Thanks for coming back for another edition of Telos Financial’s blog where I discuss different financial planning topics. The purpose of the blog is to introduce financial planning concepts and questions I receive from clients that I believe are important. I want to start discussions about that will educate, benefit, and improve your financial life. Ultimately, to help you focus on your telos!
This is a question I get a lot. Clearly, it’s beneficial to be debt free and not have to make interest payments. Some student loan interest is deductible, but there are income limits and other rules surrounding this. With the introduction of the TCJA this year, there is also less of a chance you will use the itemized deductions as the standard deduction has been increased to $12,000 for individuals and $24,000 for couples filing married filing jointly.
Paying this off is the way to most people will get rid of it, there are some scenarios where it might make more sense to not pay this off as soon as possible. As with any financial decisions, you should contact your trusted financial guide to get advice on your specific situation.
One situation that would behoove you to make the minimum student loan repayments is if you work for a public service organization that qualifies for debt forgiveness. There are certain jobs that qualify for a federal program to forgive all of your student loan debt after 10 years. In these cases, it makes sense to only make the minimum payments, so after 10 years, the largest amount is forgiven. The obvious risk with this is you may change employers or the laws may change. There’s been some discussion about this recently in the news.
Another is if you have a generous employer. There are employers that may want you to continue your education or help with student loan debt repayment. This is a rare, but fantastic benefit. If you have the option, you definitely should take advantage of it. Every employer or scenario is different and you need to know the rules and requirements well to participate in the program. As I mentioned, this is going to be the exception, but you should always be aware of programs and benefits offered by your employer.
Another situation is if you have a longer time horizon and are willing to take on some risk. Let’s say you have $20,000 in student loans, the minimum payment is $200 per month, and the interest rate is 5%. It would take just under 13 years to pay off at this rate. Further, let’s say you have an extra $1,000 of cash flow each month and you can invest or pay toward student loan debt. We’ll assume you can get 7% in the market for purposes of discussion, you are taking some risk here! If you devoted the amount toward student loans, it would be paid off in 18 months! What a huge difference and great personal success to be debt free that quickly.
In that scenario, I’d absolutely say kudos to you. It’s a huge win and requires a great amount of sacrifice, self-control, and planning to do this. It’s a statement to one’s ability to budget and restrain spending. When you are done with school, be it undergrad, graduate, etc, and land a job, there’s the strong feeling to celebrate and live it up. Suddenly, all the shiny things you always wanted are within reach. To be able to budget like this is rare in my experience.
Let’s set up another hypothetical. Let’s say you decided, in the context of your financial plan and goals, to invest some of that excess cash flow to help move forward on your other objectives at the same time, and perhaps invested $500 per month and paid an extra $500 toward student loans. In this case, your loans would be paid off in 31 months. Still a dramatic improvement over the 13 years, but almost twice the rate of the previous scenario.
Sooooo, now let’s look at a three-year period comparing these two scenarios. In the first scenario, you paid off your student loans in 19 months, then invested $1,000 per month (at a 7% growth rate), at the end of 36 months, you’d have about $17,817 invested at the end. In the second scenario, you paid off your student loans in 31 months and paid more interest because of it. In this case, you were able to invest $500/month for 31 months, then the full $1,000 for five months, so (at a 7% growth rate) at the end of 36 months, you’d have about $22,494 invested.
From a purely financial lens, both of these scenarios are clearly preferable to paying on student loans for 13 years, but the strategy of splitting your free cash flow between additional student loan payments and investment dollars is head and shoulders above when you look at a three-year period. Is this the right strategy for you and your family? I do not know. This is not meant to be financial advice for you. The only way to really make an informed decision is to have a financial plan and analyze the options with your goals.
There are a lot of different ways to slice and dice this scenario to optimize it for different purposes. I’m not recommending you follow this guideline, but I do recommend you educate yourself or pay someone to analyze for you. This is just one of the benefits working with a financial planner provides for you.
Telos Financial is a Michigan’s financial advisor for millennials, Generation Xers, & young professionals. It is a fee based, holistic financial planning firm located in Plymouth, Michigan in the Parkview Professional Building serving young professionals and families. Dennis LaVoy, CFP®, CLU® founded Telos in his tenth year as an advisor and uses his experience, knowledge, and expertise to help families and individuals in Ann Arbor, Detroit, surrounding areas, and across the country achieve their financial objectives.
The information provided here is for general illustration/informational purposes only and should not be considered an individualized recommendation or personalized investment advice. Individual situations can vary.
Data contained here is obtained from what are considered to be reliable sources; however, its accuracy, completeness, or reliability cannot be guaranteed.