Fun Fact - The Cheapest Loans

1. I was watching Jeopardy the other day, as I often do, and the champion had won several days in a row. He was running out of interesting stories to tell during yack time, so Alex asked him, "What are you going to do with all your winnings?" The contestant replied, "Pay off my student loans, for starters." I wanted to shout back to the tv set. "No! Are you kidding?" I always enjoy criticizing people who are smarter than me. He's a Jeopardy champion, while I just sit back and watch. But hey, he can't hear me, so I say again, "Don't pay off your student loans. Are you crazy?"

My daughter has a student loan from the federal government, and interest accrues at just a little over 3%. Where else can you get a loan for 3%? The bank? Not hardly! You might get 6 percent on a secured loan such as a car loan or mortgage, assuming good credit. For an unsecured loan, you're looking at double digits. And don't get me started on credit cards, which I affectionately refer to as legal thieves. They can charge 27% for the money they loan you. So if you have a loan at 3% fixed, thank your lucky stars and don't pay it off. If you have any other debt, be it credit card or consumer loan or whatever, pay that off first. If you have no other debt, then invest the money. Anyone can get more than 3% on a 15 year investment, which is the life of a typical student loan. In fact, over that time span you should be able to earn 10% or more. Of course there is risk, there's always the chance of a market crash, it could happen, and you must balance that risk against return, but dog gone it, you should be able to earn 7% with low risk, or 11% with moderate risk. So keep your student loans and put the money in an indexed fund. You'll come out way ahead, especially since the interest on student loans is tax deductible.

Of course, not all student loans are created equal. At one point in my daughter's college career, her grades were too low to qualify for a federal student loan, so we had to get a private student loan from Wells Fargo. Repayment is deferred until after graduation, like any other student loan, but the interest rate is 9.7% variable. Wow! That's somewhere between ouch and boing. If you have a student loan pushing 10%, and you have the chance to pay it off, that's probably a good idea, especially since student loans cannot be absolved through bankruptcy. Maybe our Jeopardy contestant was in that situation, not because of poor grades I'm sure, but because there is only so much you can borrow from the feds, and after that you have to turn to a bank. So perhaps he is paying off high interest private student loans. Fair enough. I hope he's not paying off his federal student loans, because that is the cheapest money in town.

2. I was looking through my mother's papers the other day, and I ran across her reverse mortgage. Interest is fixed at 3.4% for as long as she stays in her home. These mortgages are issued by banks, but are insured and underwritten by the federal government. It is a special program set up for seniors by Ronald Reagan. There are many things Reagan did that make me rather ill, like his never ending SDI boondoggle, and his obscene little wars in Central America, but this one he got right. My mother would be out on the street if it wasn't for her reverse mortgage, and I'm sure it has helped millions of seniors across the country. As luck would have it, my Mom got her money out in 2006, just in time, just before the real estate crash of 2008. Now her house is under water, but who cares - she has her money. As a thought experiment, let's say there was no housing crash, and I wanted to inherit the house, or at least the proceeds from the sale of the house. Would there be any equity - would there be anything left to inherit? Probably yes, because property usually appreciates much faster than 3%. Once again, the government is giving us the cheapest mortgage in town. Nowhere else can you get a mortgage at 3% fixed, in perpetuity. Nowhere! And if there is a crash, as we saw in 2008, the government picks up the pieces - the government absorbs the risk.

I remember the reverse mortgage agent advising us, "Don't take out all the money in a lump sum just to invest it. That's too risky." Are you high? Damn straight I'd take out all the money and invest it. Yes there's a risk, but I can certainly make more than 3%, even through a conservative portfolio.

3. Finally I turn, with some trepidation, to the IRS. This agency can at times be an unbridled juggernaut, hence Congress is constantly holding hearings on IRS abuses. The IRS can be particularly brutal to small businesses. My step father ran a small company that employed five people, and his business was audited two years in a row. The first audit was 100% clean, but that didn't matter - here we go again. Needless to say, he was pissed! All that said, I honestly think the IRS is fair, and sometimes more than fair, to the average individual taxpayer. If you can't pay your tax bill, you can propose almost any payment plan and they'll say yes. Don't just ignore them and pretend like they will go away - step forward with an honest dialog. In 2012 we filed for bankruptcy, but that does not dismiss the tax bill, which we were entirely unable to pay. Fearing the IRS boogymen, I made the mistake of suggesting a short-term payment plan with high monthly payments. I realize now that I could have asked for a longer payment schedule, which would have eased my cash flow. They would have said yes. I also didn't know, at the time, that the IRS only charges between 3 and 4 percent interest, so you want to stretch those payments out for as long as possible. Here we are again, a government loan at 3% fixed. If I won some money on Jeopardy, would I pay off my tax bill? No, just like I wouldn't pay off my fafsa student loans. That would be a mistake.

The recurring theme of this article is a series of cheap loans subsidized by various agencies of the U. S. government: Department of Education, Federal Housing Administration, and Internal Revenue Service. Republicans like to complain about the government, and sometimes they are justified, but sometimes they are off their nut. The private sector can't come close to these loans, any more than they can offer affordable healthcare or protect the environment. There are some things that companies just can't do, or won't do in the name of profits. This doesn't mean you should say yes to student loans, or mortgages, or tax debt, without careful consideration. A debt is a debt. For example, Suze Orman strongly advises against student loans. If you can't afford a 4 year university, then consider a community college. And some say that a reverse mortgage should be a senior's last resort. And tax debt is unrelenting, and immune to bankruptcy. Fair enough. But if your back is to the wall, and you have to borrow money for any of these purposes, the government does not hammer you the way a bank or credit card company would. Uncle Sam is kinder and gentler than Chase or Bank of America. Take advantage of these startlingly cheap loans, and don't pay them off early, even if you have the means to do so.

Further Reading

Suze Orman on student loans
Reverse mortgage pitfalls