By Eric Croak, AWMA
What would you do to eliminate your student loans? While taking out student loans might not be your biggest regret from the college days, it still hurts every time you see that monthly payment get taken from your hard-earned bank account.
With that being said, it’s time to conquer the age-old question of what to do with your excess income. Should you pay off loans or invest it? We take a deeper look at the pros and cons of each of these options, so you can make the decision that fits you best.
Let’s start with an example: A 25-year old pharmacist who has $100,000 in loans at a 6% interest rate will pay around $715/month. We can assume excess income above and beyond the minimum payment of $1,000. They can choose to pay the minimum and invest the remainder, or they can put all $1,715 towards loans and invest the entire amount once their loans are paid off. Which would you choose?
The chart below shows how your numbers might look:
So ask yourself, would you rather get the loan gorilla off your back faster or would you rather have more money in the end? In the finance world, our goal is to put the most amount of money in your pocket at the end of the day while accounting for separate goals and needs. Here are some considerations when making your choice:
Investment Spread: Ever heard of the word spread? Simply, It’s the difference between two loans. If you borrow money at 6% via student loans and expect to make 8% from investments then you create a 2% gain for yourself. Easy, right?
Compound Interest: Imagine a snowball rolling downhill and growing as it collects more snow. The longer the hill, the bigger the snowball. This is what time can do for your investments. You can artificially give your snowball a longer hill by investing sooner and this is the exact reason why account values will typically be higher when you invest and pay loans at the same time.
Refinancing: You worked hard for your degree so why not use it to your advantage? Student loans are considered unsecured debt, which means the borrower (you) has no guaranteed income when the loan is given out. When you get your first job, however, you turn from unsecured debt to secured debt – which means banks aren’t scared of you anymore. Secured debt gets more favorable interest rates and you might increase your spread by refinancing. Side note: refinancing has some downsides as well, such as low flexibility and lack of payment options. Make sure to talk with a professional before you jump in.
Investment Risk: There are a few certainties in life: death, taxes, and the stock market losing money. If you choose to invest instead of paying down loans, there’s a chance that the market will have a bad year and you will miss out on the potential gains of investing. Over a 20-year time horizon there will almost certainly be a year or two this happens but it’s important to remember the reason why you’re making these decisions in the first place. Over the last 90 years, the S&P 500 has made an average of 9.8% per year.
Longer Loans: It’s more mental than mathematical, but there’s something utopic about paying off your loans and never worrying about it ever again. There are multiple ways to climb a mountain; pick what makes you comfortable and get after it.
Interest Payments: Have you ever wondered why banks advertise their loan rates? 1) Because banks make a killing from loans and 2) because the consumer almost never figures out how much they’re paying the bank. If you do choose to lengthen the term of your loan, it’s important to remember you are paying a lot more in interest and taking a risk with the stock market.
401(k) Match: If your employer offers a company match on the 401(k), then 9 times out of 10 you should invest at least that much. It’s free money and a no-brainer. Anything above and beyond that match should be based on your goals and needs.
Liquidity Needs: Depending on the type of investment, you might be able to use that money in case of emergency or extenuating circumstances. Loans work a little differently and once you pay the loan, it could be difficult to access cash without using a credit card or another type of loan.
Public Student Loan Forgiveness Program: Ah, the government. They can charge you interest on loans, but they also provide an escape route if you work for a qualified non-profit. A lot of hospitals are non-profits and if you plan to stay there long-term the PSLF program might be for you. This program will forgive all remaining loans after 10 years (120 months) of service and, if you’re one of those people with a lot in loans, this can be your golden goose. It comes with a lot of strings attached so, like refinancing, it’s important to talk with a professional before making any decisions on this front.
Your route won’t look like mine or anyone else’s, but these considerations and guidelines will lead you to a more confident and successful payment path. If there’s one more piece of advice I can offer; it would be to take an hour, create a one-time plan, and you’ll be able to control your loans until they’re finally gone.
Eric Croak is an Investment Advisor Representative with Creative Financial Partners in Perrysburg, Ohio. He has his Series 7, Series 66 and his Life and Health Insurance Licenses. He can be contacted via email at firstname.lastname@example.org or through phone at 419.873.8500 ext.1033.
Securities and investment advisory services offered solely through Ameritas Investment Corp. (AIC). Member FINRA/SIPC. AIC and Creative Financial Partners are not affiliated. Additional products and services may be available through Eric T Croak or Creative Financial Partners that are not offered by AIC.