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New Officers and Warrants: USAA Would Like to Lend You $25,000. Should You Take It?

If you are a senior year ROTC cadet or midshipman, a senior at West Point, or a newly-commissioned lieutenant or ensign, USAA would like to talk to you about lending you some money.

Be careful.

Not because the loan is a terrible deal, but because all debt is potentially toxic to your financial health, if not well-managed.

The loan is simple enough: If you’re going into active duty, USAA figures you’re a pretty good risk for the money. You’ve got a steady job, and you aren’t likely to be laid off until you get passed over twice for promotion. Well, there is a lot of that going on already – but if you’re still in precommissioning or you’re a newly-pinned shavetail, you’ve got some time.

So USAA would like to lend you up to $25,000 in “career starter” money. As of this writing, the interest rate on the loan is 2.99 percent – which is darned low, compared to what a credit card would charge you on a cash advance.

You have up to five years to pay it off.

Pretty tempting.

Let’s play with a financial calculator for a bit: That interest rate and payment schedule translates to a monthly payment of $449.11.

Well, obviously, USAA seems to think you have that much money each month to play with, or they wouldn’t want you to borrow the money.

So let’s imagine you invest the money, instead.

If you can average 6 percent on your money, then, investing that loan payment every month for five years would net you $31,334. That nets you a nice little spread of $6,334. Even after you pay taxes at, say, an average effective rate of 25 percent, you do better not taking the loan at that rate. In fact, you do better even if you only get half the interest rate.

On the other hand, if you take the money and blow it on a new car, you’ve already committed to a financial wreck: Kiss 11 percent goodbye as soon as you drive the car off the lot. At the end of the loan term, if you borrowed all $25,000 available to you, you will have paid $26,946.60 for a car that is now worth just $9,250, according to, which estimates that the average new car is worth only 37 percent of its original value over five years. That’s a 63 percent disaster. Plus interest.

Accounting for Risk

You may think your future is secure, because you’ve got at least four years of a steady paycheck coming in the military, and possibly a 20-plus year career as an officer. But if you’ve been around the military for a while, you know that things happen. People get injured going through basic school, or airborne school, or Ranger school all the time. People discover that military life is not for them, even after precommissioning. It’s not unheard of for young officers to resign early and pay off the scholarship, preferring civilian life to military life. You may not get an active billet after all, but instead be flung into the private sector, degree in art history or comparative literature safely in hand, to search for a Reserve or Guard billet.

The less debt you have in this instance, the better.

If you lose or resign your commission, the loan resets to 18 percent. This is very ugly indeed.

Making Debt Work

It’s easy to see the cost of the loan. But far be it from us to focus on the cost of everything and the value of nothing. The key to making debt work for you instead of against you is to turn the debt into leverage. That is, to control lots of assets but with a relatively small investment of your own money.

Here’s how leverage works:

Let’s say you buy a $100,000 house. You put up 10 percent, or $10,000 of your own money, and borrow the rest. If the house’s value increases by 5 percent, then you make $5,000.

Now, the house only made 5 percent. But YOU made out like a bandit, because you have return on invested capital 50 percent (disregarding interest and transaction expenses).

Stock market investors would sell their souls to earn 50 percent on their money – but you can do it just putting 10 percent down on a reasonably well-selected house in an appreciating neighborhood. And live in it in the meantime.

That is the miracle and magic of leverage.

But debt is always toxic. Not that it’s evil; it’s just dangerous and must be managed with care. Because just as debt can magnify returns, it can also magnify losses.

Here’s how:

Suppose you borrow $90,000 on an identical $100,000 house – again putting up 10 percent, or $10,000 of your own money. But this time, you guess wrong, or the neighbor who moves in next door doesn’t mow his lawn. Your house, as a result, loses 5 percent of its value rather than gains. In that case, you lost $5,000 in equity… or 50 percent of your invested capital.

Remember – the lender doesn’t share in your losses. You still have to pay back every dollar you borrowed, with interest, come rain or shine.

It Sounds Like a Great Down Payment, Right?

Well, possibly. But be careful:

Home mortgage interest is generally tax deductible. That means that 2.99 percent loan actually costs less than 2.99 percent per year, once you take the tax deduction into account. But remember: In order to qualify for the home mortgage interest deduction, the loan must be secured by your residence.

If you try to piggy-back a career-starter loan (meaning, use the loan proceeds for your down payment) that interest won’t be eligible for the home-mortgage interest deduction. Mortgage debt also qualifies for more favorable treatment in the event of a default than a straight consumer loan like the Career Starter loan… especially if you live in a non-recourse state. If your state is ‘non-recourse,’ it means that if you borrow money on a house and wind up defaulting and the bank forecloses on your home, but the home doesn’t satisfy the debt, the bank cannot go after your personal assets to make up the difference.

Only mortgage debt will qualify. Since the Career Starter loan isn’t secured by the property itself, you will still be on the hook for the balance, even if your bank forecloses on your home.

Meanwhile, USAA is offering even lower rates on mortgages than on the Career Starter loan. So it doesn’t make a ton of sense to use the Career Starter loan even on the best investment likely available to you… a down payment on a first home. You are better off going with a competitive mortgage than the career starter loan. The mortgage will have lower payments on the same loan amount, too, since it is generally amortized over a longer period of time. Remember – even if you have a 30 year mortgage, you still have to pay off the Career Starter loan in 5 years or less. Or you can refinance. But that costs money, too.

Other ideas

One young Air Force officer got the Career Starter Loan when he was still 18 months away from commissioning. He initially used the money to buy a series of bank CDs of varying maturities, all between 4.25 percent and 5 percent. So he made money, risk-free, through arbitrage – that is, exploiting the difference between the guaranteed interest rate on his Career Starter Loan and what banks would guarantee him on 1-to-5-year CDs.

But that was in 2008, when interest rates on CDs were much higher than they are now. That strategy is closed to you now. Meanwhile, he had to take a cash flow hit in the first year – even with this ideal solution available to him: His money was locked up in CDs. He had to make the loan payments out of pocket (though USAA will defer payments for pre-commissionees, and up to four months for newly-commissioned officers).

He wound up making a bit of money by investing in mutual funds. But he happened to catch markets near a historic low. Even then he only figures he eked out about 10 percent. He’s not sure it was worth the hassle.

“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!”

That said, everyone is different. Grabbing the Career Starter Loan could be a great idea if you’re in one of these situations:

1. You have non-deductible debts charging you a significantly greater interest rate than 2.99 percent.

2. You have payday loans or cash advances outstanding.

3. You just need that first car to work, have no money on hand and no way to pay cash. (Get a used car).

4. You have student loans to pay off, and they are still costing you more than 2.99 percent, even after the student loan interest deduction (which goes away in 2013, anyway, except for the first 60 months of repayment).

5. You want to hedge your bets against your fortunes changing. Why? Federally guaranteed student-loan interest cannot be discharged in bankruptcy. Consumer debt, including the Career Starter Loan, can.

6. You plan to take advantage of the DoD Savings Deposit Program. This is a special program available to deployed servicemembers to make a guaranteed interest rate of 10 percent on invested money for the length of their deployment to a designated combat zone. You can stash up to $10,000 per deployment into this program, as long as you are willing to leave it in there for the duration of your deployment. If I didn’t have $10,000 in investable cash for this program, I would invest what I could, and consider the Career Starter Loan for the difference. This is only going to work if you have a combat zone deployment early in your career. That was easy to accomplish between 2003 and 2010. Combat zone deployments are a little harder to come by these days, depending on your branch and MOS.

7. Buy an investment property. You can’t use your GI Bill money for these – you have to live in the house to use your GI Bill. But if you love real estate, you can potentially do quite well using this $25,000 as seed money to leverage up to a decent-sized rental home in some markets. Be sure to take real estate agent commissions into account when you run your numbers, and work with an experienced accountant, real estate agent and attorney. More on combining a military career with real estate investment in future columns, so continue to monitor this push.

The bottom line: Getting an easy $25,000 at 2.99 percent interest rate seems like a great deal – and it is! But only compared to some other non-mortgage debts you might incur. In the long run, it’s still better to be a lender or investor than a borrower. If you do take advantage of the offer, make sure you are getting something of value.

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