Student loans seem to be the bane of every personal finance blogger. The personal finance community hates student loans. And it is easy to see why. But here I am, with a different perspective. I am in no hurry to payoff my student loans.
In fact, I probably won’t payoff my student loans early at all.
Student Loans Facts and Figures
Americans owe over $1.3 trillion in student loans. That’s trillion with a T.
Student loans are the second largest category of debt, behind mortgages.
According to the Federal Reserve Bank of New York, student loan balances have almost tripled between 2005 and 2015 (after accounting for inflation).
The average 2016 graduate left school with $37,172 in student loans.
For recent graduates, the average student loan monthly payment is $351. But this is deceiving because a small portion of student loans have really high balances. The median payment is $203, so half of all borrowers have a payment less than $203. The next 25% of borrowers had monthly payments between $203 and $400.
Student Loan Balances vs Monthly Payments
Most of the attention is on the student loan balance. $1.3 trillion is a very large number. But that’s spread over 44 million borrowers. That’s an average student loan balance under $30,000.
$30,000 is a lot for a new college graduate. The personal finance press is all about paying this off as fast as possible so you can do things like buy a house, get married, get a new car. Spend more money on other things. The media picks out stories for people with six figure student loan debt. Those stories are obviously eye-popping and that kind of debt really does delay your progression into the rest of your life.
And that’s the key: $30,000 is a lot more manageable than $1,310,000,000,000.00. Or even $150,000.
When you break $30,000 over a long repayment period, you aren’t looking at huge chunks of your monthly income. Remember, most student loan borrowers (75%) have a monthly payment less than $400. If you were a responsible borrower and took the student loans out to increase your earning potential, hopefully you are making more than $400 (or your monthly payment) more than if you hadn’t taken out the loans.
But here’s the deal, the interest rate for a lot of undergrad student loans is going to be sub-5%. These are going to be your federally subsidized loans. Most students are going to stick with the federal loans. Of course, if you went private, your interest rates may be all over the place.
Can you start to see why I’m not in a hurry to payoff my student loans?
Benefits of Student Loans
Everyone else is out there talking about how bad student loans are. But here I am telling you that they aren’t all bad.
I think most of us see the benefit of taking on student loans. I see two key benefits: early establishment of credit history and allow you to make more income over your career!
These loans are given to people with little credit history and no defined way to pay them back. Wait, this is a benefit?
For responsible borrowers, it is a wonderful benefit because you get to start building your credit history and show a responsible repayment history. With little to no underwriting, almost everyone qualifies. Can you say the same for credit cards?
But you must be a responsible borrower! Don’t take out six figures of debt to go into a career that makes mid five figures.
On the other hand, if you can leverage the loan into a degree that will allow you to make more money upon graduation or to finish a degree you wouldn’t otherwise be able to finish, you’ll end up ahead.
I can definitely say that without my graduate degree, I would not have the career that I do today. I would probably still be successful in a career, but I highly doubt I’d be making what I do today with only an undergraduate degree. Possible. But not probable. Especially when I look at my friends that I graduated with from undergraduate school who did not pursue a graduate degree.
My Student Loans
My beginning balance was less than $30,000. Those loans though helped me through my graduate degree program. I was fortunate to have my undergraduate degree completely covered by parents and scholarships. (Thanks lottery players!) As soon as my payment deferment period was over, I consolidated my student loans at a fixed rate of 4%. I also took advantage of two additional discounts – online statements and automatic drafts. This results in an interest rate of 3.5%. My current balance is just a hair under $16,000.
Now, math geniuses, tell me something. Would you be in a hurry to repay a loan with a 3.5% interest rate when you can make better returns in the stock market? In 2016, the S&P 500 was up 9.5% and the Dow Jones Industrial Average was up 13.4%.
The interest rate on the loan is very low; in fact, the interest rate is lower than my mortgage. So even if you were to look at the debt ladder repayment strategy (highest interest rate first), my student loans would not be the priority to pay first. Only the debt snowball, where you attack the smallest balance first, would attack my student loans first.
I also did the math. If I payoff my student loans today, I will save $2,509.77 in interest over 103 months (8 years, 7 months). That’s an average of $24.37 a month over that period.
Right now, I’d rather keep the cash and invest it. Or even just keep it in my emergency fund.
The cash on hand is also useful for other purposes. I’m looking at needing a new car in the near future. I could payoff the student loan balance of $16,000 or I could use that cash to buy the new car. Even if I decide to go with a luxury car, that kind of down payment will get you the best interest rates on a car loan (ie zero percent). Or couple it with other savings and I’d have no car loan. And no car loan means no hit on my credit score. Or financing costs.
My student loans are less than $200 a month and thus not a budget breaker. With a low interest rate, my student loans are not a priority for paying off first. And I have other uses for the cash. In other words, I just don’t see the benefit to payoff my student loans right now.
Hedging My Bets
There’s risk to investing in the stock market. The market can go down, like it did about a decade ago. You can pick bad investments and lose it all even if the market overall is doing well. If you payoff your debt, you are guaranteed that rate of return (in my case, 3.5%).
So what I am doing to make sure that I’ll be OK is to include those monthly student loan payments in my emergency fund that is not invested in the market. In fact it is in cash or near cash, not subject to the whims of the stock market. As I get closer to the end of the student loan period, I may decide to reduce the amount in the emergency fund, but until then, I want to make sure I am covered.
Also, until all my debts are paid off, I am keeping a relatively conservative balance in my investments. They are more broad market based and not individual stocks, and so help reduce the risk from a bad stock pick. I may not have the largest gains possible but there is a smaller risk on the principal amount invested. I am less likely to lose it and not be able to payoff my student loans later.
Why I Might Still Payoff My Student Loans Early
I definitely recognize the benefits to paying off the student loans early. There’s a certain peace of mind knowing you have one less debt to worry about. Especially a debt that is difficult to discharge in bankruptcy if the worst should happen. There’s also a benefit to simplifying your finances. One less payment to remember to make every month or to keep a running balance in your primary checking account.
And you can’t be debt free if you still have student loans.
But no, I still won’t payoff my student loans early. It’s going to take me more than 8 years and 7 months to payoff my mortgage and in the meantime the student loans will go away on their own. In fact, I have 13 years left on my plan (2030 baby!) for eliminating all the debt, taking care of home renovations, and several other big purchases along the way.
How Have You Gone Against The Grain of Common Advice?
Have you also decided to go against the grain of common advice or wisdom? Has it paid off for you? Comment below!