paying back loans

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birdlaw117
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Re: paying back loans

Postby birdlaw117 » Sun Oct 23, 2011 3:16 pm

Bronte wrote:
birdlaw117 wrote:But my question would be at the end of when you pay off your debt you can start using that $$ to invest. So what is the relationship between waiting more years to start investing (the paying loans slower route) and having some investment earnings vs having it paid down faster and starting later but with larger contributions?

Unless I'm not following your scenario, this question is more complicated than that scenario... right?


It's not really more complicated than my scenario. If you don't pay down the loan, then sure you'll have more money to invest, but you'll also still have more principal to pay down. When you invest by paying down your loan, you don't lose the principal. It's just that it's completely illiquid.

No offense, but I'm just not sure without seeing the numbers behind it. It's not that I think you're wrong, it's just that I would like to see it. I don't expect you to draw up a scenario and post it on here in response though.

Brassica7
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Re: paying back loans

Postby Brassica7 » Sun Oct 23, 2011 3:18 pm

birdlaw117 wrote:
Bronte wrote:The benefits of compounding are the same between normal investments and investing in debt reduction. In a normal investment, interest compounds on a growing principal. When you pay down debt, you don't get this benefit of compounding. However, you reduce the principal upon which interest would be compounding against you, so you still get the benefit of the compounding.

Here's an example: Investment 1--You put $10,000 in a 3-year investment that pays 10% per year. Investment 2--At time 0, you put $10,000 toward the principal on a loan that bears 10% interest per year. You don't make any other payments for three years.

What you make on the first investment at the end of three years is simple: $3,310 (calculated by 10,000*(1.10)^3-10,000). What you make on the second investment is the difference between what you would have paid in interest without the $10,000 payment toward the debt. If you didn't make the $10,000 payment, you would pay $33,100 in interest (calculated by 100,000*(1.10)^3-100,000). Making the payment, you pay $29,790 in interest (calculated by $90,000*(1.10)^3-90,000). The difference between the interest you did pay and the interest you would have paid is $3,310. Thus, the investments are identical in terms of interest paid.

(Obviously this hypothetical is stylized. Loan payments compound monthly. Further, you will be paying both principal and interest when you make payments. I am confident that the principle holds true, however, despite these complications.)

It is thus clear that it is highly unlikely that you will be presented with any better investment opportunity than paying down your law school debt. Paying down your law school loans gives you a 7.5-9% risk-free, tax-free investment opportunity (depending on the interest rate of your loans). There is nothing in the market that comes close to this. Municipal bonds may be a good deal right now, but they get nowhere close to this.

As others have stated, the primary advantage to investing in something other than your loans is that loan payments are a wholly illiquid investment. It's good to have some liquidity, but not at the expense of passing up the opportunity to invest your loans. It seems like the best advice is to build a reasonable liquidity cushion (cash or cash equivalent savings) while paying down as much debt as possible. Once that liquidity cushion is built, payments on debt should be accelerated.

But my question would be at the end of when you pay off your debt you can start using that $$ to invest. So what is the relationship between waiting more years to start investing (the paying loans slower route) and having some investment earnings vs having it paid down faster and starting later but with larger contributions?

Unless I'm not following your scenario, this question is more complicated than that scenario... right?


I don't think it is more complicated than the scenario. Paying off debt is financially identical to investing--the only question is balancing the student loan rate against expected returns from the investment, then factoring in concerns about liquidity, tax implications, and the risk of the investment vs. the zero risk repayment of student loan option. Liquidity favors investing and not paying back the student loan, but tax implications and risk heavily favor repaying the student loan. I agree have a rainy day fund is good, but beyond that liquidity is not as important, unless you are saving up for a house.

"So what is the relationship between waiting more years to start investing (the paying loans slower route) and having some investment earnings vs having it paid down faster and starting later but with larger contributions?" This will even out to zero, as long as the interest on the student loans and the interest on the invested savings are the same. Bronte and I are arguing that, while it may be possible to get a better return than 7.9% on an investment, it is risky. We therefore conclude that paying down the loans is the best investment option because it is risk free, tax free, and is at a high rate of return relative to other investment options.

Bronte, my apologies if I have misstated your argument.

Brassica7
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Re: paying back loans

Postby Brassica7 » Sun Oct 23, 2011 3:24 pm

quakeroats wrote:
Bronte wrote:The benefits of compounding are the same between normal investments and investing in debt reduction. In a normal investment, interest compounds on a growing principal. When you pay down debt, you don't get this benefit of compounding. However, you reduce the principal upon which interest would be compounding against you, so you still get the benefit of the compounding.

Here's an example: Investment 1--You put $10,000 in a 3-year investment that pays 10% per year. Investment 2--At time 0, you put $10,000 toward the principal on a loan that bears 10% interest per year. You don't make any other payments for three years.

What you make on the first investment at the end of three years is simple: $3,310 (calculated by 10,000*(1.10)^3-10,000). What you make on the second investment is the difference between what you would have paid in interest without the $10,000 payment toward the debt. If you didn't make the $10,000 payment, you would pay $33,100 in interest (calculated by 100,000*(1.10)^3-100,000). Making the payment, you pay $29,790 in interest (calculated by $90,000*(1.10)^3-90,000). The difference between the interest you did pay and the interest you would have paid is $3,310. Thus, the investments are identical in terms of interest paid.

(Obviously this hypothetical is stylized. Loan payments compound monthly. Further, you will be paying both principal and interest when you make payments. I am confident that the principle holds true, however, despite these complications.)

It is thus clear that it is highly unlikely that you will be presented with any better investment opportunity than paying down your law school debt. Paying down your law school loans gives you a 7.5-9% risk-free, tax-free investment opportunity (depending on the interest rate of your loans). There is nothing in the market that comes close to this. Municipal bonds may be a good deal right now, but they get nowhere close to this.

As others have stated, the primary advantage to investing in something other than your loans is that loan payments are a wholly illiquid investment. It's good to have some liquidity, but not at the expense of passing up the opportunity to invest your loans. It seems like the best advice is to build a reasonable liquidity cushion (cash or cash equivalent savings) while paying down as much debt as possible. Once that liquidity cushion is built, payments on debt should be accelerated.


Of course, law school loans aren't like traditional loans. You can't easily default, but you can change the terms that apply in ways that may alter what's best for you to do, i.e., IBR and LRAP. For those of you staying in big law long term, you should pay off your loans as slowly as possible and invest your extra money as aggressively as your age range allows. Have an emergency fund outside of this. This way you get a better return than 7.5% if things go as planned and extra liquidity in the short term unless we have another serious correction. Even for those in other situations, this is probably the best idea. The only problem with student loans is that you can't default easily. I'd say this is more than made up for by IBR and LRAPs.


I strongly disagree. It is true that stocks have performed better than 7.9% since the Great Depression (I think it is 9-10%), but you will owe taxes on the gains outside of a Roth IRA, and you may lose money. Also, there are a lot of reasons to think that the next 40 years may not be as good for the US economy as the past 80 were. At 7.9% interest, zero taxes and zero risk, paying off student loans fast is the best "investment" out there.

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quakeroats
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Re: paying back loans

Postby quakeroats » Sun Oct 23, 2011 3:25 pm

Bronte wrote:
quakeroats wrote:Of course, law school loans aren't like traditional loans. You can't easily default, but you can change the terms that apply in ways that may alter what's best for you to do, i.e., IBR and LRAP. For those of you staying in big law long term, you should pay off your loans as slowly as possible and invest your extra money as aggressively as your age range allows. Have an emergency fund outside of this. This way you get a better return than 7.5% if things go as planned and extra liquidity in the short term unless we have another serious correction. Even for those in other situations, this is probably the best idea. The only problem with student loans is that you can't default easily. I'd say this is more than made up for by IBR and LRAPs.


You're stating conclusions without supporting them. You can't use IBR or LRAP if you're making big law money.


The reason we ultimately worry about debt is the threat of default. We aren't worried about that on a biglaw salary. We're worried that we get canned and can no longer afford the loan. IBR and LRAP make that unlikely for us.

Also, there's no way to know you'll be staying in big law long term. It's best to assume you'll conform to the average four year attrition rate.


Why's that? To use a similar situation with which we're familiar, how can you be sure you'll get an LSAT score good enough to get into a top school when well over 90% of people won't?

I don't know what you mean by you can "adjust your loans." No matter what, if you don't pay down your loans, you are forgoing the 7.5% return.


I mean IBR and LRAP adjustments (not in the traditional sense of the word adjustment, as the terms of the loan already include or presuppose these features). If you use either of these options, there's a very real chance you won't see the full burden of the loan.

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birdlaw117
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Re: paying back loans

Postby birdlaw117 » Sun Oct 23, 2011 3:26 pm

Brassica7 wrote:I don't think it is more complicated than the scenario. Paying off debt is financially identical to investing--the only question is balancing the student loan rate against expected returns from the investment, then factoring in concerns about liquidity, tax implications, and the risk of the investment vs. the zero risk repayment of student loan option. Liquidity favors investing and not paying back the student loan, but tax implications and risk heavily favor repaying the student loan. I agree have a rainy day fund is good, but beyond that liquidity is not as important, unless you are saving up for a house.

"So what is the relationship between waiting more years to start investing (the paying loans slower route) and having some investment earnings vs having it paid down faster and starting later but with larger contributions?" This will even out to zero, as long as the interest on the student loans and the interest on the invested savings are the same. Bronte and I are arguing that, while it may be possible to get a better return than 7.9% on an investment, it is risky. We therefore conclude that paying down the loans is the best investment option because it is risk free, tax free, and is at a high rate of return relative to other investment options.

Bronte, my apologies if I have misstated your argument.

Okay, cool. There are also other considerations, such as having a higher debt-load will hurt your other financing (though I suppose having more assets would help, so this might be a wash too?) that are non-ROI (sort of) factors as well. I definitely think it's important to have a healthy mix of investing/rainy day fund and debt-repayment.

As far as my question is concerned, no need to try and refute it without numbers, because that's really the only way that I'm going to be sure either way. I don't expect anyone to run that analysis for me though.

ToTransferOrNot
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Re: paying back loans

Postby ToTransferOrNot » Sun Oct 23, 2011 3:28 pm

In response to Quaker: God wtf.

No, the main reason people are bothered by debt is not the risk of default. In the case of student loans, the main reason (biglaw) people are bothered by the debt is the fact that the interest rate is really high. $160k in debt is suffering well over $10k in non-deductible interest a year. You apparently don't think that's a big deal, for some incomprehensible reason, but that $10k represents well over a month of after-tax biglaw salary.
Last edited by ToTransferOrNot on Sun Oct 23, 2011 3:29 pm, edited 1 time in total.

Brassica7
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Re: paying back loans

Postby Brassica7 » Sun Oct 23, 2011 3:28 pm

[quote="quakeroats"]

The reason we ultimately worry about debt is the threat of default. We aren't worried about that on a biglaw salary. We're worried that we get canned and can no longer afford the loan. IBR and LRAP make that unlikely for us.

[quote]

Also, the interest working against you. Even if IBR makes the risk of default less severe from a personal perspective, a guaranteed 7.9% return without tax is great. Better than the average stock return (because of the tax advantage and the zero risk).

ToTransferOrNot
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Re: paying back loans

Postby ToTransferOrNot » Sun Oct 23, 2011 3:31 pm

Also, the credited investment strategy is choosing to not have children and die young;)

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Old Gregg
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Re: paying back loans

Postby Old Gregg » Sun Oct 23, 2011 3:39 pm

ToTransferOrNot wrote:Also, the credited investment strategy is choosing to not have children and die young;)


Another is choosing to be in debt until the day you die. What's the use in being conservative now so that you can enjoy life only when you're old?

I'm not seriously saying that I'd do this, though I'm somewhere in the middle. But a lot of people take this approach.

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birdlaw117
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Re: paying back loans

Postby birdlaw117 » Sun Oct 23, 2011 3:46 pm

Brassica7 wrote:
quakeroats wrote:
The reason we ultimately worry about debt is the threat of default. We aren't worried about that on a biglaw salary. We're worried that we get canned and can no longer afford the loan. IBR and LRAP make that unlikely for us.



Also, the interest working against you. Even if IBR makes the risk of default less severe from a personal perspective, a guaranteed 7.9% return without tax is great. Better than the average stock return (because of the tax advantage and the zero risk).

Only the interest payment is without tax, but your point still stands.

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Bronte
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Re: paying back loans

Postby Bronte » Sun Oct 23, 2011 3:49 pm

1) I don't know anything about the reason why most people worry about paying back loans. What we're talking about here is that, given that you do have to pay back your loans, investing in paying down your loans is likely the best investment opportunity available to you in the market. When you don't pay them, you forgo that investment opportunity. This has the real effect of increasing your loan balance by 8% per year. This is money you have to pay back.

2) Assuming you'll be in big law long term is not the same as assuming you'll get a high LSAT score. That analogy is bad because you don't make any important financial decisions in reliance on your LSAT score. A better analogy would be assuming you'll be top 10% at your law school.

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Re: paying back loans

Postby Old Gregg » Sun Oct 23, 2011 3:53 pm

Assuming you'll be in big law long term is not the same as assuming you'll get a high LSAT score. That analogy is bad because you don't make any important financial decisions in reliance on your LSAT score. A better analogy would be assuming you'll be top 10% at your law school.


Not really, though it depends what you define as "long-term." I define "long-term" as being in biglaw until you're at least a senior associate. At any big law firm, becoming a senior associate is purely a function of doing good work and lots of it. Partnership is much more random than that. Assuming you'll make partner is akin to assuming you'll make the top 10% of your law school. Probably even worse. Assuming you'll make senior associate if you work hard and do good work isn't. Barring a Latham-ing, people who leave big-law early are those who truly want to leave (hence the phrase, "voluntary attrition").

So it's not as egregious to assume that you'll last until at least year 7 if you want to last until year 7, and use that in determining how much of your loans you should pay off and how quickly. Of course, you have to take into account the economy. If you're working at Latham, I wouldn't make that assumption. If you're working at S&C, I wou;d.

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Re: paying back loans

Postby Brassica7 » Sun Oct 23, 2011 4:08 pm

birdlaw117 wrote:
Brassica7 wrote:
quakeroats wrote:
The reason we ultimately worry about debt is the threat of default. We aren't worried about that on a biglaw salary. We're worried that we get canned and can no longer afford the loan. IBR and LRAP make that unlikely for us.



Also, the interest working against you. Even if IBR makes the risk of default less severe from a personal perspective, a guaranteed 7.9% return without tax is great. Better than the average stock return (because of the tax advantage and the zero risk).

Only the interest payment is without tax, but your point still stands.



Sorry, I wasn't clear, but none of it is taxed because you are paying off debt, so it is not income. Once you make about 75k you cannot take a tax deduction on student loan interest (another good reason to pay the loans off fast if you are in biglaw). What I was trying to say is that if you pay off your loan early, that is like making 7.9% interest tax free. If you invested that money instead of paying off the loan and made the same interest (unlikely that it would be exactly the same, but it is easier for our example), you would need to pay tax on the gain.


Example: You owe $100 on a student loan at 7.9% interest, and you have $100 disposable income for the year. You can pay off the loan, or invest the $100 in a magically safe bond that pays exactly the same interest rate, 7.9%. If you pay off the loan now instead of in a year, that saves you $7.90, and you do not owe any tax on this; there is no gain from the bond because you did not invest in it. If you instead invest the $100 in the bond, you will make $7.90 on that investment and owe $7.90 on the student loan. This seems like it should even out, but the $7.90 from the bond will count as income, and be taxed. Therefore, you will have less money than if you paid off the loan. You would therefore need to earn a higher interest rate on the bond than you pay on the student loan (by your marginal tax rate of the income) just to break even. That is why I say that paying off the student loan early is a "tax free" investment.

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birdlaw117
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Re: paying back loans

Postby birdlaw117 » Sun Oct 23, 2011 4:18 pm

Brassica7 wrote:Sorry, I wasn't clear, but none of it is taxed because you are paying off debt, so it is not income. Once you make about 75k you cannot take a tax deduction on student loan interest (another good reason to pay the loans off fast if you are in biglaw). What I was trying to say is that if you pay off your loan early, that is like making 7.9% interest tax free. If you invested that money instead of paying off the loan and made the same interest (unlikely that it would be exactly the same, but it is easier for our example), you would need to pay tax on the gain.


Example: You owe $100 on a student loan at 7.9% interest, and you have $100 disposable income for the year. You can pay off the loan, or invest the $100 in a magically safe bond that pays exactly the same interest rate, 7.9%. If you pay off the loan now instead of in a year, that saves you $7.90, and you do not owe any tax on this; there is no gain from the bond because you did not invest in it. If you instead invest the $100 in the bond, you will make $7.90 on that investment and owe $7.90 on the student loan. This seems like it should even out, but the $7.90 from the bond will count as income, and be taxed. Therefore, you will have less money than if you paid off the loan. You would therefore need to earn a higher interest rate on the bond than you pay on the student loan (by your marginal tax rate of the income) just to break even. That is why I say that paying off the student loan early is a "tax free" investment.


Gotcha. That's true.

Really, the way you wrote it made sense, I just misinterpreted it.

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Re: paying back loans

Postby Bronte » Sun Oct 23, 2011 4:18 pm

birdlaw117 wrote:Only the interest payment is without tax, but your point still stands.


The return on paying down debt is not taxed, unlike the return on other investments.

birdlaw117 wrote:But my question would be at the end of when you pay off your debt you can start using that $$ to invest. So what is the relationship between waiting more years to start investing (the paying loans slower route) and having some investment earnings vs having it paid down faster and starting later but with larger contributions?

Unless I'm not following your scenario, this question is more complicated than that scenario... right?


I'll try to answer this question again, but better this time, although I think others have already answered it. I'll do with with numbers again.

Scenario 1: You have $100,000 in debt at a 10% interest rate. Over the course of three years, you make the minimum $10,000 annual payment. The rest of your available salary, say $70,000 a year, you invest in an account that (improbably) earns 10% per year risk free and tax free.

Scenario 2: You ave $100,000 in debt at a 10% interest rate. Over the course of three years, you pay down the entire debt. Like the above investor, you have $80,000 in available salary per year. You also put the rest into an account that earns 10% per year risk free and tax free.

In these two scenarios, the investors will have an identical net worth at the end of the period. Investor 1 will have $231,700 in the bank and $100,000 in debt. Investor 2 will have $131,700 in the bank and zero debt.

However, and here's the key point, as you reduce the interest rate that the investors can earn in their account (the hypothetical best investment available in the market), Investor 2 becomes increasingly well off. Here's the spreadsheet: https://docs.google.com/spreadsheet/ccc ... n_US#gid=0. To see it in action, reduce the "Account Return" figure to something like 5.00%.

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RMstratosphere
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Re: paying back loans

Postby RMstratosphere » Sun Oct 23, 2011 4:19 pm

Is it possible to refinance federal student loans after graduation with a private institution at a lower interest?

bdubs
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Re: paying back loans

Postby bdubs » Sun Oct 23, 2011 4:21 pm

RMstratosphere wrote:Is it possible to refinance federal student loans after graduation with a private institution at a lower interest?


I have looked for this information and come up with nothing, so my assumption is that the answer is no.

ToTransferOrNot
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Re: paying back loans

Postby ToTransferOrNot » Sun Oct 23, 2011 4:22 pm

RMstratosphere wrote:Is it possible to refinance federal student loans after graduation with a private institution at a lower interest?


Aside from convincing the first national bank of family to take out a HELOC, I haven't figured out a way:/

ETA: Probably because they wouldn't have the protection against discharge in bankruptcy.

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Re: paying back loans

Postby quakeroats » Sun Oct 23, 2011 4:22 pm

Bronte wrote:1) I don't know anything about the reason why most people worry about paying back loans. What we're talking about here is that, given that you do have to pay back your loans, investing in paying down your loans is likely the best investment opportunity available to you in the market. When you don't pay them, you forgo that investment opportunity. This has the real effect of increasing your loan balance by 8% per year. This is money you have to pay back.


Over the long term, you can get more than 8%--a very favorable interest rate--in other investments. If we're just talking about getting the best return on average, you shouldn't go out of your way to pay off your loan quickly. This also has the advantage of providing liquidity in case of emergency, but even without that, you should pay your loans slowly.

2) Assuming you'll be in big law long term is not the same as assuming you'll get a high LSAT score. That analogy is bad because you don't make any important financial decisions in reliance on your LSAT score. A better analogy would be assuming you'll be top 10% at your law school.


It's not in strict reliance--that is, things falls apart financially if the condition fails. I'd argue that most people graduating from top schools should take my approach, but I'd also argue that the super majority of people who plan to stay in biglaw should too.

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RMstratosphere
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Re: paying back loans

Postby RMstratosphere » Sun Oct 23, 2011 4:24 pm

ToTransferOrNot wrote:
RMstratosphere wrote:Is it possible to refinance federal student loans after graduation with a private institution at a lower interest?


Aside from convincing the first national bank of family to take out a HELOC, I haven't figured out a way:/

ETA: Probably because they wouldn't have the protection against discharge in bankruptcy.
bdubs wrote:
RMstratosphere wrote:Is it possible to refinance federal student loans after graduation with a private institution at a lower interest?


I have looked for this information and come up with nothing, so my assumption is that the answer is no.


Thanks for your responses. I don't want to belabor the point but I'm admittedly a finance n00b. Why is this the case? Why can't you walk into MegaBank with your biglawl check and work something out?

Apologies to the financial wizs in this forum that will rightfully throw up in response to my question.

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Re: paying back loans

Postby bdubs » Sun Oct 23, 2011 4:25 pm

RMstratosphere wrote:
Thanks for your responses. I don't want to belabor the point but I'm admittedly a finance n00b. Why is this the case? Why can't you walk into MegaBank with your biglawl check and work something out?

Apologies to the financial wizs in this forum that will rightfully throw up in response to my question.


You have no collateral to secure your loan. They can't repo your degree, so no one wants to lend to you.

ToTransferOrNot
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Re: paying back loans

Postby ToTransferOrNot » Sun Oct 23, 2011 4:27 pm

Biglawl check or not, giving someone an unsecured dischargeable $160k+ check at less than 7.5% just isn't going to happen. There's no guarantee you'll keep your biglaw job, and the fact that lawyers are effectively prohibited from filing for bankruptcy doesn't really sway bankers.

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Re: paying back loans

Postby quakeroats » Sun Oct 23, 2011 4:29 pm

ToTransferOrNot wrote:Biglawl check or not, giving someone an unsecured dischargeable $160k+ check at less than 7.5% just isn't going to happen. There's no guarantee you'll keep your biglaw job, and the fact that lawyers are effectively prohibited from filing for bankruptcy doesn't really sway bankers.


Many major American corporations would kill for 7.5%. That's an investment-grade rate, and no one here is anywhere close to that.

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RMstratosphere
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Re: paying back loans

Postby RMstratosphere » Sun Oct 23, 2011 4:29 pm

ToTransferOrNot wrote:Biglawl check or not, giving someone an unsecured dischargeable $160k+ check at less than 7.5% just isn't going to happen. There's no guarantee you'll keep your biglaw job, and the fact that lawyers are effectively prohibited from filing for bankruptcy doesn't really sway bankers.
bdubs wrote:
RMstratosphere wrote:
Thanks for your responses. I don't want to belabor the point but I'm admittedly a finance n00b. Why is this the case? Why can't you walk into MegaBank with your biglawl check and work something out?

Apologies to the financial wizs in this forum that will rightfully throw up in response to my question.


You have no collateral to secure your loan. They can't repo your degree, so no one wants to lend to you.


Thanks, folks. I appreciate the feedback. I'll return to the humanities now.

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Re: paying back loans

Postby c3pO4 » Sun Oct 23, 2011 4:30 pm

RMstratosphere wrote:
Apologies to the financial wizs in this forum that will rightfully throw up in response to my question.


There are no finance wiz's ITT. Just a bunch of words strung together meaninglessly.




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