Debt, a 3-Way Loser

By Michelle Singletary
Sunday, October 8, 2006

For the past several weeks, I've been spending my Wednesday evenings taking a class at my church called "Financial Freedom." Among other things, the class aims to teach how debt can put you in bondage.

"Debt is not something you flirt with," Charles Ellerbe, my instructor, said during the first class.

That's a hard lesson to learn in a society in which we're encouraged to embrace debt, contends Ellerbe, who has been teaching the biblical principles of managing your money for more than 10 years at First Baptist Church of Glenarden. He has helped hundreds of people get out of debt.

I thought again about Ellerbe's warnings after some readers wrote to say that I was reckless for recommending recently that someone take a $30,000 life insurance payoff and put it all toward paying down a $39,000 student loan debt carrying a 3.5 percent interest rate.

You would have thought I suggested the person burn the money.

"Why in the world would you pay off a 3.5 percent loan when you can put that money in the bank?" one reader asked. "Were you sleeping in your finance classes?"

Others criticized me for not suggesting the person stick to the scheduled loan payments because the interest is tax deductible. Still others thought I was being irresponsible for not recommending that the borrower invest the money.

I did reconsider what I suggested. In fact, recognizing that some people need a second opinion, I consulted a finance economist. Specifically, I asked Lewis Mandell, professor of finance and managerial economics at the University at Buffalo, to analyze the following choices:

· Paying down a 10-year student loan debt of $30,000 versus keeping it for a tax deduction. (We picked $30,000 to simplify the math.)

· Paying off the debt at 3.5 percent compared with putting the cash in a savings account earning 4 percent.

· Paying the debt versus investing the money.

Let's take the first point. If the former student has a modified adjustable gross income of less than $65,000 (single) or $130,000 (married filing jointly), qualified student loan interest is deductible up to $2,500 per year. This particular tax deduction is available regardless of whether you itemize tax deductions on your tax return.

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