Next month I’ll be moving into a much cheaper apartment, I have decided to drastically downsize and this decision is going to save me $500 dollars per month. Like most people under 45 with a college degree that opens up the question of whether or not I should put that extra money towards my student debt. I crunched the numbers and, spoiler alert, I decided not to. However, this is a tough decision, one you may be contemplating. In order to help your process, I decided to outline some of the pros and cons of paying more towards your student debt.
First a little background. Dave Ramsey is a well-known personal finance personality who has popularized the concept of the debt snowball. Ramsey’s advice tells people to first save an emergency fund and then start paying down debt, from the smallest amount owed to the largest. The end goal is to be debt-free.
While this is great advice for credit card debt, I have always been skeptical of following a debt snowball method when it comes to student debt. First of all, I have 6 figures of debt, right now at $114K. Regardless of the expenses I cut, that’s years’ worth of extra payments and when it comes to investing, time is our greatest asset. Do the numbers really add up that I will be better off by eradicating my student debt faster? Being debt-free is great, but I don’t want to be in my 40s with a net worth of $0!
Let’s explore the pros and cons of paying more towards your student debt.
I tend to think the biggest pro of paying off student debt fast is emotional. I hate my student debt. It has ruled my life for almost 10 years, starting from the moment I decided to get an MBA. I pay $1000 a month and will be doing so for the next 13 years.
I can’t begin to describe how strong my desire is to shake the yoke of those monthly payments. I often think of what I would do if I didn’t have to make sure I always had that $1000 to put towards my debt.
Thus, I would call the biggest pro to paying off student debt the emotional freedom of living debt-free.
Pay less into the black hole of interest
If paying interest infuriates you then paying off your student debt faster might be a good idea for you. Especially if that interest rate is over 7%. Why 7%? Because that’s the benchmark I use for an assumed return on investments. You might see that percentage higher or lower elsewhere, but I tend to think 7% is a good, conservative number. You don’t want want to overestimate your returns and ultimately screw over your future self.
Federal student loan interest rates range from 3.73%-6.28% right now. However, historically they have gone much higher. My graduate PLUS loans we’re around 8% since I graduate in 2014.
If you’re paying interest rates that are higher than what you could expect from returns on investments you might be better served by re-financing than paying more on a monthly basis.
I know some people are holding on to high-interest rate federal loans for a variety of reasons – bad credit scores, loan forgiveness, or holding out for student debt forgiveness. All valid reasons, but there are other options available. Do some research specific to your scenario and crunch the numbers to see if you’re really better off paying more.
When you put money towards your student debt there’s no speculation involved. You don’t need to think about the potential for flux in your balance. What you pay is what you get.
This isn’t the case when you invest. The stock market is unpredictable, and depending on the investments you make there’s a possibility you could lose money.
Historically the stock market has returned 8%-10% and if you’re invested in broad market funds, it’s a pretty safe bet. But it’s still a bet. My personal opinion is that if the whole S&P 500 shits the bed in a way in which it won’t bounce back, we all have bigger problems to worry about than retirement. In the end, it’s a decision you need to make for yourself though.
In the long run, you’ll make more money by investing the extra cash
I had to crunch some serious numbers in order to confirm this statement. Here are a few details of my situation:
- I have $114,550 remaining on my student debt (ugggh)
- I have 13 years left if I pay the minimum (another uggh)
- My interest rate is 4%
As I mentioned at the beginning of this blog, I currently have $500 I will be saving in rent. So I calculated the long-term value of putting it towards my debt vs. saving it. If I pay that money towards my debt, I’ll be out of student debt in 8 years (woohooo!) and save $6,288 on interest payments. Then if I take what I paid towards my student loans plus that extra $500 per month, I’ll be investing $17,471/year.
All in, at the end of 13 years (my repayment schedule if I pay the minimum), Ill have $103,661 in the bank.
Sounds good right? But what if I start investing that $500/month now? How much will I have in 13 years when I’ll be officially debt-free? $124,674.
Yep, Ill be $21,013 richer by NOT paying extra towards my student debt.
You can use the interest from savings to pay your debt
My monthly payment towards my student debt $1,000/month. I could pay that just on interest if I save $171,429 and assume that 7% rate of return.
That’s an insane amount of money and I’m not totally sure I can get there in time for it to benefit me. However, If you have a long re-payment timeframe ahead of you or if you have less debt than I do, it’s worth knowing how much you’ll need to save to pay your debt via interest alone.
Simply take your total yearly payments and divide them by 0.07. That’s what you’ll need to pay your debt with interest alone. This investment calculator will show you the breakdown of your ending balance, year by year. By saving instead of paying off debt could you hit a point where your savings pay your debt for you?
At the beginning of this list of pros and cons of paying more towards your student debt, I wrote about the emotional freedom of being debt-free. Paying your debt isn’t the only path towards that sense of freedom though. I recently listened to a podcast interview with a financial advisor who told all of his clients to save rather than pay extra towards student debt.
The deal was that once they had enough saved to pay off the debt, they could choose to use it to pay the debt in whole or hang on to it as investments. Not a single client ever chose to use the money to fully pay off the debt once they had it saved.
The same freedom with being debt-free is possible just with the option to be debt-free at any point you so choose.
Personally, I bought a fixer-upper house 4 years ago with the intention of fixing it up and then selling it at a profit once I had enough in equity to pay off my student debt. I never could have predicted that housing markets would skyrocket the way they have and I now have more than enough equity to sell, pay off my debt and still pocket some cash.
I have chosen not to though. The option of doing so gives me the freedom to decide and it has been a breath of fresh air to have that option. I currently have some great renters in the house and have no intention of selling. I prefer the long-term passive income to the ability to eradicate my student debt quickly.
Student debt sucks. There’s no getting around that fact. Many of us are drowning in it. There are pros and cons of paying more towards your student debt, but for me, the cons outweighed the pros.
Before you start throwing your cash at student debt to get out from under the burden, be sure to crunch your numbers. There may be greater long-term payoffs to putting that extra money aside. Your future self will thank you.