Arbitrage Opportunities & Revisiting the topic of paying off your debt

And asking the question, do no-debtooors have a mental illness

It is with a somber heart that we write this post to you today. We want to discuss a serious illness that is affecting our society. It is a silent disease that plagues our communities. It can affect the young, the old, men & women, all races, religions, and creeds. However it appears to heavily be focused on the below 30-year old and above 60-year old male population. This pandemic has been spreading over the recent years and is now entering full blown crises status.

Of course, we are talking about the mental illness of ‘no-debtooor-ism’.

Over a decade of low interest rates and a booming stock market has made for some interesting times in the field of being a gooroo. There really hasn’t been much to advise on. This has lead to a world of advice being relegated to:

• Pay down debt

• Buy low-cost ETFs

• Budget & save

And in a world of 0.01% earnings on a savings account, that 2% APR debt is huge.

Well, the economic regime changed. We now have savings accounts earning 2.5%. However, the no-debtooors? They are still pushing for debt pay-off at any cost. But are you surprised? These are the same geniuses saying to pay off all your student loans when the government was yelling “LOAN FORGIVENESS IS COMING!!!”.

[F’er Note - These same gooroos have turned around and claim they saved their followers money for retweeting that you could ask for money back on payments you made. Being a twitter gooroo means never having to say ‘I was wrong’]

All right, enough talking about the fake-gooroos…you have debt, what should you do?

What Should You Do When Savings Accounts Earn More Than Your Debt?

Life doesn’t give you easy arbitrage opportunities often…but when life gives you arbs, you don’t look a gift horse in the mouth when you get back on and ride it again.

During the recent few years, rates on loans got low. Car loans were available at sub 2% APRs, student loans got down to 2.5%. You could get 30-year fixed rate mortgages for sub-3% rates. If you were smart, you had the opportunity to refinance any debt at historical lows. (Hopefully you had an older loan to refinance and didn’t make a purchase at high prices).

Arbitraging Difference In Interest - Free Money (But The Least Important Reason)

We are going to start with the arbitrage since it is actually the least important reason to do this.

At the risk of being so simple that it is offensive to you, our Chad readers. If you have debt that has a 2% APR and a savings account that earns 2.5% APR. And you have the cash to pay off the loan balance. And you are debating doing it… You can just drop the money in the savings account and have your loan auto-paid from your account.

It is really that simple.

Sure, a 50 basis point arb is only $50 a year per every $10k in the account ($10,000 x 0.50% = $50).

However, you can certainly juice the arb a little more…

Squeezing a Little More Juice Outta the Arb The Gift Horse Gave You When You Fell off…

Let’s say you have a 3-year car loan with $30k outstanding…which we really hope you don’t because that is like $900 a month car payment….For simplicity & round number purposes, assume the loan is pays off equally so it decreases by $10k each year.

[Note - this is conservative, since you’d actually have more at the end of each year which = a bigger arb and only makes the numbers look a bit better. Under a real amortization you’d have ~$21k and ~$11k balance so an extra $1k to arbitrage.]

You could juice the arb a bit by locking up your money today in something with more yield.

Since we mentioned Alliant Credit Union earlier, we just pulled their CD rates and they are in the low 3% range. However we have seen 2 year CDs as high as 4%.

We really should contact Alliant CU and get an affiliate link huh?

You could put $10k in a 12-month CD and $10k in a 24-month CD.

Assuming rates don’t change on your 2.5% savings account for the 3 years you make ~$350 over the 3 years in arbitrage. Again, nothing to write home about, but if you are on a budget or just starting out, that is better than nothing.

Still, we haven’t gotten to the real benefits of keeping all that cash in a savings account…

Interest Rates Going Up? Got That Flexibility

What if the FED continues raising rates to their 4.5%+ target over the next couple months? Savings rates follow the FED, so we can assume a 4.5% interest rate on your savings account vs your 2% loan APR.

Now you are making 2.5% arbitrage. That is $250 a year for every $10k outstanding. Rough maths with $20k balance in year 2 and $10k balance in year 3, you are starting to get up around $750 of free money over the 3 years.

You are now getting PAID a ~1.5% annualized return on your cash for HAVING debt.

Interest Rates Going Down? Got That Flexibility

Oh No, JPow realizes he is crashing the economy and lowers rates. You have your entire loan balance in products that are FDIC insured, and you can pay off your debt as your CDs mature or once your savings rate is equal to your 2% debt APR.

Rates go down and you only make $300 or so from the CDs you locked in at 3% for 1 and 2-years.

That means your downside is $300 for 24-months (assuming you just pay the balance on the loan in 2 years when the 2nd CD matures).

• Downside of +$300 over 24 months

• Best Estimate of +$750 over 36 months

• Upside of >$750 over 36 months (if FED raises rates even further than 4.5%)

Yup. It’s an arb.

And we STILL haven’t hit on the biggest benefit of doing this…but first

…Even More Juice For You…

We should also add that you can open a new savings account to get even more juice out of this. SoFi, still has a $300 promo going on if you open a new account and hit some attainable direct deposit number. It also has a 2.5% APR today if you have a direct deposit, even small 2-digit direct deposits. We mentioned it back in July as a good opportunity.

Since then Bank of America put its own $300 promo on a new account. Assuming banks keep competing for your business, you can:

• Open accounts with your $30k & change your autopayment to draw on the new account

• Get the promotion bonus

• Wait the required time

• Repeat by opening an account at a new bank

Assuming you do it one time per year, you added over $1,000 to your little arbitrage. We have now MADE $1,500 to $2k from HAVING debt between the interest & promos.

Technically, you could churn bank accounts regardless of the debt. But a lot of banks require either a large deposit or hitting a cumulative direct deposit amount to get the bonuses. So having a lump sum, like $30k, you can move to the new account helps get the bonus.

[Note - if you are going to do the above arbitrage, having a separate account used solely for autopaying the $30k debt is the safest way to not end up accidently overspending elsewhere and blowing the arb.

Also note, you can set up a automatic transfer to move your direct deposit amount out of these banks to your regular checking account. Your deposit just needs to hit the bank to qualify, it doesn’t need to stay in the bank.]

Cash vs Cashflow

The typical response from the no debtooors when your present the above is something along the lines of “But if I pay off my debt, I have more cashflow which makes me better off if I lose my job”.

Well, surprising no one, they are wrong about this, you make yourself more fragile.

Lets assume you have $50k of savings to your name (you really need to pump those numbers up by the way).

Your 2 options are:

• Pay off the $30k loan, have $900 a month less expenses but only $20k savings leftover vs.

• Put the full $50k in a savings account with autopayment coming out of it (or $30k in savings and $20k in something with a higher yield)

Now you lose your job.

Are you really better off by paying off the debt? Let’s say it cost $2k a month to live. How long do you survive?

With only $20k in savings and no debt payments to make you have 10 months until you burn through all your money.

With $50k in savings but a $900 extra expense (so $2,900 monthly cost), you have 17.25 months.

Again, you are better off not paying off your debt because you have a bigger safety net today.

[Note - Additionally, you can usually work with lenders on any loan to lower or freeze your payments if you have hardship. This allows you to extend that 17.25 months even further.

So again, you will be better off with more cash and lower cashflow than you would be by paying off your debt.]

[Insert Emotional Reason Here]

Really there is only 3 reasons to pay off debt early if the APR is less than you can earn in a savings account.

1. You are an irresponsible child and will spend your money on junk if you don’t pay off debt,

2. Some emotional reason like “I don’t want to owe the bank money because it is slavery” or “I want the happiness of holding the title to my car” or “I am a no-debtooor and need to flex on twitter about having no debt”

3. You are rich and the 3 seconds it takes to put $30k into a savings account then set up autopay isn’t worth the effort.

If #1 is you…stop reading. Go to a mirror and look yourself in your eyes. Really look hard. Now think about your life. You are an adult. Time to be responsible.

If #2 is you, then fine. Just realize you are being illogical and suboptimal. Now stop flexing on twitter and telling other people to pay off all their debt. You are costing them money and many of them could really use any extra money.

If #3 is you…we appreciate you reading our post that doesn’t pertain to you. Congrats on making it. Although we do know a few very well off people that just get off on finding free money regardless of how immaterial it is to them, so maybe this post still helps you.

This post is targeted to people still trying to make it. And for those of you in that boat, having more flexibility, being less fragile, and making a few hundred to thousand dollars is material.

Bonus: “Once We Pay Off The Debt We Can Start Investing”

One bonus item - there are people out there who are overpaying on their debt in order to free up cashflow to invest later. So they don’t have the $30k yet, but are putting $3k a month into the loan. Then once it is paid off, they will put that $3k into investments.

Well…if you can guess…STILL better off arb’ing it. Put that $3k into a savings account until you have the loan balance in.

Rough maths and round numbers. Our previous example had a payment of $900 a month. Every month this person puts $3k into the savings account and $900 gets drawn down, for a net contribution of $2,100.

After around 10 months you have put in $30,000 to the savings account and your balance on the savings account is around $21k and change, which is the same as the outstanding balance on your loan. You are basically immunized since there is enough in the savings account to make the rest of your autopays.

So in both cases it takes around 10 months to put the full $3k into investing. But by using the savings account, you wind up with $200 extra dollars at the end.

Aka - nothing on your plan changed except you paid the excess loan payments into a savings account instead of the loan. You get to start investing at the same time. But by taking advantage of the arb you make an extra $200. Or if you want to think of it differently, you can pay ~$200 less towards the loan and put that right into your first investment 10 months in the future.

Still better off…

Conclusion

To wrap up this weeks free post, for most of us we have a unique opportunity to earn some genuinely risk-free money.

It has been decades since savings accounts were earning more than the debt people had. If you are thinking of paying off a loan with cash on hand, a better option to consider is opening a separate account for the sole purpose of getting paid money for having debt.

Sure, you aren’t going to get rich doing this. And your focus should absolutely be on getting your income up. But a few spare minutes to make a few hundred to thousand dollars is a pretty good ROI. Especially if you are still in the early innings of your wealth creation.

Then add in the fact you keep flexibility to have more upside and make yourself less fragile in case the economy tanks, and it is a no-brainer move. Remember, life is about weighing the opportunity costs of your decisions, and paying off your debt that is less than a savings account rate is negative value.

Good Luck Anon