Matt's post on Debt and MS

[Andrew]

Yesterday @Matt wrote a post "critiquing" @Chasing The Points play with student loans.

My fiancée is currently doing her MBA (as I believe Chasing The Points is as well) and her employer is reimbursing 50% of her MBA tuition. She has not taken out a student loan to pay for the MBA as we have the funds to pay out of pocket for the remaining 50%.

I am just wondering if this is smartest approach for us? Is there anything better we could be doing with that money, where we would see a greater return than the interest or origination fee we would need to pay for a loan?

 

[Matt]

I'd say there probably isn't, but I would be keen to hear if there is. It's a simple arbitrage question, and the math is pretty straightforward:

If you can deduct interest: salary under $75,000 ($155,000 if filing a joint return) then APR * (1-effective tax rate) EG yesterday we said 7.2% * (1-.35) = 4.68%
If you cannot deduct interest as salary is over those levels then effective rate = nominal rate so its a flat 7.2%

Now... can you find an opportunity that pays more than that?

The risk variable to throw in would be if the tax deduction goes away (say the MAGI threshold lowers, or you guys get a promotion etc) does the investment still out perform the cost of the loan now it is not deductible.

You might be able to find some fixed income that pay more than 4.68% but they would be long term offerings, and with interest rate risk you could buy into a losing proposition. There might be stocks that could offer greater than 4.68% but they obviously have risks... and you'd have to pay taxes on your gain unless you used the inflow from the loan to fund a tax advantaged account that you couldn't otherwise afford - eg if you don't have a ROTH and this could pay for one, it could be something to consider.

Another thing that could offer the upside you need for the arbitrage is investment property, and using this for a down payment. But then you are really getting into leverage. Ultimately I think the decision should be made if you can visualize losing say 50% of your loan in an investment, and still recover from it -how much would it set you back, would you be in debt for years due to this risky move?

The one thing I would be most in favor of using the money for would be my own business... that at least I have control over, so if a capital injection could boost it then it might be an option, but for other people who haven't run a business they should realize most of them fail.

 

[Andrew]

Matt,

Thanks for the response. My fiancée doesn't have a Roth but does have 401k matched by her employer (up to 6%). I know she is matching that 6% but I need to make sure she is maxing out her ability to contribute to that. If she isn't then I assume it might be a good idea to have her max out her 401k (I believe it is $17.5K a year) and then look into opening a Roth as well?

She makes over $75K so she can't deduct from the student loan.