Paying off student loans early isn’t always the obvious financial decision. Make your own decision on the trade-off between student loan repayment and other goals
One of the most popular topics on personal finance blogs is that of paying off student loans, the faster the better. Amazing headlines are made from someone paying of student loan debt in the tens of thousands over just a couple of years.
And why not? The total amount of student loan debt in the United States has doubled in the last seven years to $1.36 trillion in the first quarter of 2015. Whether it’s the ticking time bomb of financial disaster that some suggest or just a booming burden on the economy, it is one of the biggest financial decisions any of us face.
So a lot of people are shocked when they ask me if I am paying off my student loans and I reply…
And it’s not as if my student loan balance is so miniscule as to be inconsequential. Two years of military college, three years at a public university and a Master’s in Business left me with just under $65,000 in student loan debt in 2003.
It’s not as if I do not have the money to pay it off either. I deposited nearly $20,000 last year in my investment account and added to a few other bucket accounts for emergency savings and various projects.
So why am I willing to buck the ‘popular’ wisdom of paying off student loans early?
Student Loan Repayment and the Debt Deniers
I ran a post earlier this year about using debt responsibly along with an infographic on the profit potential from borrowing through a mortgage and investing in different assets. The idea is that debt is a financial tool. Used wisely, it can help you build your financial future just as easily as a carpenter uses his tools to build a house.
The debt deniers do have a point. Use debt irresponsibly and it will smash your financial fingers up something awful.
But that’s no reason to completely avoid debt or to pay it off as soon as possible, without regard to other opportunities.
I locked in the rates on my student loans years ago when I started repayment. The rates on my four loans range from just 2.07% to 2.75%, less than a percent over inflation. At that rate, I'll take all the money I can get and reinvest it. Even on investing conservative for my age, I can still earn well over the interest rate on the loans.
Your own rates may be higher but even current rates on an undergraduate Stafford loan are just 4.6% for the 2014-2015 school year. Many student loan consolidation services even offer a quarter percent deduction for signing up to withdraw the payment directly from your account each month.
Even on the higher rates, student loan rates are still well below the interest rate you’re probably paying on other debt.
Beyond some of the lowest rates you will ever get on debt, student loan repayment offers a number of opportunities through different repayment plans and debt forgiveness.
There are currently seven different repayment plans available, between which you can choose and change according to your own financial situation.
- The Standard Repayment Plan offers a fixed payment of up to ten years with interest paid throughout the loan repayment.
- The Graduated Repayment Plan offers a lower initial payment which then increase every two years or so and payments up to ten years.
- The Extended Repayment Plan offers fixed or increasing payments over 25 years if you owe more than $30,000 in student loans.
- The Income-Based Repayment (IBR) Plan fixes your maximum monthly payment at 15% of discretionary income for up to 25 years. The payment is the difference between your adjusted gross income and 150% of the poverty guideline for your family size. If you haven’t paid off your loan after 25 years, any remaining portion is forgiven.
- The Pay as You Earn Repayment plan sets your maximum payment at 10% of discretionary income for up to 20 years. You must be a new borrower on or after October 2007 and have received a disbursement on or after October 2011.
- The Income-Contingent Repayment Plan also sets your payment by how much you make for up to 25 years. The plan is similar to the IBR though the calculation is slightly different.
- The Income-Sensitive Repayment plan sets your payment according to your income for up to ten years but payments can vary depending on your lender.
Not only are the rates on my student loans extremely low, the options in the student loan repayment are perfect for my financial situation. Last year, I shifted some of my schedule to building my two blogs. While I still put in a little over 30 hours a week doing investment analysis for private clients, my income is lower since the blogging income hasn’t picked up yet. Beyond that, my wife started attending nursing school full-time.
Taking advantage of the Income-Based Repayment plan means the payments on my student loan decrease and give me more financial flexibility.
Depending on your income, choosing from the different repayment options may not make much of a difference. But there is still another huge reason against paying off student loans early. If you work full-time for the federal, state or local government, you might qualify to have the remaining portion of your debt forgiven after ten years through the Public Service Loan Forgiveness Program.
Of course, I do plan on paying back my student loans and it will probably be pretty soon at the rate my income is increasing. Most people underestimate how much you can get paid to blog but I'm proof that it can build to a six-figure income very quickly.
How to Balance Student Loan Repayment for Financial Freedom
This isn’t going to turn into a mega-post discussing every benefit of not paying off student loans early or how it plays out in every financial situation…I promise. I am only saying that you have to look at the costs and benefits of paying off your student loans, or any debt, rather than just accept the conventional wisdom.
It all starts with setting financial goals and your budget. Budget first for savings and retirement investing. I see too many people wait until they are completely debt free before they start saving.
Wake up! Shopping is too much fun and you may never be completely out of debt. Always chasing the debt monkey will leave you old and tired, with absolutely no savings for the retirement you deserve.
A recent survey by the Government Accountability Office (GAO) found that almost a third (29%) of Americans 55 or older had no savings. Even those that had some savings, the average of $104,000 for those between 55 and 64 years old is only enough to return about $310 a month through an annuity.
You will still need to make the minimum payments according to your plan but paying off your student loans should come after other high-interest bills. The average household carries $7,200 in credit card debt at an average 15.07% rate. That amounts to additional interest charges of $750 a year versus the current rate on a student loan.
It’s admirable to want to live debt free but it isn’t always the best financial decision. Stop paying off student loan debt just because it’s the popular thing to do. Take advantage of lowest rates you will ever find and the most flexible repayment options around to use good debt responsibly and create your financial future.
About the Author
Joseph Hogue is a financial expert and investment analyst. After serving in the Marine Corps, he started his career investing in real estate before becoming an investment analyst for some of the largest private investors. He's appeared on Bloomberg and on CNBC as an investment expert and has published ten books in personal finance. Now he helps investors reach their financial goals and invest in the stock market with some of the same advice he used when working for the rich.