You are all giving very generous explanations for why people don’t pay down their loans. The adults I know with high interest credit card balances don’t pay them down because they can’t afford to. They’d rather keep their current levels of consumption. They are aggressive at getting lower interest cards to swap out their balances, using everyone’s grace period for maximum benefit, but they are certainly not looking at a spreadsheet which says, “Don’t buy that new phone at Best Buy… pay off the phone you bought last year and are still paying down first”. Occasionally they get a wake up call… like a month where they struggle with cash flow on maxed out cards… and they cut back. And once the cash crisis abates it’s back to business as usual.
So I’m seriously doubting that the majority of people with college loans are meeting with their HR rep at work to evaluate their deductions, IRA match, and assess their benefit packages to make sure that they’re maximizing their ROI on every marginal dollar. And figuring out that contributing to retirement is a better use of cash then paying down loans.
I’m doubting it. I work in HR. People are frequently moronic when it comes to their paychecks and no amount of education can move them off their bad financial habits. Employees like getting a refund in April or May even when you show them that they are lending the federal government money at zero interest. Employees like paying extra for dental and vision care even when you show them that they are paying an $800 premium for getting a $600 benefit. Employees LOVE prescription drug coverage with a $5 co-pay even when you show them that they can save $1,000 a year by dropping to a less expensive plan, and that they haven’t had a prescription drug prescribed to them in three years. And EVERYONE loves long term disability plans which pay for dollar 1, on day 30, even when you show them the tables which clearly demonstrate that this is not the right plan based on their age, family composition, etc.
So sure, the 28 year olds out there aren’t paying down their loans because they’ve done a cash flow analysis which demonstrates that they’re getting a higher rate of return with lower risk by investing the cash elsewhere… Yup, that must be the answer.
I agree with @blossom. The other issue with rationales behind not paying off loans is that it assumes that people are rational & disciplined, and will use money saved from the lower interest rate to invest in a better interest rate or in retirement. In reality, most people are not rational about money at all, and just don’t invest. They spend. They don’t pay off the loan and they don’t invest elsewhere. That extra $55 he talks about essentially disappears—who knows where? Coffee from Starbucks, a pair of shoes, lunch out.
Everything in our economy encourages spending, our entire economy is based on our being consumers, so is it any surprise when people spend, even against their interests?
This is why I think it’s best to pay off loans first. It’s better considering human nature. Get it done when you’re young and you can save with a cheap car & a crappy apartment, as opposed when you are older and raising a family, and then suddenly you need diapers, preschool, etc.
@generations couldn’t agree more. It’s been hard to have a long term investment ROI that yields more than most student loan rates, even at 4.29% currently for stafford loans. Sure there is the stock market but it’s hard to tell in the next few years if that is all going to burst or not…in the end the prospect of higher ROI either goes over people’s heads to use the extra cash for immediate spending or the few will actually find investments able to yield long term ROI above 5% after factoring in taxes and inflation, but even then it’s a long shot and unpredictable…Most are better off paying that loan balance off in order to control spending and reduce the cashflow hits slowly at a time.
Nice analysis, but you are essentially leveraging the student loan to invest in an uncertain asset. Increasingly many investors think that a long turn 8 percent return is unlikely, and many pension funds have been ratcheting down those expectations for some time.
On the other, hand there is a 100 percent probability that blossom will be paying the 6.8 percent interest on the loan. So, what you rather invest in?
1 - An asset with a 100 percent guaranteed rate of return of 6.8%.
2 - An asset with a 50 percent chance of returning 16% and a 50 percent chance of earning 0% for an average return of 8%.
Some people might might choose 2, but most people are risk adverse and will choose 1. IMHO, the 120 basis point difference in return is not worth the risk involved.
@Zinhead the only people I hear nowadays that can pull off an 8-10%+ annual ROI are those going into hella risky investments (i.e. day trading, heavy debt real estate, junk bonds, and peer-to-peer lending). I would roll my eyes if I heard someone say they took out a student loan just to free up cash to invest in a “guaranteed” 10% ROI loan to a friend or relative 8-|
I don’t feel sorry for him, but view the autopsy of his life it as a cautionary tale about a very intelligent, educated and outwardly successful person who was not a success financially.
First of all, if the D didn’t qualify for a nickel of need based aid at Stamford- we’re not exactly talking about someone living on the edge financially. Second, how many people get the grandparents to fund college and grad school? In my world, middle aged parents are paying for assisted living or a CNA to take care of the elderly parent so they can keep their jobs and continue to provide for both their teenage/college aged kids AND their parents. Grandparents are barely hanging on financially- let alone paying for “most of the cost of the girls’ education”. And third- calling colleges extortionists (nobody puts a gun to your head and insists that your kids apply to Stanford and Emory) points out the level of entitlement throughout the cautionary tale.
I’d say this is a story of how a “very intelligent, educated and outwardly successful person” grew up without any appreciation at all of how lucky he is.
1, I don’t follow how the loan can be seen as an asset, since it is, by nature, a liability with a 100% guaranteed annual rate of return of -6.8%. However, if we are talking about it as an investment with respect to long-term - retirement - planning, then it supports an investment insofar as the negative rate of return reduces the rate of return of the investment during the period the loan and the investment co-exist. Once the loan ceases to exist, the investment stands on its own as an asset, bolstered by the differential rate of return achieved during the repayment period. I recognize your point is that you have certainty that your loan will cost you 6.8% per year, and there is value in certainty.
This statement is an oversimplification of an investment strategy. It assumes that the investment strategy will be unchanged, based on the most risk possible, and that the investment is based on a single initial amount rather than a gradual building of the investment. In other words, the statement is true if I contribute my entire investment at one time, invest it in a single stock, make no further trades, and withdraw it at a predetermined time - in this case, there is a possibility of earning 400% (or more) and there is a possibility of earning -100% (i.e. losing everything).
In reality, as a twentysomething, I have room for plenty of risk, so I am currently invested 95% in stocks, 4% in bonds, and 1% in cash; among the stocks are a mix domestic and international small cap, mid-cap and large cap companies.
If I had $30,000 invested in 2008, it would have been $15,000 by early 2009 (statistically speaking). However, where it would have cost me $100/share to invest in 2008, it would have cost $50/share to invest in 2009. And by today, the market has recovered (and then some) from the lows of 2009, meaning the $50/share investments I had made at the bottom of the market would be worth well over $150/share. In other words, these highs and lows are just statistical anomalies - irrelevant in the grand scheme of my retirement planning as a twentysomething.
In 2036, in my 40s, meaning that the need to have money socked away and available is more pressing, though still not incredibly urgent. As a 40something, I am more sensitive to dips in the market (what if something happens and I can no longer work; my retirement will be needed to supplement disability insurance, potentially right away), but since my plan is to continue adding to my investment for another 20 years, I can still be invested primarily in stocks and only partially in bonds, which give me a more secure method for growing wealth.
In 2056, I will be preparing for retirement (or already retired). which means that I am sensitive to market fluctuations. In the years leading up to retirement, I can’t afford to see my portfolio value dip by 50%, since then the withdrawals I make early in retirement account for an inordinately large proportion of my total retirement account balance. As a result, I am more heavily invested in bonds than in stocks.
In summary, if I were in my 50s, I would be far more risk averse than I am today because I should be more risk averse. Conversely, if I were to be the typical definition of “risk averse” today, then I would actually inject more risk into my long-term financial outlook. Risk typically accounts only for the risk of losing nominal principal, making it theoretically least risky to secure money in a savings account - your money is insured by the FDIC and you have no risk of loss of principal. However, if I have $10,000 in a savings account paying 1%, and if inflation averages 3% over the next 40 years, my $10,000 will become $15,000 and have the spending power of just $5,000 today. Suddenly, the risk averse measure looks WAY more risky. If I took that same $10,000 and invested it with an average annual return of 6% (let’s be conservative here), it would be worth about $97,000 after 39 years. If the bottom fell out of the market and I lost 50% of my investment value during year 40, I’d still have $48,500, which would have the spending power of 15,000 today.
Another point worth making is that the math I was doing in my previous post assumed ideal behavior. In other words, someone with student loans would have the discipline to say, there is a specific amount that I am setting aside for loans or for savings every single month, and that amount will remain unchanged regardless of whether the loan exists. In reality, if someone has had no choice but to spend $350/mo on loans and finally pays them off (by paying an extra $50/mo), chances are good that the loan money will not convert into savings money on a one-to-one basis but will, instead, be partially absorbed into regular spending habits. If, however, you are accustomed to “paying yourself” in the form of contributing to retirement or emergency savings, there is a not-insignificant mental reward that you experience when you check your retirement balance and see it rising. I looked at my own recently and was almost startled by how much I had saved (interestingly enough, my average rate of return from career start until the end of January, which totally destroyed my returns from 2015, was right around 8%; with the rebound in the last three months, my average rate of return shot up to 11%). Seeing how much as already there gave me proof that if I continued along this path, I would not need to make radical changes to my financial life in order to prepare for retirement 40 years in the future.
Think of the liability as simply a negative asset. By paying it off, you are avoiding the negative return incurred by paying the interest.
Yes, the example was was over-simplistic as the choices involved have to be understandable to the various people reading this message board. At the same time, the continuum of investment returns you anticipate through your life is the result of an endless series of binary choices like the one presented.
Congratulations on starting young with saving money. It will be nice to be in your forties and know that your retirement is pretty much setup.
That’s the point - I AM that 28-year-old. (29, actually). I’m speaking from admittedly anecdotal experiences of myself friends. Of course it’s a combination of factors - I mentioned that in my first post, when I said I was tired of delaying gratification. Um, yes, I like to buy nice clothes and get a drink with my friends every now and then, and after spending most of my 20s in college and graduate school, I’m honestly just not interested in living like a hermit so I can throw an additional $200 a month on my loans and pay them down by the time I’m 35 instead of 38. Do I realize that I will be paying more in the long run? But I also absolutely made the choice to put a higher percentage of my income into my 401(K) vs paying off my loans faster because the rate of return is higher (and because I was 29 and not 22 when I started saving for retirement, and because of personal observation of elders in my family who didn’t have enough money for retirement). I also made the decision to pay off credit card debt faster than student loan debt because the interest rate is higher on the CCs.
Also, why would I meet with my HR rep to evaluate my deductions and retirement match? I would go to a financial advisor for that.
Insurance is for when unpredictable things go wrong. No, maybe Employee A doesn’t have anything that requires drugs now. And then next year they’re diagnosed with diabetes and need expensive drug therapy. Or maybe they decide to get LASIK surgery and that vision benefit becomes important, or they realize they need a root canal because they haven’t been getting their cleanings regularly. Whatever. Insurance isn’t as easily valued because it’s not just about the benefit you get from it now; it’s about trying to avoid future money problems you can’t predict. Car insurance works the same way - I hope I never have to use my car insurance, and most years I pay out way more than I get back in services. Except for that one year I did $3,000 worth of damage to my car and I only paid a $500 deductible.
Insurance is actually easy to value. You don’t sign up for your benefits on day one of your job and get locked into them for the next umpteen years. And your HR rep is perfectly qualified to review your family composition/age and point out where you are missing the boat on benefits you qualify for but haven’t selected, as well as benefits you are paying for but don’t need.
Your point about Lasik is exactly the issue. Cosmetic procedures are not covered by most vision/dental plans. Vision insurance is a good deal for someone with glaucoma, NOT for someone who doesn’t like the way reading glasses look at a restaurant when they’re squinting at a menu in candlelight. Dental insurance is a good deal for someone with a chronic jaw or tooth issue- not someone who puts off routine care (ironic in your example, since regular cleanings ARE covered by most plans) and then needs root canal (you can’t take the years of benefits you didn’t use, by not getting cleanings, and mash them together during the year you have high expenses for root canal… the plans are annual).
I drive an old clunker and my car insurance is quite inexpensive. I don’t need fancy coverage because my car isn’t worth that much. I have an umbrella policy in case- god forbid- I’m in an accident and someone gets seriously hurt, but there are very accurate tables to look up how much coverage you need based on how you drive (accident free for over 30 years in my case) and what you drive.
Insurance is QUITE easily valued Juliet- that’s why actuaries make big bucks, and why most people pay for coverage they don’t need (and a LOT of people carry no insurance).
I think some of the disconnect here is that there is a difference between not paying the loan down early and not making the regular payments.
The time-value of money is such that carrying interest bearing debt is only useful if one is using those funds for a significantly higher rate of return. The delta between the typical 401K and the typical interest rate on a student loan makes this a non-starter. Pay down the debt. Pay more expensive debt first. Save at the highest return rate.
For example: if your employer does a 50% match of the 1st 6% you invest in 401K. Stick to the 6% until you are effectively debt-free. Once you reach that point, bump it up to 15%.
Unlike mortgage interest, the interest on student loans is not deductible, is it? Low interest mortgage loans can be partially justified as most real estate appreciates in value and the interest is deductible.
Actually, the reason why actuaries are paid well is precisely because insurance is difficult to value, so you need highly trained mathematicians to do it. Either way, I wasn’t talking about financial value alone; I was talking about the combination of insurance’s financial and personal value to the people who get it.
LASIK is actually covered by my medical benefits, which is precisely why I used it as an example. But you can insert whatever you want to in there - a broken leg, open-heart surgery, physical therapy for a child.
Depends on how much your insurance premiums are - dental insurance is pretty cheap. At my last job,* I think my dental insurance was something like $4, so that’s $48 a year. A single root canal can cost $900-1200. That’s 20-25 years of monthly payments of my dental insurance. If I need a $1,000 procedure twice in the lifetime of my working career, my dental insurance has paid for itself. Chances are if I am not getting regular cleanings I’ll need it more often than that. And if I need it before I’ve spent 20 years saving $4 a month, well then we’re getting into the personal value side, because now I don’t have to live in pain and progressively make the problem worse while I try to scrape together $1,000 to pay for a root canal, if I were lower-income.
And if I AM getting regular dental cleanings and still need a root canal, the value of the dental insurance goes even higher, since without insurance dental cleanings would probably cost an adult around $100 a year.
This is also leaving off the social benefit of health insurance, which is indirectly personal as well. You pay insurance into a pot not just so you have money but so others in the pot have it when they need it as well. If only sick people get health insurance, the costs shoot up. If someone chooses to go without health insurance because they are relatively healthy and the cost is too high, and they break a leg, you still pay for it - through raised prices at the hospital to cover unpaid bills, charge-offs and charity care. You also may pay for it in raised costs at that person’s workplace (food service, retail, manufacturing, administration, whatever it may be) because of lower productivity or the cost of replacing them if they can no longer work. Add this up across people and it can become large. There’s lots of economic research on this.
@Torveaux
As mentioned above, there are restrictions to it, but most young people can deduct student loan interest. Once you reach $65,000 (single; $130,000 married filing jointly), the deduction is phased out until it is gone at $80k/$160k, and at that income level, student loan interest should not be overly burdensome (those living in the Bay Area may disagree, though).
As far as I understand, sound financial planning requires three parts: cash flow (wages, cost of living, minimum debt service), offensive positioning (advance debt payment, retirement investment, other investment, goal saving), and defensive positioning (carriage of insurance and buildup of emergency funds)
There is a reasonable, logical balance of those three parts, which means that it is sometimes but not always beneficial to throw every spare dime at debt service.
I’m not sure how much stock anyone should put in that article.
The source of the data is a survey by Citizen’s Bank. Note that the article mentions services available to borrowers near the end. (More specifically, Citizens is pushing private consolidation loans in the original source.)
The article is written with bias aforethought and appears to have manipulated the way the numbers are reported in an unscientific manner. Look for the link in the second graf where MoneyTalksNews links to their source, which is a press release put out by Citizens on BusinessWire. Compare the language used to describe millennials in each piece.
For example, BusinessWire states that “46 percent have limited their spending on entertainment and social events” while MoneyTalksNews says “Just 46 percent said they’d cut their entertainment and social event expenses.”
The MTN piece also changes a critical bit of language throughout, going from “have limited” to “were willing to cut.” In addition to injecting an anti-millennial spin not present in the press release, there’s a methodological issue at stake, too.
Neither article specifies how the questions were asked or what the answer options were, and it makes a big difference.
Example: “Please answer yes or no. Have you limited the amount you spend on travel?” vs. “Would you be willing to limit the amount you spend on travel?” If the survey asked “have you” then no claims can be made about “willing to.”
Even more important, the survey does not appear to have asked how much millennials are spending in the categories assessed, nor if the spending is reasonable.
Example: Are you willing to limit the amount you spend on entertainment or eating out? Answer: “Well, I think I saw one movie in the theater last year, and I grabbed Taco Bell on the way home from work this week, so no, I’m not willing to limit it further because it’s not like $8/month will do much, you know?”
Anyhow, the press release is a sales piece, and the MTN article has been spun in a biased fashion.
I think it is also safe to say that around 1/3rd of college students have their parents taking care of the financials. Even if the graduated student has taken over the payments, they trust their parents worked out a low loan rate.
