Being aggressive towards debt has a time and place. With high interest debt, yes, annihilate it. With low interest debt, such as student loans, read on to discover the trade offs. 

Many recent graduates with student loan debt rush to pay off their balances. They hate the idea of carrying a debt balance for years or even decades. There are cases where a little debt is okay through. I am one of the 54% of Americans who took on some form of student loan debt. Like me, you may have dreamed about the day you can pay it off. In thinking through it I’ve realized it is better for me to slow down that process and instead put my extra money in a place where it is “working for me”. I don’t like carrying around debt, but building my net worth is more of a priority. My approach may be contrary to what you’re used to hearing. Consider that paying down debt is a bet, similar to investing in stocks and bonds. However paying down debt has a guaranteed return since you will never have to pay interest on that amount in the future. Guaranteed returns are hard to come by in life, but in my case the return on paying ahead on low interest debt is small compared to what I could make in a balanced mutual fund. So I decided to make better use of my money by focusing on contributing to my retirement accounts.

Unfortunately for me, I don’t qualify for a student loan forgiveness program. If I did, then I’d only to pay the bare minimum required to keep my credit good and the loan program happy. More on that in a little bit.

Student Loan Interest Rates May Not Cost You That Much

It is helpful to know all your loan balances and at what interest rates. Then you can decide which ones are most imperative to pay off first, i.e. the ones costing the most money each month and over time. 

For example, if you have an average interest rate of 3.43% on your student loans and 26.99% on your credit card it would make sense to put all extra money towards paying off your high-interest debt first. When it comes to student debt in general, make sure to check out the 13 most common and costly student debt mistakes.

You are not forced to pay ahead on your loans. Making extra payments can feel good but that could be costing you. Instead of paying down low interest debt you could make contributions to your retirement account or even a taxable brokerage account. There your money would be "working for you" where it grows based on compound interest. How much of a return you get depends on risk tolerance and what kind of savings options you have (like an employer 401(k) match). 
 

The stock / bond market has returned an average of 8.7% since 1928 (on a portfolio of 70% stocks, 30% bonds). 8.7% is much higher than 3.43%!  Now if my loans were at 6%, that is only 2.7% below the average return, not as attractive. 

Your actual return will vary, and in the short term, yes, it could be negative. My plan is to let it ride for a very long time. Even if it does drop I plan to continue contributing. Not everyone has the discipline to do that though. Market drops can stir strong emotions and cause people to panic.  So, it is up to you to decide what debt to keep and what debt to pay off in lieu of investing, but the interest rates on the debt, and your expected returns based on asset allocation can help you gauge that.

You May Have The Option to Get Your Loans Forgiven

Certain occupations are eligible for student loan forgiveness and in some cases cancellation. Check out the Public Service Loan Forgiveness website to see if you qualify. There is a list of required qualifications but it is worth looking into if you are a teacher, police officer or work for a not-for-profit, just to name a few.

For teachers, make sure you teach in a shortage area in your state to qualify for Perkins Loan Forgiveness. 

If this were something you would qualify for, it would make sense to take the following steps:

1. Make certain you qualify.
2. Apply for a different type of repayment plan.
3. Make on-time minimum payments until your loans are forgiven for good.
4. Keep all the plan paperwork, loan statements, and get proof the loan is paid off in full.
    

If your loan is eventually going to be forgiven, it would not make sense to pay it off early, or pay ahead at all. Instead it makes more sense to put the slack in your budget towards investments of your choosing. One month you may want to put your extra money into my savings account and another month potentially investing in the stock market. If you’re new to the stock market there are plenty of resources for helping you get started.

For people pursuing loan forgiveness, one thing to consider is if you will be in a qualifying occupation long enough to actually take advantage of the program. If not, you may be paying unnecessary interest on your loans. You must check back often with the loan officers to confirm things are still moving in the right direction. To discover if you qualify, try calling your institution’s loan officer or visiting StudentAid.gov.

Loan cancellation or forgiveness is another option. Make sure you have researched the option in its entirety to ensure you qualify. Some other options are discharge or cancellation for bankruptcy or total and permanent disability. It is important to look at all options before throwing money at the loans when they may be forgiven in the next few years later.

Student Loans Have More Flexible Repayment Options

Applying for a different repayment option rather than a traditional plan may be a boost for your budget. Loan repayment programs include qualifying income-driven repayment plans such as pay as you earn or income-based repayment. 

Some common outcomes of refinancing / consolidating loans or changing your payment plan:

1. Reduce your interest rate.
2. Minimize total interest paid over the life of the loan.
3. Establish a smaller monthly minimum payment.

You can find the complete list and explanation at Studentaid.gov. 

The Bottom Line

Some people sleep better being out of debt. Yes, the idea of chasing returns in the stock market is a gamble, though the odds are in favor of long term buy and hold style investors. In addition, hindsight is 20/20. When you pay down debt it is a guaranteed return.

The same is true if you are able to refinance at a lower rate. If it takes 4 hours of phone calls and paperwork to shave off 0.25% on your debt, and that saves you $2000 over your lifetime, that is $500/hr, plus more flexibility in your budget.

Or, perhaps, you’re like me and have a considerably low interest rate on your student loans. In this is the case, you may want to consider putting your extra income toward investing in your retirement accounts while continuing to make minimum payments on your loan balance. But if you’re unsure if either of these strategies makes sense for your financial plan, try consulting with a financial professional who can point you in the right direction.