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How to Pay Off a Student Loan Early

Kathy M. Kristof occasionally answers reader questions of general interest on personal finance. Here are some answers to recent questions:

Q What is the most effective manner to pay my student loan off early? My loan is currently $13,000, with a monthly payment of $167. I am now able to add $167 to that payment each month. Would it be best to pay an additional payment of $167 each month, or would it be best to just have the money applied against the unpaid principal? --W.W.

A Most lenders automatically apply any additional payments to principal, which benefits you because it means your future interest obligations are calculated against a smaller loan balance. The only reason you might want to go the other way is if you believe that you’re only temporarily flush and may need a payment hiatus in the future. In that case, you must specifically ask your lender to apply the extra payment to a future month.

Q Are U.S. Treasury bonds and notes subject to early “calls”? --C.M.P.

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Treasuries don’t get “called,” or paid off early. As for the corporate bonds, call your broker and ask when they can be called and whether he or she believes that they might be. Generally speaking, companies call their bonds when they can refinance the debt more cheaply. If you’re earning double-digit interest rates on corporate bonds, an early pay-off is likely.

Q I have been looking for a present-value calculator for some time, without success. Can you tell me where one might be purchased? --A.C.S.

A You can find present-value calculators virtually anywhere calculators are sold--drug stores, electronics stores, department stores, etc. But the present-value function is not always clearly advertised. Often these machines are labeled “business” or “financial” calculators, because most do much more than calculate present values. No matter, if it has “PV” and “FV” keys, it’s a present-value calculator.

Q I recently refinanced my home. My original mortgage was for $148,000 at 9.375% with monthly payments of $2,073.39. There were 10 years remaining on the mortgage. The new mortgage is $148,000 at 6.25% with a monthly payment of $911.26 for five years. At the end of the five years, I must refinance or make a balloon payment of $138,139.

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Is it better to pay off this mortgage by the end of five years by prepaying an additional $2,006 per month, or should I invest the $2,006 each month? If so, what type of investment? What would I have to earn after taxes to equal paying off the new mortgage balloon payment? --F.R.P.

A That depends on your tax bracket. You also need to factor in the cost of refinancing at the end of the five-year period. Since you didn’t mention your tax rate, and because refinancing fees can vary, I’d have to speculate. But, a conservative estimate says you’d need to earn at least 9% if you’re investing versus prepaying the mortgage.

That’s not an overwhelmingly high return. But it’s very generous for an investment that’s essentially risk-free. You might be able to get a higher return by investing in far riskier ventures. But if you don’t like risk, you can’t beat paying down the mortgage.

Send questions to Kathy M. Kristof, c/o The Los Angeles Times, Times Mirror Square, Los Angeles, Calif. 90053.

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