Math Vs The Mind – The Low Interest Debt Conundrum

Last week my final student loan payment of 2017 cleared, bringing the total amount paid this year to over $15,300. That’s not bad considering that SoFi only required me to pay $4697. Then again looking at that $15K in the context of a $110K take home income and approximately $42K loan balance at the beginning of the year, I am underwhelmed.

Admittedly, last January I did plan to pay off most if not all of my loan by the end of this year. I could say that I would have accomplished my goal had it not been for getting laid off, but between me and you, it was more keeping up with my rising credit card bills than no longer having a job that prevented me from making a bigger dent in my student loan repayment.

Back in September I made peace with extending my loan payments for another year or so. While I would rather not be carrying a $28K debt burden into a new year with uncertain income (if any), I wasn’t in sack cloth and ashes about it either. However, lately I’ve been reading quite a few articles around the personal finance blogosphere about getting debt free and it’s making me rethink everything I once thought.

The Math

On my last day of work a colleague admonished, “Oh, don’t pay off your student loan. Keep that as long as possible. It’s so cheap.” He said this without knowing my total debt, interest rate or monthly payment. True he was right, but he couldn’t have known that for sure. Instead he operated off the assumption that even if my student loan rate was 6-7%, the money I’d use for additional payments above the minimum would generate greater returns in the market right now (my IRA and mutual fund are up 14.9% and 10.5%, respectively) than I’d be saving myself in interest payments. That’s not even factoring in the compounding growth those returns will bring me in the future.

Interest Only

When trying to think through the best use for finite resources it is logical to want each dollar to have maximum impact. The gift of low interest debt can ultimately turn into its curse because the math makes it easier to justify keeping it, and for many it opens the gates to taking on more.

I have several friends living with the trifecta of high income, good credit, and loads of low interest debt. Many cannot quite bring themselves to accelerate debt repayment because “it makes no sense” to rush through a zero interest car loan and 3.5% student loans and mortgages. And while on paper that may be true, adding large recurring bills to the cost of taxes, food, childcare, transportation, insurances, etc. vaporizes six figures very quickly.

Other Considerations

Often when evaluating the price of debt it is easy to overlook the opportunity cost. For example, when I purchased my bedroom furniture in 2015 I took advantage of a 24 month 0% financing special. Although I was able to keep over $3400 in my pockets at the time, over the next two years I gave up a portion of my monthly cashflow to service that debt. That final payoff hurt my heart.

But my broken heart mended pretty fast when the money that I would have spent on a monthly payment was once again mine to do with as I pleased. True, paying off my furniture only returned a measly $50 to my operating budget, but it felt so good to have it.

In my case $50/month is not making or breaking any of my financial goals. However, I am required to spend roughly $21,000 annually for the pleasure of keeping my mortgage and student loan. Regardless of the fact that it accounts for under 20% of my take home pay and a large percentage is tax deductible, that’s still a whole lot of money with which I could be doing other things.

For many of my friends debt repayment eats upwards of 40% of their take home pay. Even if they are repaying mostly principal, the maintenance costs leave very little room for saving or the investing that has a higher ROI than paying off the debt.

Reality

Even when we do the math on paper, it rarely translates to reality. “My money is better off in the market,” means nothing if the dollars siphoned from debt repayment never wind up in the market. Real talk, outside of my 401K max and ESPP I made no additional investments this year.

I can’t even say that I didn’t have available cash to invest. It just went to GrubHub instead.

I always intended to increase my loan payments to 4X-5X the monthly minimum and buy additional shares. However, month after month there was never an extra $250 to $500 leftover after I was done “doing me.” Life happens and it’s normal to want to live it. I sure as hell do. However, living life without guardrails served to derail the point of low interest debt, which is to free up cash for more lucrative purposes. In hindsight I should have automated in order to protect my intentions from my actions.

Why Not Do Both

There is an age old debate about whether it’s better to invest or pay down debt. It doesn’t have to be an either or proposition. I’ve tended to do both at the same damn time. Sure I could invest more if I reclaimed the $21,000 my debt requires, but I would also lose out on years of returns if I didn’t make smaller contributions now. Here are my five considerations when it comes to handling low interest debt (let’s say less than 5% APR).

1. Total Debt Burden – Before Christmas I test drove a $70,000 Benz E class. Even with a $10K down payment and a 3% APR, the monthly note would have been over $1000/month. It’s important to remember that cheap debt still creates a bill and the bigger the debt, the higher that bill is.
2. Cashflow – How much monthly cashflow is debt consuming? Paying for past purchases prevents spending on present and current ones. Only your budget can tell you how much is too much. One of the biggest reasons I chose to keep cash on hand rather than pay more on my student loan was because servicing the debt was a low burden that did not prevent me from directing money toward other expenditures that I valued more. However, if debt repayment is preventing other priorities from happening, then even if the interest rate is 0% it’s still costing more than you can afford.
3. Tax Deductibility – I do not recommend keeping a $10,000 annual payment just to “save” $2800 come tax time. That math does not make sense. However, when it comes to prioritizing which low interest debt to tackle first, this can definitely be a consideration.
4. Loss of Income – Monthly bills that were manageable with regular income can quickly become impossible without it. Before determining that your debt is too cheap to get rid of consider if you would be able to maintain minimum payments without income and for how long. If the answer is not even a little, not even close, not even at all then once again the cost on that debt just skyrocketed. A fully funded emergency fund has kept me from needing a job and there is enough in there to keep SoFi and Chase from calling me for months.
5. Comfort – This one is probably the most important factor and there is no formula for measuring it. The math can say whatever it will, but if you’re uncomfortable carrying tens to hundreds of thousands in debt then don’t do it. Conversely, if having less cash stashed or missing out on the gift that is compounding interest gives you heart palpitations then keep a level of debt that you can easily handle.

It’s Up To You

The topic of debt elicits strong feelings. Some see it as a tool to free up cashflow to be able to make more money elsewhere, and others see it as an evil to be avoided by any means necessary. Personally, I view it in both ways. There was no way I would be a homeowner right now without debt. However, a large part of me would love to plow through the red in my balance sheet as quickly as possible.

It makes it even more complicated when the debt isn’t in the crisis zone and you’re doing pretty darn alright. At that point it comes down to your personal goals and whether being debt free will get you there faster. That’s when you have to put the pen to paper and do the math. Remember, it’s not just about comparing rates. Opportunity costs and contingency plans also have to be considered. Ultimately, it doesn’t matter what others think as long as your decisions allow you to sleep comfortably at night.

Are you currently living with the gift and the curse of low interest debt? How have you decided to manage it? Are you really investing the extra money? Is there any extra money to invest? Hit the comments and leave your thoughts. In the meantime, I’m going to head over to SoFi’s website and glare at my loan balance in the hopes it will get scared and go away.

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