This week, CNN Money ran an article written by a 2009 engineering graduate. This recent grad suggested that rather than aggressively paying down his $55,000 in student debt, because his interest rates were between 3% and 6%, he would only pay the minimum. He reasoned that rather than spending money paying down his debt fast, he would invest in the stock market, where the historic returns on the S&P is about 11%.
The article (located here) makes one nice point. If you have low interest debt, you could come out ahead by earning higher interest elsewhere. In certain limited cases, such as the one presented, it may make sense. However, there are a few things that should also be noted from the article.
Point #1: The Author isn’t actually rich
The entire premise of the article is that you can get rich by not paying off your student loans. This is false. The author may have “tens of thousands” the stock market, but this sum, while nice to have, is hardly rich. Furthermore, he claims to be “well on his way” to paying off his student debt. Put anther way, his loans are still not paid off.
Point #2: The approach is a gamble
The author is betting that the stock market will perform according to its historic performance. This assumption could be wrong. Its possible that it could lose money, and it is possible it could make more. By investing this money, he is passing on a sure thing. The article presents the question as simple math. Find the higher interest rate, and put your money there. It isn’t that simple. The student loan interest rate is known and fixed, the stock market return is a question mark. If you have very low interest rates it makes sense, but at what point does it shift? Would you pass up a guaranteed 6% for a possible 11% like the author did? What about 8%? It comes down to risk.
Point #3: There are advantages to paying off student debt not considered
Suppose the young engineer in the article wanted to buy a house. By only making minimum payments, he still has many years of payments at $460 per month. That means when it comes time to buy a house, his mortgage options will be significantly limited. It could be the difference between buying the house you want, or having to get something smaller or in a less desirable location. It could even be the difference between getting a mortgage and not qualifying. What builds net worth faster? Building equity in a house or renting and earning some extra money in the market?
The Bottom Line
The decision to invest vs. pay down student debt is a difficult one. Despite how one article may present it, there are many variables to consider. It certainly isn’t as simple as looking at two interest rates.