Should I keep my student loans or should I roll them into my existing mortgage? How much lower should my mortgage rate be for it to make a difference?

Usually this is a quick yes… If all the stars are right. If you were refinancing and were able to pay off a student loan, it’s probably a good idea.

Loan Factors

If rates aren’t hurt because of this and closing costs aren’t increased drastically you’re saving in the long run by lowering the effective interest rate.

Interest Spread

How much lower should the new rate be before you decide? Actually the rate could be higher and still be effectively less. ??? You are only allowed to deduct a maximum of $2,500 in student loan interest on your income tax return. You start to lose this deduction at $55,000 (single) and $110,000 (married). So a married couple earning $150,000 annually would not be able to deduct any student loan interest on their income tax return.

What is the cash value of the lost deduction?

It depends. Ironically, the folks you earn more are in higher tax brackets and would benefit more. If we assumed the married couple earning $150,000 is in the 25% tax bracket we can assume a 25% return on deduction if they were already itemized.

Let’s do an actual example -

Single Attorney Earns $120,000, and is in the 25% bracket after deductions. He has $100,000 in student loans at 6% for 15 years. Making things simpler we’ll apportion the interest evenly over the life of the loan.

The total interest paid would be approximately $51,894. That’s $3,459 a year (cheating for simplicity). 25% of that is $865.

So over the life of the loan the interest deduction would have been worth $12,974 (865*15 years)

That said – The cost of the Student Loan at 6% is $64,867 (interest plus the lost tax deductions)

If we had the same loan as a mortgage or equity loan at 7%, we’d pay $61,789 in interest. Essentially we maintain a financial advantage refinancing at a higher rate!

Financial Decision Making

This shoe doesn’t fit everyone perfectly. You should consult with your tax advisor to see how you fit into this equation. There are other factors that need to be weighed before making this decision. For example, refinancing and paying off student loans would not be wise if it raised the overall interest rate. You would end up paying a higher rate on the entire mortgage.

This is definitely something to put under consideration and mention to your tax planner.

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