Why I Stopped Paying off My Student Loans and What I Did Instead
Password creation and memorization is a headache, especially for financial related institutions. So when I was prompted to create login credentials for myfedloan.org, I gave them a piece of my mind by creating the perfect, profanity-rich password to express my feelings. Now every time I log in to the site I feel slightly empowered. Stick it to the man, right?
I’m mostly kidding, except for the password, that’s real. My student loans enabled me to make it through college without any major financial strain or starvation. I’m grateful to have had the opportunity to attend college even more grateful that I stayed away from more expensive schools. That doesn’t change the fact that being a young professional with debt right out of the gate just sucks, simply put.
My total student loan debt upon graduation was just shy of $20,000, with average interest rates of 4%. At that point in time, I had a decent grasp of personal finance and common school of thought suggested throwing every dime I could at my debt. As I began making okay money and living in a dump of an apartment with roommates, I put a big dent in the $20,000 balance. $10,000 in the first year of repayment, to be exact.
If you’re familiar with my backstory, you’ll remember I started a business and had to adjust my focus to learning everything I could about business and personal finance. During that time, I realized that while being debt free was extremely important, there were alternatives that could produce more immediate and long-term financial success. In other words, every large student loan payment I made was money that I could have used elsewhere to set myself up for returns much higher than the 4% interest rate.
Ultimately, I decided to make minimum monthly payments and put the extra resources to better use. This article will cover the strategies I’ve experimented with and believe are better than repaying student loans in most cases. It’s important to note that these strategies won’t be for everyone. I’ll do my best to cover the exceptions and potential workarounds at the end of the article.
The Potential Return of Investing > Accumulated Interest on Student Loans (by $8,000)
Investing is a touchy subject. If you know anyone who’s lost money investing in “the next big thing” or invested heavily before a market crash, you’ve been warned about the perils of the stock market. And there’s no denying that the stock market is risky. Unless you have Warren Buffett’s money to invest, you won’t have any say in what goes on at a particular company. Meaning, the success of your investment is out of your control.
When it’s all said and done, the market increases over time. It has its ups and down, sometimes massive downs where people see 50% of their portfolio temporarily disappear, but it always corrects upward. Companies fail and single stocks undeniably have risk and volatility, but as a whole, the market continues to rise. We won’t go into the details of single-stock investing versus index fund investing in this article – but know that investing has always been and will be a great asset allocation.
To recap my student loan dilemma, I paid $10,000 of my $20,000 balance off in a year before having a mindset shift. Though my balance is now below $10k, I’ll be using $10k for the sake of easy math.
If paid in full, I would pay $10,000.
If paid over the next year, I would pay $851/month for a total repayment of $10,212.
If paid over the next five years, I would pay $184/month for a total repayment of $11,040.
If paid over the next ten years, I would pay $101/month for a total repayment of $12,120.
That’s a difference of $2,120 between paying it in full and over the next ten years, a 21.2% increase.
“What do I gain by paying it off completely?”
For the sake of comparison, let’s say I invested $10,000 in an S&P 500 index fund today, and that investment saw annual, inflation-adjusted returns of 7%. That $10k investment would be worth $19,672 without any additional contributions, or a 97% increase.
A 7% return is very conservative and accounts for a market downturn in that 10-year time frame since Mr. Market has been on a bull run since the 2007-2008 financial crisis. It’s worth noting, the SPDR S&P 500 ETF (SPY) has returned just shy of 7% over the past ten years, including the financial crisis.
- I’ll owe an extra $2,120 repaying my student loans over the next ten years versus paying them in full now. That would lead to a total repayment of $12,120.
- If I invested the same $10,000 balance in an index fund and saw conservative returns, I’d end up just shy of $20,000.
- The potential upside of investing outweighs the downside of delaying my student loan repayment by nearly $8,000.
Investing in Yourself
The average cost of a book is around $10, yet the potential return from a great book is immense. If you gain a new skill, idea, perspective on your life or business, or get inspired to make a big career move, a book could pay for itself a thousand times. And compound interest isn’t restricted to financial investments, books and the knowledge acquired from reading grow exponentially. Ideation, or the formation of ideas or concepts, improves rapidly as you add quality information to your natural hard drive (brain).
One downfall with books is the potential for inaction on the received information. Courses are a great way to combat this inaction for a few different reasons. For starters, courses are typically ultra-specific and focused on one topic. Instead of going a mile wide and an inch deep like you may find in a book, a course should take you a mile deep into a particular niche. Another reason courses are great for action is their higher price tag. While spending $10 on a book isn’t going to motivate you to pick it up or apply what you’ve learned, spending $500 dollars on a course should fire up your engines. Lastly, most courses will have workbooks or guides for taking action, removing the difficulty of deciding where to start.
Courses and certifications share a few perks like high price tags and specificity, but certifications truly shine in their ability to immediately impact your earning potential. Using an example that’s in my wheelhouse, let’s say you’re knowledgeable about nutrition, eating, and fitness. Depending on your current level of expertise and free time, you could become a certified personal trainer or nutrition coach in a few months. (I’m talking about an NCCA accredited certification, not a weekend certificate.) Upon completion, you could get a part-time job or freelance for $50-$100 an hour depending on your geographical location and professional skills. This same strategy could be applied to nearly every industry and could generate serious side hustle income.
We’ve covered it already, but a common issue with investing in yourself and knowledge/skill acquisition is the potential inaction. Hiring a coach, mentor, or someone to hold you accountable is one of the best investments around. Many coaches will share most of the knowledge you’d get from books, courses, and certifications in addition to the accountability and motivation they provide. And don’t forget about the power of spending as a motivator. Coaching will likely be a larger and longer-term investment than courses or certifications.
Career Capital & Compensation Increases
More often than not, income increases with age and experience. According to a Mercer 2016-2017 US Compensation Planning Survey, “the average salary increase budget is expected to be 2.9% in 2017, up slightly from the average increase budget of 2.8% in 2016.” Salaries and wages have been under the spotlight recently, and many people expect to see faster increases in pay. Yasss.
Not so fast, those are only budget increases. You’ll have to stand out and be extremely valuable to your employer to get above-average pay increases. Investing in yourself and picking up new skills could be a great way to differentiate yourself. While most of your coworkers are going home to watch Netflix and spending their weekends gallivanting around town, you could be putting in extra work to dominate your job.
This is a win-win strategy no matter what happens at work. Even if you decide to pivot to a different industry, quit your job like me, or worst case, lose a job, you should be able to leverage your improved expertise and skill set to land higher salaries or create income-replacing opportunities over time. If this holds true, making minimum payments on debt and freeing up present-day capital is an ideal strategy because your future income will cover both debt repayment and continued investing.
To simplify, if the difference in total interest is a reasonable amount, would you rather be strapped for cash now with lower earnings or wait a few years for increases to your income? It’s hard to give when you’re hungry. If you find yourself stressed about making ends meet and deprived of the simple pleasures of life, pulling back on debt repayment is a no-brainer.
Cash Is King
We’re nine years into a bull market and stocks are hitting all-time highs. If history repeats itself, there’s an inevitable correction or downturn lurking around the corner. The argument could be made that now is the perfect time to pay off debt, and I couldn’t argue with that logic. However, if I paid off my $10k balance and the market crashed tomorrow, I would be awfully upset that I didn’t have more capital to buy great companies at a tremendous discount.
Going back to our 10-year investment hypothesis from earlier, $10k invested in a crash or market low has massive upside. $10k invested in the S&P 500 during the bottom of the financial crisis (March 2009) would be worth around $35k today. Wouldn’t you love to have cash in the war chest for a repeat opportunity?
Speaking of market downturns and financial crises, having cash on hand also means not losing 50% or more of your net worth during rough patches. Having ample cash simply stacks the deck in your favor. You’re better equipped to capitalize on any opportunity that presents itself. The caveat is determining how much cash to have on hand versus out working for you in the form of investments or other projects, but that’s a story for another day.
The Exceptions and When You Should Pay the Piper
Paying off debt and becoming debt free is always a good strategy. You won’t hear any arguments from me if you choose to go that route. That said, if you’re intrigued by the points I’ve made and are wondering if there’s any reason you shouldn’t start investing in yourself instead of repaying debt, keep reading. Six scenarios came to mind where paying off debt would be the way to go, in my opinion.
- If your debt total is massive, pay off the loans. Four percent interest on $10k won’t make or break you over ten years. Four percent interest on $100k, on the other hand, most likely will.
- If you have a high interest rate, even with a moderate loan balance, pay off the loans or consolidate your student loan debt.
- If you want the peace of mind that comes with being debt free, pay ‘em off.
- If you are a big spender or have an expensive lifestyle, you’ll be fighting an uphill battle as a successful investor or better-using money that could go to loan repayment. Self-awareness is an underrated skill – be honest with yourself.
- If you lack confidence in your ability to invest wisely, improve your career, make money with a side hustle, or make better use of the money in one way or another, pay off the loans. If you are skeptical that you could use money to make more money, you won’t.
- If you are lazy comfortable with your current situation (unlikely if you’ve made it this far into the article), pay off the loans until you want to change your situation.
If you’re upside down with student loans, do a bit of research on LendEDU, a platform that allows you to pre-qualify and view personalized student loan refinance quotes from the leading student loan providers. It’s free to use, takes no time at all, and has no impact on your credit score thanks to a “soft pull” they use. You can start your simple, free application here.
- Perform an analysis of the opportunity cost of paying your student loans off early in lieu of potential investments.
- Investing in yourself in the form of continuing education, professional development, and coaching to take your game to the next level is always a wise investment. Could you increase your earning potential in the near future?
- Your income will likely increase over time. Would you rather be strapped for cash now when you’re not making much or wait a few years until you see increases to income?
- Cash opens doors and allows fast capitalization on opportunities.
- Delaying your student loan repayments could be a terrible idea depending on your situation. Run through scenarios, crunch numbers, be real with yourself, and then make a decision.
Well, what do you think? Did I change your mind about your monthly student loan payments?