Should I pay off my student debt?
This is a no judgment post. Do you have an ungodly amount of student debt? Yes? Guess what, you’re normal.
Yup, these are real. US students have $1.3T of student debt. The federal government has almost 10x as much asset value in outstanding student loans than home mortgages. Like I said, got a bunch of student debt? You are normal.
But it’s still debt. So what should you do?
Pre-requisites before considering paying off your student debt
- You have at least 3 months of living expenses in cash (in a checking or savings account)
- You have a steady job
- You’re not working in a job where it’s likely your debt will be forgiven (eg, you’re not working in a rural hospital or something like that)
Ie, you are capable of paying your bills, and you’re really going to have to pay off that debt at some point (or totally screw up your credit).
The math
The math is actually pretty simple. First, look up the interest rate on your student debt. If you have student debt from multiple sources, you should understand the rates of each loan, not just the weighted average.
Now the question becomes if you don’t pay off the student debt, what ROI should you expect if you were to invest it in something else? That’s covered in more detail here, but the short answer is about 8% if you invest in the S&P 500.
So if your student debt interest rate is 8% or higher, pay it off. Pay all of it off before investing a dime in anything else.
If your student debt interest rate is close to 8%, let’s say anywhere between 5% to 8%, it’s a judgment call, but I’d err on the side of paying it off. Investing your money always carries risk. The market could go down, and you could lose money. However, paying off your student debt is completely risk free. Not to mention, there’s also the psychological benefit of not having that student debt anymore, which I’m sure you’ve thought about once or twice…
If your student debt is less than 5%, you really do need to think about investing instead of paying it off. Eg, let’s assume you have $50,000 in student debt and $50,000 in cash (not counting your “safety net” of at least 3 months of living expenses). Let’s also assume your interest rate on the debt is 4%, and if you invested the cash, you’d get a 8% return.
In 5 years, here’s what would happen.
Your savings:
Your debt:
Source: investor.gov
Your savings is now about $74k and your debt is about $61k. Your decision to not to pay off your student debt made you $13k!
But of course, you’re not guaranteed to make a 8% return, and you are guaranteed to accrue that interest on your student debt. So it’s a judgment call. The lower your student interest rate and the more financial stability you have in your life, the more willing you should be to not pay off your student debt, and vice versa.
Last, but not least, remember how we talked about how you need to understand the interest rates on all of your student loans, not just the weighted average? You need to make your decision on a loan by loan basis. Often, former students will have a lower interest rate federal loan and a higher interest rate private loan. You may come to a different decision on your private debt vs your federal debt.
What not to do
- Don’t automatically assume you should pay off your student debt before investing in the stock market.
- If you choose to invest and not pay off your student debt, invest in something that will get you market returns like the S&P 500 or a good robo advisor like Wealthfront. Do not invest in crazy shit like this.
- Don’t skim the policies regarding your student loans. You need to understand them in detail. There may be special considerations (eg, forgiven interest for paying early) that may swing your decision.
In conclusion
What did we learn?
- If you have a lot of student debt, you’re normal.
- Before considering paying it off, you need to have at least 3 months of living expenses in cash.
- When considering paying it off, do the math, and do the math for each individual loan.
- If you choose to invest vs pay it, invest in assets that will get you market returns.
Student debt sucks, but it’s a reality. Making a smart, conscious decision about how to handle it not only saves you money, but it also prepares you well for making bigger financial decisions like buying a home. At least that preparation comes free of charge!
