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I applied for the USAA Career Starter Loan in November 2008. At the time, I was a junior in college and about 18 months from commissioning. It was quite the rush to see $25,000 deposited into my checking account. From start to finish it took about a week to complete the loan application and have the cash deposited into my USAA checking account. I moved the money into a savings account within a day or two, and then began to think about what I wanted to do with the money.
I knew I wanted to invest most of it. At 2.99% interest, I was convinced that I could use the low interest rate to profit from arbitrage. I researched for a few days and then went into action.
My first step was to create a CD ladder. A CD ladder allows you to have greater access to your money while also maximizing your interest rate. I structured mine so that I would receive a payment every year for the next five years. All the CDs were purchased through USAA and ING Direct in November of 2008, when interest rates were much higher (500%!) than today. I invested $2000 into each CD and received the following returns:
1 Year CD – 4.25%
2 Year CD – 4.25%
3 Year CD – 4.5%
4 Year CD – 4.75%
5 Year CD – 5%
$10,000 total invested in CDs
As you can see, I was already making money off my 2.99% loan. At most I was making 2%, which barely covers inflation in even the lowest inflation years, so I wanted to increase my return on investment.
I waited until Jan 1, 2009 to start phase 2 of my plan. I took the remaining $15,000 I had from the loan and invested it in:
$3000 International Stock Mutual Fund
$6000 US Stock Mutual Fund
$3000 US Bond Mutual Fund.
I held on to the funds for 14 months. As I approached my college graduation and realized how much debt I was about to graduate with, I sold the funds for $17,000 and made about a 10% after taxes and paying the interest on my USAA loan. I was able to pay off my Department of Education Direct Ed loans and knocked out nearly a quarter of my student loan debt before I even started working. These loans were over 6% interest as well, so paying them off with a 2.99% loan makes perfect sense.
My CD ladder has paid me $2000 + interest for 3 years running now, every November. I still have two more CDs maturing this year and next year. Since I can access the money and only give up a small portion of accumulated interest, I consider them the foundation of my emergency fund. As each CD matures, I simply deposit the cash into a savings account, and so my liquid emergency fund grows every year. To be a true CD ladder I should reinvest the money into a new 5 year CD each time the CD matures, but rates as so low right now I'd rather just have immediate access to the cash.
Looking back on my experience with the career starter loan, I don't know if I would have taken it. On the one hand, having access to $25,000 cash at 3% is an excellent deal. On the other, making $471 payments every 15th of the month sucks. Two years after I've commissioned I've whittled down the loan to $13,000. Still halfway to go!
With today's very low CD and saving accounts rates, the arbitrage I described is no longer possible. If you have any kind of loan with an interest rate over 3%, it absolutely makes sense to take out this loan. If you don't, I think it would be best to just put your $471 (or just round it up to $500) every month in your emergency fund until it's topped off to 6 months of your expenses. Or, if you're not putting away money in your Roth IRA, you can max it out every year ($5000 a year max) by simply depositing $416.66 a month in your account. This is very easy to do in MyPay, look for instructions in a forthcoming post.