Warning: WORDS... and tax shit

I've been trying to figure out the ins and out of Stafford Loan interest deduction to determine whether I should try to pay back an unsubsidized $2000 Stafford loan as fast as possible, or if I should take my time or even wait until I graduate. My wife and I will be getting $2000 very soon which I can use to pay off this loan, or for other things like a nest egg account, starting an IRA, or rent and car payments.

In my reading, I find these important pieces of information:
1: It seems you can only deduct interest if you are legally required to make "interest payments"
2: If you are married but file separately, you cannot deduct the interest

In regards to 1: At first I took this to mean that you couldn't deduct the interest if you we're REQUIRED to make payments yet (ie still in school), however reading on made it seem more like "you cant deduct the interest you paid while paying off your nephew's loan as a gift" when only the nephew was legally required to pay the interest

In regards to 2: I understand the requirement, but I honestly don't understand why they would have this requirement. How would being married but filing individually help you? Maybe I'm just missing something. If someone would care to explain why this would be important, I'd like to understand.

This next part might be more important...

The deduction of interest is considered an "adjustment of income". My interpretation of this is that it's not a direct deduction so you will probably not get all your money back. For example, if I payed $500 in loan interest for the year, and deduct that from a salary of $20k, that doesn't mean that the taxes I pay will be $500 less. If anything, it seems like that would result in paying... maybe $100 less in taxes? If this assumption is correct, then the addition of interest to your account would want to be avoided.

The only reason I'm bringing this up in the first place is that I was reading some Suze Orman book a friend of mine had and it suggested paying as little on your student loans as possible "since the interest was tax deductible". The point was that the money could better be spent invested in an IRA or allotted to pay a mortgage or credit card debt.

So what should I do? Should I use the money and pay off the Stafford loan ASAP, or have any of you recently graduated folks found that you recover most of your student loan interest on your taxes, to the point where I shouldn't even worry about accruing interest? Thanks for any advice. Sorry about the long and complicated question.

7/30/2008 4:59:27 PM

Quote :

"How would being married but filing individually help you? Maybe I'm just missing something. If someone would care to explain why this would be important, I'd like to understand."

You could have one person take the standard deduction and one person itemize to have a lower total AGI.

7/30/2008 5:37:21 PM

You will be able to deduct the interest as you pay it. Its an adjustment on the front page of the 1040. It will work to reduce your taxable income which will reduce your tax liability. The tax savings will probably be the amount of interest x your incremental tax rate (dependent on income).

Some questions you need to ask yourself are:

1. What is the interest rate on the student loan?
2. What rate of return will I receive on the investment?
3. Is question 2 greater then question 1?

That student loan interest deduction is not that great of a tax break and it starts to get limited with higher income.

[Edited on July 30, 2008 at 6:01 PM. Reason : 1]

7/30/2008 5:42:14 PM

Quote :

"You could have one person take the standard deduction and one person itemize to have a lower total AGI. "

No you cant. If one itemizes so does the other.

7/30/2008 6:01:12 PM

^ That's true

I think the point in the book was that if you can invest in something that will return 8 or 9%, that could be a better deal than using the money to pay back a loan with 5% where you get some of the money back. If the alternative is buying video games and porn, then you should probably pay off your loan.

We're already strapped as hell with money right now (semester fees are due) and after I pay those I'll have nothing but my nest egg/emergency account that I'll like to not touch. I'm worried if I immediately pay out all $2000, the loan will be paid off but that will leave us with nothing again. I may pay off half then start paying off more next month when my wife is working full time and I will have some freed up money to pay off loans. I figure accruing an extra 30 or 40 bucks interest is worth the safety of already having next months rent in August instead of waiting until September 1st to get it direct deposited.



[Edited on July 30, 2008 at 6:09 PM. Reason : reason]

7/30/2008 6:07:22 PM

Generally student loans are the cheapest loans you will ever have in your life. Typical rule of thumb is you want to pay them back as slowly as possible unless you are completely financially solvent.

the interest rate tax deduction on a $2000 student loan is going to be very small dollar wise, think about it like this, you will essentially get between 25 and 30% (depending on your tax bracket) of the total amount you pay in interest, back as a credit.

it sounds like you are not financially secure, you will probably be better off by holding on to the $2000 cash in some sort of emergency fund. your student loan interest is no more than 8.25%, credit card interest rates start at that. if you need emergency car repairs tomorrow, having your student loan paid off isn't going to help you with that, the $2000 in a savings account will. if you have high interest loans, like car loans or credit card debt, apply the $2000 to that instead.

thats my suggestion

7/30/2008 6:28:44 PM

Quote :

"No you cant. If one itemizes so does the other."

Right. I was saying one couldn't take the standard deduction and the other itemize.

7/30/2008 11:25:07 PM