Taking out a student loan is a sad part of the college experience, these days. The latest numbers for the class of 2016 have just come in and the average graduate owes $37,172. This brings the national total to $1.44 trillion, spread across 44.2 million Americans. Roughly 3 out of every 4 students leave college with some debt. Oh yeah, and these trends are all on the rise as the cost of college keeps skyrocketing. So what should you do with your debt?
The Argument For Keeping The Debt
The only reason some people argue for keeping your debt is that you can use the debt as leverage. Most student loan debt comes with an interest rate of roughly 3-6% . The stock market typically will return 7-8%. The idea is to make the minimum payment towards the debt and invest the rest. Any money you pay towards your student loan has a rate of return of whatever your interest rate is.
So yes, the very simplified math says to absolutely keep your debt for as long as possible. A return rate of 4.75% (interest rate of student loan) vs. 7-8% is pretty obvious. The problem is, we are taking out the human element and making some big assumptions.
5 Reasons To Pay Debt Off Fast
1. Feels Amazing!!
This first point can not be overstated. When Theresa and I got our debt paid off after we got married, it felt incredible. I mean it felt like we had won the lottery. We felt rich as our net worth shot up to zero. We set a goal and achieved it faster than we thought we could and eliminated a reoccurring expense. Getting that debt eliminated is a whole different feeling as opposed to making some 401k contributions.
2. Guaranteed Return
One thing that bothers me is that people act like the market will always return 7-8%. I know it has felt like that for the last 8 years but people are quick to forget that this market thing actually goes down, too. When they make the argument for keeping the debt, they act like you are guaranteed to make at least 7%. Over 40 years, that is a perfectly safe assumption, but over 10 years or 5 years or 1 year; not so much.
However, you are guaranteed to get a return on investment of whatever your interest rate is. The average interest rate for student loans debt is roughly 4.75%. That is a damn good guaranteed return. The best return you can get on a CD right now is around 2%.
3. You Will Be In Attack Mode
Once you say that your primary goal is to pay down this debt, you will act differently. You are going to find ways to save money and earn money that you couldn’t have planned for. As you see that amount owed dropping every day, it energizes you and makes you feel like you are winning.
Now, it is possible to approach investing the same way, but most people do not. Investing is such a long term goal so it is tough to think about depriving yourself for 40 years. Paying off student loan debt is a 6-24 month process for focused individuals. You can be okay with living like a broke college student for one more year, but not 40.
4. Eliminate Revolving Debt
Once your loan is paid off you can say goodbye forever to one more monthly bill. Average student loan payment amount is around $300. Once the debt is paid off, it will be liking getting a $300 per month raise that you can do other things with.
It also makes it easier to buy a house when you have less revolving debt. You can only have 40% of your income going towards debt every month so having student loans will decrease the kind of mortgage you can take out.
5. Leveraging Your Debt Is Insignificant
People act like they are potentially missing out on a hundred thousand in market returns by paying off student loans. This might be true if it took you 40 years to pay off your student loans but everyone should be able to pay them off inside of two years. Let’s look at the math.
Debt $37,172 at 4.75% interest, assuming 8% (which is far from guaranteed, point 2) market return and assuming you would invest as much as you pay off in debt (you wouldn’t, point 3).
If it takes you two years to pay off your debt, you missed out on $1,886 in market returns, one year $1,208, six months $594.
So worst case scenario, your net worth is $1,886 less after two years than it would have been had you kept the loans. But, now you don’t have to make a $300 a month student loan payment. Which sounds better to you? Net worth of zero with zero bills or net worth of $1,886 with $300 a month payment due for the next 8 years.
Debt can be used as leverage and it can help you get ahead. Student loans just typically aren’t one of them. Don’t get caught up in this game of thinking that all debt is okay, or even good, as long as the interest rate is below 6%. When times are good and the market is returning 10%+ every year, it feels smart, but it will feel crippling when the market is flat or dropping.
And please don’t be one of the 8 million people who has defaulted on their loans. That is right, 8 million, or 1 in 6, have not paid a dollar in over 9 months. This might seem like a solution, short term, but you risk having your credit score ruined, having your wages garnished, facing huge fees and super high-interest rates.
College is awesome and our degrees have paid for themselves many times over. I will soon be posting our story of how we paid off ours in less than 6 months and what we learned to help you.
Do you agree or disagree with using student loan debt as leverage? Do have student loan debt?