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Jan
18
Debt reduction is very popular in the personal finance blog world. Some of my favourite blogging friends are trying to reduce their debt (including being frugal, I’ve paid for this twice already…, single guy money, credit withdrawal, rocket finance, gather little by little, and others).
I have two major debts, the largest is my mortgage which weighs in at over £86,000 (about $172k). The other debt that I carry is my student loan, which originally totalled £12,000 (~$24,000) and is now down to around £9,000 (~$18,000). I’ve got no intention of paying off my student loan early at all.
I took out a loan for each of the four years of my degree course from the government backed Student Loans Company. There are three unusual factors about this loan which lead to me to decide not to pay it off early, they are as follows:
- repayments are income contingent - 9% of earnings above £15,000 (~$30k)
- if I haven’t paid it off by the time I’m 65, or if I become unfit to work, it will be written off
- interest is pegged to inflation
Why do these lead me to not pay it off earlier?
paying off slowly is risk free
The last two features combined mean that if something unforseen happens and I have a much lower income, or I am unable to work, or even if I get stuck in a minimum wage job, my student loan will not hamper my life further. If my income is lower, my repayments are lower, and I won’t be retiring with this loan still over me. It is safe for me to pay the minimum for as long as I like.
paying off slowly makes money
If I continue to pay it down at my current rate, it will take me another 10 years to pay off my whole student loan. At the moment I have about £200 of spare money a month that I could use to pay off my student loan early. If I used this money to pay down the loan more quickly, then I calculated that I could do it in about 2.5 years.
However, I could take that £200 and instead of using it to pay off my student loaninvest it in the stock market tax free via a stocks and shares ISA.
Assuming that there is always £200 plus my student loan payment available per month, either for debt reduction, or for investing in the stock market, that inflation is a relatively high 4.5%, and stock market returns are a reasonably conservative 7%, I would be £1,300 better off investing in the stock market. £1,300 is a lot of money.
disadvantages of paying it off slowly
The only disadvantage I can see is that I don’t get to experience the much vaunted debt-free feeling. I have it on good authority that it’s very satisfying. I don’t know, I’m in this for the long haul, and I think £1,300 will be very satisfying. And over the following 30 years to retirement, that £1,300 (assuming 7% returns) could grow into nearly £9,800. And that’s a very, very satisfying indeed.
what have i really done?
I really am investing £200 in the stock market (in pension and ISA, switching to an ISA only in April), and paying off my student loan as slowly as they’ll let me. Eyes on the prize.
Image by tompagenet.
If you like what you're reading, why not leave a comment below, subscribe to my feed, or check out some of my best posts.You might also like to read:
- student loans and salaries
- planning for retirement: pensions vs buy to let part 2
- does debt-free mean mortgage-free?
Comments
14 Responses to “why i’m not paying off my student loans early”
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Retirement Savings versus Student Loans | Moolanomy on
August 19th, 2008 1:01 pm
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I agree - a Student Loan is pretty much the cheapest money you’ll ever borrow - even despite the interest rate rising sharply recently.
I’m currently deferring my student loan (I think the rules allowing deferrement may have changed since I left Uni), although I may go over the income amount when you’re required to start paying it back soon, so I might have to start paying it off later in the year. I’d rather put the money to better use elsewhere though (credit cards, mortgage).
If my interest rate was tied to inflation I’d probably feel differently
As it is, one sits at 9% and the other at 7%… yuck.
Good thing for people to think about - I just “negotiated” my wife’s schools down from a $100 payment per month to $39 a month because her interest rate is locked in at 3.00% . . . The difference in payments is being contributed toward our retirement.
I completely agree with not paying student loans back early, that said I am aiming to pay mine off in full this year. I was happy with the little deductions while I lived in the UK but after moving out of the country, the hassles of paying small amounts to debt back in the UK are too great, I have set up a seperate high interest savings account with monthly contributions and when it is equal to my loan debt I will pay it off. If I still lived in the UK, I would follow your plan though.
Yeah, I agree. Of my debts, my student loans are likely the last ones that will get paid off. A few of them are at higher interest rates, but most are very good (3.75% range).
Still, it was alot easier getting (and spending!) the student loan than it is now paying it back!
Thanks for explaining your reasoning on slowly paying back your student loans. You seem to have a solid plan and if it’s working for you, then you should do it.
I think you are doing the right thing. If you wanted to pay down debt then pay down the mortgage since it is “riskier” so to speak than the student loan - if you are unemployed, you will still have to pay the mortgage.
My definition of debt-free includes my mortgage which coincidentally is almost exactly the same size as yours, so according to moi, we both have a long way to go before being debt-free.
Mike
I also agree. I have a student loan that amounts to $50/mo US (which is worth what, .25 cents in Euros these days?), and is at a whopping 5%. I earn that much in my savings account doing next to nothing.
Interesting approach. I think you’ve explained a lot of reasons why it makes sense for you. As for us, I think we’ll be doing a moderate snowball at times. But that’ll depend on interest rates, income, investments and the like. After all, it’s important to get started investing early because of the wonders of compounding.
I still have a student loan I haven’t bothered to pay off. It’s only about $5300 now so I could pay it all off quite easily, but the interest rate is locked in at 2.625%. That’s going to be lower than inflation just about all the time so it’s never struck me as particularly smart to pay it off. I took out the loans as an insurance policy and never had to use them to actually pay for college so I’ve been sitting on the full amount of the loans ever since. I’m still glad I took them out since I’ve been making money off that money (though not much) and it contributed a great deal to my sense of security after I graduated to have the student loan money in the bank.
The terms are so generous and you can do so much better by investing your money, you’d be crazy not to do what you’re doing. Even tho’ I’m a great fan of debt-freedom (in fact, just seconds ago posted a long squib on how to pay off debt), I think your strategy is very smart.
Good to see I’m not the only one with this idea. Makes me feel a lot more comfortable.
@Looby:
If there was hassle involved - like if I was living abroad - I’d probably pay it off earlier too.
@Mike:
Interestingly I can get a savings account at a higher rate than my mortgage interest rate, so I’m not overpaying that one either. But that’s a much tighter difference.
I was just old enough to miss out on the student loans… had to make do with not a lot of money though
I’m not paying back my student loan, at all. My first degree was earned in Australia, and because of dual taxation agreements, my UK income isn’t counted for loan repayments (this may change in future, but I don’t believe it will change for me). Obviously I’m racking up inflation-linked interest, but I’m ignoring it in my debt/credit calculations. My ‘debt’ is only ~£3000, but I know of other people (mostly Swedes, whose student support is far more generous), for whom student loans become a significant factor in when, and when, they return to a home country.