Student Loan Interest Deduction: Who Really Wins? - The Broke Professional

Student Loan Interest Deduction: Who Really Wins?

Give them more interest deductions please!

Give them more interest deductions please!

I’ve talked to many colleagues and students about what their student loan payoff plan is and why they chose it.  I’ve heard extreme answers like some who are just going to stretch their plan out as long as possible and pay the minimum until the end, and some people who are forgoing investing their money or getting married until their loans are paid off.  Others don’t really have much of a plan.  They will just pay the minimum and throw some extra money at random loans.  My method of choice is the Avalanche method, in which you pay the minimums and apply any extra payments to the loan with the highest interest rate.  It will save you the most time and money.  Period.

Regardless of what method (or lack of method) people used, many did mention or have questions about the student loan interest deduction.  For 2015, the IRS will allow you to deduct any student loan interest paid from your Modified Adjusted Gross Income (MAGI), up to a maximum of $2,500.  There are some stipulations, of course, that will disqualify some new grads or make it tough to get a decent deduction.

Income Limits

Many tax deductions and credits have income limits, presumably to help those who need them the most.  The income limits for the student loan interest deduction is $80,000 for those filing as single and $160,000 for those filing a joint return.  Many people with a health profession degree such as medicine, optometry and dentistry have starting salaries in the 6 figures, which means if you’re single, no student loan deduction for you.  Which is slightly ironic since these are professions with high amounts of student indebtedness.

What this all means is that for many professionals graduating with student loan debt, the deduction will never apply to them.  Lots of new grads have heard of this deduction and will never be able to use it.  While not many will feel pity for a professional who makes 6 figures, it is disappointing that they will see no help from the government in paying off their loans.

And the Winner is…

Banks make money by keeping people in debt.  Be it mortgage debt, home equity lines of credit, credit card debt or student loan debt, banks get fat off of consistent interest payments coming in from its customers.  Some may call me pessimistic (my wife certainly does), but I like to look at transactions from the other side of the table.

While the student loan interest deduction does indeed help a lot of people, the “people” it helps the most are the banks that issue the student loan debt.  As I mentioned before, many professionals I’ve talked with mention the interest deduction as a reason they are not paying their loans off early.  This is music to a bank’s ears.  Not only does the deduction not affect their bottom line in the least, it allows them to keep collecting interest payments from its borrowers when they might have paid off those loans otherwise.

For example, a loan of $50,000 with a 5% interest rate has a $500 minimum payment.  With minimum payments only, this loan would take 10 years and 10 months to pay off with $14,814 in interest paid along the way.  What happens if you’re able to double your monthly payment and pay $1,000 a month?  It shaves the life of the loan down to 4 years and 9 months with $6,185 in interest paid.  Paying down your loan aggressively will finish off your loan 6 years faster and with $8,000 more in your pocket instead of the banks.

The winner, once again, is the banks at the expense of the borrowers.  I use this as extra motivation in trying to pay off my loans as quickly as I can, and I hope others will also.

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Comments

  1. I’ve just never really understood the philosophy of not paying off the debt. Why pay the interest – even if you have a great rate? Don’t get it!!

    • Same here. I would argue to at least have some sort of emergency fund in place before starting to pay off debt aggressively, but after that, go at it! There are too many benefits to having no debt, but my two main ones are increased cash flow and piece of mind.

  2. We only graduated with about $10K in student loan debt, but it still felt daunting at the time. We paid the standard monthly payment until we got to the point when we hit the income ceiling for the interest deduction. Once we couldn’t get the deduction anymore, we were forced to ask ourselves why we didn’t just pay it all off already. And we worked harder, and did it. So for us, the income limit was a good thing. And even though we lost the deduction, we still felt that was fair, as having a federal loan is still “government help,” plus we feel strongly that we have an obligation once our income reaches a certain point to pay our fair share to help the country run.

    • Yeah being near the income limit is not necessarily a bad thing. It means you’re probably doing pretty well actually! I would do the same thing and just try to pay it off as quickly as I could. You get to pay the government back and make sure the banks don’t get to keep more of your money.

  3. I’ve never understood people who keep loans around for their tax deduction benefits. It never seemed like a win to me.

    Even assuming we had a mortgage with enough interest to itemized (yay low AZ housing prices!), payoff would still be a priority.

    • I agree. The only ones winning are the banks that are servicing the loans. It’s the whole spend 1 dollar to get 30 cents back thing. Not a good deal. Thanks for the comment.

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