Pay Off Debt or Invest?
Dave Ramsey says: "Your debt is an emergency. Your house is on fire! You must pay off those loans with 'Gazelle' intensity." But, in the back of my mind, I wondered if this was true. What if I paid the minimum amount and invested the rest of my savings in the stock market? I was pretty convinced by Dave Ramsey but I wanted to run the numbers myself to make sure I would come out ahead.
So I played with a couple tools I ran across: The Student Loan Amortization Calculator (this was recommended by the financial adviser I worked with) and The Compound Interest Calculator (Fair warning, this calculator may change your life. Use 5% interest rate for a conservative estimate. Index funds have averaged a 7%-12% return in recent history.)
Here are are the numbers I came up with.
Scenario 1: Slow Payoff: I keep my loans around for 10 years and make minimum payments (about $2k). I invest the rest of my savings into index funds (ideally $5k a month). Then, according to the compound interest calculator, I'll have $754,673.55 at the end of 10 years.
Sounds good. I'll be rich!
Scenario 2: I go "Gazelle intensity" and put all my savings towards loans to pay them off in 2 years ($7k/month). Then for the next 8 years, I put the same amount of money into the stock market. At 10 years, I would have $802,125.15! Dang. Look at the chart below
Investment Earnings
Assuming a 5% Return on Investment and Yearly Compounding
So if I go "Gazelle intensity," not only do I get the psychological satisfaction of being student debt free, I also come out $50k ahead.
Unlike house loans, student loans don’t have any inherent value. I can’t resell my loans for a profit. If I go bankrupt, according to the current law, the student debt won’t go away. So paying it off quickly is completely in my interest (pun absolutely intended ha).
Look at this loan payoff comparison. Blue is if I took 10 years. Coral is if I took 2 years. Doesn't it just make you happy?
Loan Payoff Timeline
Assuming I'm starting when I refinanced my loans at $208k at 3.875%.
Another win: In slow payoff, I would pay $43k in interest. In "Gazelle intensity," I would pay only $8k of interest TOTAL. Nice.
Fun fact: I paid $32k of student loan interest in 2017 alone. You're welcome, Sallie Mae.
If you're wondering if refinancing is the right move for you or whether PSLF or REPAYE may be better, check out this great spreadsheet by The Student Loan Planner. If you're ready to refinance, I highly recommend SoFi.
Beyond the Numbers:
Another big reason Gazelle intensity works for us is I know how my brain works (My husband is a lot more disciplined than I am). If we had decided to take it easy and pay loans back slowly, we would most likely not have saved $7k a month. We most definitely would not have deflated our lifestyle. I probably would have inflated our lifestyle. Maybe we would invest 2-3k a month, if I was good. Numbers wise, this would put us way behind at 10 years... We would have $475k.
The goal of paying loans off quickly has MADE us save 7-8k every month. It has taught my family discipline, budgeting, and team work. It has made us squeeze every last penny out of our income to “pay ourselves first.” We have found ways to optimize our budget and trim out the excess. We learned that most of this excess spending wasn’t making us happy anyways. There is no way we would have done all of that had we decided to pay the loans off slowly.
Another really great bonus is that my kids are learning the value of money. My three year old looks forward to taking the macaronis out of our debt jar every month. We make it a family affair and chant “Debt is bad!” and cheer as each macaroni comes out. Hopefully he won’t be the weird kid at the playground giving financial advice. Oh wait… that’s me. Sigh. Anyways, I hope all of this will instill a healthy respect for money into my kids. I do see it happening and it’s quite amazing. Look at this little cutie so proud of himself for counting macaroni's.
Taking Macaroni's out of the Debt Jar on Loan Payment Day
Let's say it together... "Student debt is bad!" 'Till next time folks!