Most people who have student loans want to pay them off early. Maybe that’s your goal and you’re paying towards them month by month and sending in extra toward the principal balance. Well if that’s you, I’m going to potentially turn that entire concept on its head. My question to you is … why? Why should you pay off your student loans early?
In most scenarios, it doesn’t make economic sense to take existing cash to pay low, fixed rate money, that is tax deductible with a long amortization schedule. As an alternative, take the cash you were going to use to pay off your student loan early and invest it in high return on investment endeavors like real estate investing.
This subject comes from a conversation I had with someone recently. He had set himself a goal at graduation to pay off his $60,000 in loan debt in four years. Sacrificing his social life, he worked two jobs and pinched every penny. His whole world revolved around paying off these student loans early and he was thrilled that he had succeeded.
However, my response to this achievement burst his bubble. I said, ” You paid off long term, fixed, low interest rate debt early? Debt in which interest payments are tax deductible? What are you thinking?” Of course, he was curious and asked me why I felt that way. I told him that, I had only recently paid off my student loan because it was on a 15-year amortized loan. I deferred it as long as possible, even though I could have paid is off long ago. Why? Because it would have been financially irresponsible for me to do so.
3 Reasons Not to Pay Off Your Student Loans
- The Interest is Tax Deductible: For most people the interest in tax deductible.
- Fixed, Long-term, Low Interest Rates: My student loans were at 4%, so by paying off my student loan at 4%, I’m saying that the best I can do with my money is a 4% return. Of course, I can do better than that. In fact, over the past 10 to 15 years, I have consistently generated over 40% cash on cash returns. If I pay off a student loan, I’m taking money that I could have a 40% return on and only getting a 4% return.
- It Helps with Credit Score: A student loan that has been consistently paid off for a long time is a trade line on your credit that improves your credit score. Older trade lines, like my student loan, have given me over 800 on my credit score and I wanted to keep it there for that purpose.
Most people are told to just get out of debt, and they never look at debt this way. But the reality is not all debt is bad. There’s such a thing as good debt.
A perfect example of good debt is in real estate. If you own rental property, your asset is paying the loan each month. The debt against the rental property is good debt. I have a video called Should You Pay Off Bank Loans on Investment Properties. In it I encourage you to resist paying them off. In fact, if you do pay it off after a 30-year amortized loan, refinance it. Get more good debt against that asset.
You Are an Asset
In addition to good debt where you put debt against assets that you own, I’m going to argue that you are an asset yourself. That student loan originated from an education obtained with the intention of improving your ability to earn an income. I call that good debt.
With that student loan, you can earn more money than the payments on your student loan. Not unlike a rental property, when the mortgage payment is $1,000.00 per month and the rental income is $1,500.00. The goal is to leverage yourself reasonably and responsibly as much as you possibly can.
It’s Not a One Size Fits All World
In my recent conversation, the young man said that he was a disciple of Dave Ramsey and he was just trying to stay out of debt. Dave Ramsey is a great guy with lots of helpful financial advice that people should listen to. However, the challenge is it’s not a one size fits all world.
I met Dave Ramsey a long time ago in Nashville at a Christian businessman’s networking meeting held at the church I used to attend. He was leading the meeting that day and talking about financial matters. He knew I was a house flipper and during the presentation, he would occasionally poke fun at me. He would say, “Phil would do it this way, but he’s a house flipper and he’ll be out of business in a year.” He said, “Look, I tried it the hard way, Phil. House flipping just doesn’t work.”
I told him that I had to disagree. I didn’t want to speak out of turn, but it is possible to be fiscally sound in your approach to real estate investing. The irony is, I made my fortune flipping houses and he was wrong in his prediction of my financial future.
High Return on Investment
The point is, it’s not a one size fits all world. When you have the financial intelligence to produce a return far higher than your student loan, it makes sense not to pay it off early. Keep it going and use the money you would have taken to pay it off early, to invest in things that bring in a higher return on investment.