Growing up my parents were big fans of Dave Ramsey and his philosophy of getting out debt as quick as possible.
When I graduated college and started making my student loan payments that philosophy stuck with me and I tried to make extra $50-$100 a month payments, which severely cut into my pizza and beer money (probably a good thing at the time).
As I started making more money I would sometimes make principal only payments and double up on my student loan payment. It felt really good knowing I was going to pay less interest overall and that I might reduce the 10 year term on my loans.
But as I began to educate myself on personal finance and investing, I learned something that I wished I would have learned sooner. It has everything to do with opportunity costs.
In microeconomics, opportunity costs are the loss of potential gain from other alternatives when one alternative is chosen. Basically that means that the money you invest in your student loan payments cannot be invested elsewhere.
I now only pay the minimum on my student loans and for a couple very good reasons.
In this post, I want to break down the top 5 reasons why you should only pay the minimum on your student loans.
#1 You aren’t building wealth for yourself
When you pay student loan interest you are making someone else wealthy. They earned the interest because you borrowed the money and are collecting what is owed. But by paying extra you are helping them make their investment less risky (good job).
But that extra money can actually start to make you more wealthy. You see, paying on debt is a liability. Whereas, investing your money into something like your 401k is an asset.
Instead of paying back your student loan, consider investing the extra amount you would otherwise put on your loans into something that will return 6%-8% in the stock market or a mutual fund.
Take the extra $100 and invest it into something that will continually give you a return year over year and grow. There is no better time than today to start planting the seeds of your investment trees.
Now you are paying down your debt and building up your assets. Great work.
#2 You aren’t paying yourself first
I am a huge believer in always paying yourself first. What that means to me is that you work hard for your money and if you only work hard so you can pay everyone back then what is the point?
Pay yourself first means buying books to educate yourself on personal finance. It means travelling the World to get life altering experiences that shape who you are and the impact you want to make in this World.
I know so many millennials who work 40+ hours a week just to make ends meet. I totally understand how stressful and unfun that is.
If you are in that situation, then make sure to set some money aside to enjoy life and don’t pay extra on your student loan because someone convinces you that paying extra on your loans will help you get out of debt faster.
#3 You are stuck with your student loans
My wife and I agreed to stop complaining about our student loan debt. We are the ones that signed the papers, we are the ones that wanted to go to college, and now it is time to pay our debts.
Most student loan debt is unique in that you can’t file bankruptcy on it. I view it as hybrid debt because not paying your student loan bill is less risky to your financial future than not paying a credit card bill.
So use this to your advantage.
I am not saying skip payments, but I am saying that you should feel comfortable to use the extra money you have from your paycheck on saving for your first house or buying a dependable car because if you lose everything your trusty student loan debt will still be there. But waiting 10 years to pay it off before buying a house can set you back and make you miss out on the house appreciating or other tax benefits of owning a property.
Sinking money into student loan debt because you view it the same as a credit card debt is misguided. You can negotiate a repayment plan with your student loan company or file for a temporary pause in your billing if you meet certain requirements.
You are stuck with the debt so don’t even think about it and take your extra money and buy things you need to move up in life.
#4 Tax benefits on student loan interest aren’t great
If you live in the United States you are able to write off the first $2,500 in student loan interest payments (although the newly proposed tax plan will remove this deduction in 2018).
Although this does help, for couples filing jointly this isn’t a huge benefit compared to other deductions like having a dependant or paying down a mortgage.
I have heard friends say that paying more into their student loans let’s them write more off. This is only true up to $2,500 so you might want to reconsider how much you are actually paying.
#5 Refinance before you pay extra
There is no better time than right now to refinance your student loans.
My wife and I have refinanced our student loans nearly every year we have held them.
The reason why it makes so much sense is because the interest rates are still really low compared to what they have been historically. When we refinance for a lower interest rate we try and keep our term (the time we have to pay off the loan) the same and usually our monthly payment drops anywhere from $10-$40 dollars.
You now have extra money you can invest in yourself or your asset creation.
It might not seem like a lot of money but having an extra $400-$500 go into a retirement account will do much more for you in 40 years than paying that down on your student loans today.
Give your money a chance to grow.
Wrapping it up
The 5 reasons I have shared with you are why my wife and I don’t make extra payments on our student loans. If you are convinced to do the same, awesome.
Now it is time to figure out where your extra money can best serve you and your financial goals.
If you agree or disagree with my thought process here I would love to talk about it in the comments below.
I had to save this for a reference purpose. I particularly completely agree with your point on investing a bigger chunk of what you could have used to offset a student loan.
I think people rather want to pay off to have that feeling of being debt free.
Graduating with significant student loan debt tempts you to pay for purchases with a credit card. A credit card balance leads only to wasted money on unnecessary interest and nothing more. Keep your student loan debts low and pay your credit cards off on time and in full each and every month.
This is a really interesting post. I always thought I wanted to get out from under my debt ASAP. But when you put it in terms of investing money now, you’re right.
On one hand, my interest rate is 6% (roughly). If the stock market returns 7% a year, conservatively, I’m still making 1% by investing some of that “extra” money I was putting to my student loans that I now put into the stock market. Does that make sense? It could.
Would I be happier with some extra money and some savings? Plus the ability to invest? Yeah, I would. I could pay $225, which is $2,700 a year, write off $2,500 (well, for now…) and invest the other $3,300 (difference between what I pay annually right now and what I would pay if I paid the minimum).
Very interesting…