On August 29th 2011, I embarked on a mission to pay off $90,000 of Harvard MBA student loans as quickly as possible. By zeroing out my savings, looking for ways to increase my income, and cutting back on expenses like flying home to see my family for Christmas, I was able to make my final loan payment seven months later on March 29th.
Was I too aggressive in paying off my loans? Should I have taken advantage of the full 15-year repayment period?
The typical analysis starts with the math. If the interest on my loans averages 5% and the S&P and DJI indices are low-volatility and experiencing consistent returns well above this, then someone with a pure profit motive and just a smidgeon of risk tolerance would favor a well-diversified equities investment strategy over making extra debt payments. That was the math and the macro environment during the seven months I was paying off my loans that might have convinced me to not pay them down so quickly.
Then there was the heart of the matter, the human side. And this is where the question becomes extremely personal.
I realized, just prior to kicking off my mission, that I had become a slave to consumption. I had a job I didn’t love to pay for my student loans, mortgage, two cars, motorcycle, and my monthly entertainment budget of roughly $1,400. I was working hard and playing harder, but that equation doesn’t typically balance out in the long run. I had some savings from my pre-MBA days and I was contributing 10% of my salary to my 401k, but I wasn’t building my savings outside of my retirement fund, so my options were limited. Start a business? Forget about it. Start a family? Not likely. Take a year off and travel? Impossible. Retire early? Heck no. Retire at 65? Probably not.
I wasn’t doing what I wanted to do be doing with my life. And that’s completely fine—many of us don’t start living our dream life immediately after we receive our diplomas. The problem was that I wasn’t even close to being remotely on-track to eventually live my dream life. I didn’t have a plan.
I didn’t have the fiscal discipline to look at things objectively and unemotionally and say, “My expenses are out of control. Rather than spend all of my money, I’m going to invest in some general market index funds and participate in this bull run we appear to be on. I’ll come out ahead if I invest in the market now rather than pay off my student debt right away.” I had enough self-awareness to know that I couldn’t switch off my spending like that. As such, my mentality was closer to: “Holy $#%@! These two years since graduation have been fun, but what’s the endgame here? Why am I spending all this money? I need to seek freedom and get rid of this debt burden immediately so I can plot a new course.”
Recognizing the problem and attempting to grab hold of the reins, I did what worked for me: I went cold turkey on spending, put all my savings towards the loans, leased my spare bedrooms to strangers from Craigslist, sold off my second car and motorcycle, and did what made financial advisors the world over shudder and bristle—I cashed out my IRA and completely zeroed out my 401k contribution, even the 4% that was matched by my employer. Every single spare penny I made went to my student loans because I knew I couldn’t trust myself with it.
I fully embraced a frugal lifestyle and I paid off my student loans. My newfound financial stability allowed me to take a risk and change employers and take a job in a field I had very little experience in. My job satisfaction went through the roof. I was on-track!
The experience of paying down my loans early was priceless because it taught me that it’s very possible to enjoy a frugal lifestyle. Spending money, I learned during those seven months, really doesn’t create happiness. So now I’m on a mission to pay off my house in the next two years, but I’m doing it in a much different way. Rather than make extra payments now with every spare penny I make, I have the discipline to set aside some of my savings into a small emergency fund and the rest of my savings I put into index funds to try to get a return that’s higher than the interest rate on my mortgage. And once I’ve saved the equivalent of my mortgage in these index funds, I’ll buy my house from the bank and own it outright.
When my house is paid off, I’ll have to gross only a quarter of what I make now to maintain the same sort of lifestyle I enjoy these days. There will be options galore.
It’s also worth noting that I’m not in such a rush to be debt-free that I’m completely neglecting the far future, as evidenced by the 15% salary contribution to my 401k.
My friend and former HBS classmate here in Austin has a wife, several kids, six figures of student debt, and a mortgage. However, he’s not letting any of that stop him from incubating a brilliant business plan, and by the end of this year he plans on walking away from his high-paying corporate job to launch his own business and live his dream life.
I have another friend here in Austin who’s married with children and is over $1M in debt because of the mortgages he’s taken out on numerous residential and commercial properties around town. He’s investing in local real estate in hopes to cash in on the boom that Austin has been experiencing recently.
This juxtaposition of my friends’ situations and mine is intentional and serves to put the “personal” in personal finance. Never in my life could I imagine starting up my own thing or investing in properties while married with kids and paying down a mortgage and student loans, but the truth is that people do it every single day.
In my finance class at HBS, debt was a generally positive term and often referred to as “leverage” because companies can use it as a lever to potentially take their sales and income to new heights. By taking on debt, a company can fund activities like research and development that would otherwise be unaffordable if the company had paid for it using only their cash on-hand. The objective is to fund something like R&D that will hopefully lead to new products that will grow sales and earnings. This doesn’t always happen, of course, just like if (God forbid) my friend’s business doesn’t do very well or Austin’s real estate boom turns out to be more like a bubble.
One real-world example of leverage might apply to the typical recent grad who just received $500 from his friends and family when his parents threw him a graduation party. Student loans are leverage—college students take out student loans in the hopes that they can use their college education to secure a higher-paying job than they could get with only a high school diploma. So with the $500 cash, our grad has two options: Stay leveraged with the student debt and spend the $500 on something else, or use the $500 to reduce some of the leverage.
Let’s say our grad is unemployed and he doesn’t have a suit for his interviews. In this case, it actually makes sense to hold off on the early loan payments so he can buy the suit that will help him land a job that will allow him to make early loan payments so that he can de-leverage himself. In other words, it’s definitely more profitable to stay in debt for a little while longer to secure the tools necessary for getting and keeping a source of revenue than it is to deplete one’s savings to make early loan payments.
Paying off your student loans is not a prerequisite to living the life you want to live and nobody should ever tell you or make you feel like it is. By all means, look at the numbers. Consider the opportunity costs of paying off your debt versus doing something else with your money. Ask yourself if you have the discipline to do something more profitable with your money than using it to erase your debt early. Listen to your heart. Decide. Then give full measure.