If you have student loans and you want to pay them off early, my question to you is ... why? Why pay off student loans early? In most cases, it doesn't make good financial sense to take present day cash to pay off long amortization schedule, low, fixed rate money, whereby the interest is tax deductible (for most people). Instead, it's better to take the money you were going to use to pay the student loan off early and invest it in high return on investment endeavors like real estate investing. Here's a more detailed explanation:
Why Pay Off Student Loans Early?
Have you ever asked yourself that question? Maybe your goal is to pay it off early and you're paying your student loans off early month by month by sending in extra toward the principal balance. Well if that's you, I'm going to potentially turn that entire concept on its head.
This subject comes from a conversation I had recently with an individual. He had set a goal at graduation that in four years he was going to pay off his $60,000.00 in loan debt. Working two jobs and saving every penny, he achieved his goal. He didn't go out to eat with his friends and didn't drink coffee at Starbucks. His whole world revolved around paying off these student loans early and he was elated that he pulled it off.
As he was telling me about achieving this massive life goal, I burst his bubble by saying, "You did what? You paid off long term, fixed low interest rate debt? Debt in which interest payments are tax deductible? You paid that off early? What are you thinking?" Of course, he was intrigued by my response. So, he asked me why I felt that way. I told him that, deferring it as long as I could, I had recently paid off my student loan because it was on a 15-year amortized loan. I could have paid is off long ago, but it would have been financially irresponsible for me to do so.
3 Reasons Why Not to Pay Off Your Student Loans
- Fixed Long-term Low Interest Rates: My student loans were at 4%, so if I pay off my student loan at 4%, I'm telling myself and the world that the best I can do with my money is a 4% return. Obviously, that's not the case with me. In fact, I have consistently generated over 40% cash on cash returns over the past 10 to 15 years. At 40% returns, if I pay off a student loan, I'm taking money that I could have a 40% return on and I'm sending it into this abyss that's only given me a 4% return. If I pay it off, I'm getting a 4% return.
- The Interest is Tax Deductible: For most people the interest in tax deductible.
- It Helps with Credit Score: A student loan that's been in place for a long time is a trade line on my credit that helps with a strong credit score. Older trade lines, like my student loan, have given me an over 800 credit score for a very long time. I wanted to keep it there for that purpose.
Most people never look at debt this way. They are just told get out of debt. However, the reality is there's such a thing as good debt. Not all debt is bad.
The perfect example is in real estate. When owning rental property, the debt against that rental property is good debt because your asset, the rental property, is paying off the loan each month. I have a video on whether you should pay off loans for your investment properties. In that video I tell you to resist paying them off, but instead keep them going. 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
I'm going to argue in addition to good debt for assets that you own, where you put debt against them, there's also you personally. You are an asset yourself. That student loan originated from an education received for the purpose of improving your ability to earn an income. I call that good debt.
The good debt is that student loan, which is, I'm assuming fixed, has a low interest rate and is tax deductible. Now what you have is the ability to earn a lot more money than the payments on that student loan. Just like a rental property when the mortgage payment is $1,000.00 a month, but your rental income is $1,500.00. You want to be leveraging yourself as much as you possibly can reasonably and responsibly.
It's Not a One Size Fits All World
In my conversation, he brought up Dave Ramsey. He said he was a disciple of Ramsey and he was just trying to stay out of debt. Dave Ramsey is a wonderful man with lots of great financial advice that people should listen to. However, the challenge is it's not a one size fits all world. We need to ask ourselves tough questions like, "Why pay off my student loans early?".
Incidentally, I met Dave Ramsey a long time ago while living in Nashville. Ramsey is from there as well and we were at a Christian businessman's networking meeting. It was a small meeting at the church I used to attend over on Old Hickory Boulevard in Nashville. He was the one leading the meeting that day, talking about financial matters. Since we had introduced ourselves, he knew I was a house flipper. Consequently, throughout 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 a year from now." He said, "Look, I tried it the hard way, Phil. House flipping doesn't work."
I told him that I thought he was wrong. I didn't want to speak out of turn, but it is possible to be very fiscally sound in your approach to real estate investing, where you don't ever put yourself in a position that you would go belly up. The irony of it is, I made my fortune from house flipping. He was wrong about his prediction of my financial future.
Invest in High Return on Investment
The point being, it's not a one size fits all world. When you have the financial intelligence to be able to produce a return far higher than your student loan, then it makes a lot of financial 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 lot higher return on investment.