How to Compare Loan Options

“It’s not hard to make decisions when you know what your values are”          

– Roy E. Disney

Difficult Decisions

Which of these options would you choose?

  1. Paying $8,000 of interest over 10 years
  2. Paying $5,000 of interest over 5 years
  3. Paying $3,500 of interest over 2 years.

A little overwhelming isn’t it? This list could be your choices for student loan repayment options, with different payback periods and interest rates. How can you possibly figure out which is best? 

If you said, “Option 3, duh…”, you’d be paying less interest overall, but at what cost? What you can afford to pay, depends on your income. If your monthly payment is too high, you can’t afford to live. You can’t give up too much of your income for student loans or else you can’t pay rent.  

 

So, the smallest interest might not be the best? That also depends on what you think your money is worth over time. 

This comparison is a time value of money problem.  You remember what we said about investing:

        If you invest at 5%, you need just $7,102 today in order to have $50,000 in 40 years.

Okay, now turn this around.  The net present value of $50,000 in 40 years at a 5% rate of return is $7,102. How does that help?  It allows you to compare everything at one point in time, today. 

 

I know, it takes some really good technique with a calculator.  In future posts, we will try to tackle more of this.

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