Removing Your Shackles: How Fast Is Too Fast?

Hi guys, SmarterBucks recently asked me for my thoughts on if I paid off my loans too quickly. Here’s my response:

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.


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21 responses to “Removing Your Shackles: How Fast Is Too Fast?

  1. Alison

    You rock with your advice. And you’re an inspiration with your situation! Thanks for sharing your perspective and wisdom!

  2. Word. Thank you for sharing! What are your thoughts on buying a house? I’m trying to pay my student debt off within the next 2 years (, but don’t know if the opportunity cost of buying is greater than renting in that time period.

    • Good question. Before we go there, I stopped by your site. It looks awesome and I’ve added you to my blogroll. Don’t let us down.

      Buying a house is more than just a financial question. Do you really want to be tied to one place? Experts say it takes at least five years before any sort of equity can be gained…I haven’t crunched the numbers for any great length of time, but it pays to put 20% down so you can avoid a couple hundred bucks a month in PMI–unless you put 5% down and put the other 15% in equities (or to pay down your student loans) and earn an interest rate high enough to justify paying PMI. Also, there’s the market to consider–are you buying in a valley or a peak? It’s impossible to know right now–you’ll only know once the valley turns into a peak or vice versa, and that could take years. Either way, if you’re cool with roommates, you can rent out rooms and have them pay for your mortgage.

      Personally, I think the market is fairly stable right now, interest rates probably won’t get any lower, and renting out your rooms to folks who will pay your mortgage is a no-lose situation. I’m a yes as long as your interest rates on your student loans aren’t insane and you can still make some good progress there.

      • Jen

        Joe, it’s good to have you back. Ani, I looked at your blog. I can’t wait for you to meet your goal! You’re definitely on target and I have a few things to add that may help you analyze what’s right for you. I’ll make it short and sweet since you don’t know me and probably won’t put much stock in what i have to write (also because I checked out your blog so I know you are up to the task of doing the research).

        Joe’s right–if you can’t afford the 20% down, you can’t afford the house. Also, anticipate paying a 6% commission and most likely additional repair costs when you sell. This obviously diminishes your equity and that’s why people use the 5-year rule. If you’re going to move in less than five years, it may not be worth it to buy now. Homes are going up in my area. I know a lot of Florida is still depressed so it’s a gamble if you want to try buying now and hoping homes will rise. Just don’t buy a home in a neighborhood with a lot of foreclosures because it’s going to bring down the value of your home. Also, don’t buy a home just because you think you’re going to miss buying at the bottom of the market or all of your friends are doing it. If it’s a home you’re “settling” for just to become a home owner or if you cannot be approved for much of a loan due to your outstanding student loan debt, you should probably wait until you can afford the home you really want to live in for awhile.

        Plan for the life you have, not the life you want to have. By that, I am referring to your well-intentioned post about buying a house with the intention of it being an investment and having roommates to use the surplus rental income to pay down your loans. You need to be able to pay the mortgage all by your lonesome because, in short, the only person you can rely on is yourself. What if your roommate loses his or her job, you can’t find a roommate, or he or she is a psycho that needs to be evicted? Remember, none of Joe’s side-jobs were his golden ticket to success despite his best effort. Joe also had some “issues” with one of his roommates, which he appears to have blocked out. 🙂 Roommates are great for sharing costs, just make sure you’re fine if he or she leaves to get married or buy his or her own house.

        The amount you pay in rent is not the amount of mortgage you can afford. Owning a home is far more expensive due to insurance, taxes, association fees, and stuff that breaks. If you’re accustomed to living in an apartment, your expenses will be far higher in a home because you will pay more for utilities, landscaping, etc. Depending on the housing demand in your area, you may find renting is far cheaper than buying.

        I don’t mean to deter you from buying a home; I want you to consider several different aspects of the decision because it’s one of the biggest investments you will ever make. So much for keeping this short. 🙂

        • anylight

          Jen, thank you so much for your thoughts! I really appreciate it. I agree, my thoughts on getting a place and having roommates pay for it is short cited. I’ve done a lot more research since then, and obviously continue to do so and to solicit advice. Thanks again, and stay tuned!

      • Thank you so much for the plug and advice!! Very much appreciated! I’m definitely at a fork in the road regarding the home purchase. I just put up a new post with my thoughts. Stay tuned!

  3. Insourcelife

    I followed your blog while you were paying off your student loans but never posted before… I know you disappeared for a while there but it’s nice to see you back as your writing style is engaging and your story is a great example of what can be accomplished if you’re ready to make some sacrifices. While I don’t agree 100% with the way you went about paying off your student loans (I would’ve continued with the 4% matches and would never touch the retirement savings), I think what you’ve accomplished is absolutely inspiring to many.

    I also agree about the importance of “personal” in finance. I am currently on my own quest to pay off my big mortgage dropping thousands in extra principal payments every month, even though I could probably make more in the market since my interest rate is only 3.25%. I could put the extra money in index funds, however, there is always a chance that the market will drop especially considering the new record highs being set this year. I like KNOWING that in a couple of years my mortgage will be paid off and I will have the additional financial freedom to pursue other interests without jeopardizing my family’s standard of living, since our expenses will drop so much. Sounds like you and I have the same goal but we are taking slightly different roads to get there. And again, this is what makes the finance personal!

    • Mike

      You have a 3.25 interest rate. Assuming you have a long time horizon more than 5 years you could get 8 percent in the market. It might be smarter to not be afraid of that debt and look at it as leverage as I wrote about below. 8-3.25 = 4.75 percent. 4.75 percent you would be gaining on your money for all the money you put in an investment account instead of an early repayment account. You would be gaining free money by putting your same early house repayment into an investment account instead of early repaying. Look at my post below and talk to your investment advisor about possible this as possibly an opportunity for free money over a long time horizon instead of being afraid of it. You would probably gain a free $100,000 you could spend on vacations etc., over the course of your loan early repayments if you invested this way instead of being afraid of debt. Look at is as low cost leverage at 3.25 percent. Free money you can put into the stock market over a long time horizon. This might not be good for all people, but talk to your financial advisor about this instead of early repayment I would suggest.

  4. Barbara

    You are such a good writer and I always enjoy what you have to say about money. I do hope you continue with your blog notes! Barbara

    Sent from my iPad

  5. MJ

    appreciating your continued spirit of generosity,
    anticipating your next post/episode.

  6. Great post, and I agree, I think there’s a lot more too it than math in wanting to get rid of loans quickly. I’m going down the same route, my loans not only are so expensive that it makes no mathematical sense to hold on to them longer, but the stress is killing me as well! Between them and my car loan, I have a payment plan set up that will raise my net worth the quickest, and that’s what makes me feel more comfortable with the whole situation. Others feel more comfortable enjoying life more now and don’t care much about the overall interest paid, but I do. There are very few people that get their dream life after a diploma, and I consider myself no different! I’d rather scrimp and save and live cheap when it’s easier for me — at 24 — than to worry about having less money when I need it more, when I have a family, mortgage, more financial responsibilities, etc.

  7. Cat

    Can you please help me figure out how to do the same? I have 60k in student loans… I’m growing extremely stressed over it.

  8. Rebecca

    Wow. I just found your blog and will be bookmarking it and using every penny of advice to embark on the same journey. I just accepted another 30k of loans from financial aid for this upcoming year, putting me over 100k after I finish 12 years of college and hopefully gain a sparkly PhD. I hope I can do the same as you as get rid of this debt asap. Thanks for the inspiration and providing the steps so we can actually do it!

  9. Jackie

    Hi. Just wanted to say I read your blog and it made me wanted to pay down my own debt. Had same scenario. I was 120,000 in debt. I was paying 1300 in payments for last 7 years and I still find myself owning the same amount. I bought an expense house and a German car and at the end of each month I spend more money then I make. I make 140,000 and still can shake off me debt. Well. I am proud to say after reading your blog, I paid down all my credit cards and I and down to only 14k for student loan from 120k after 10 months of intense determination to pay it down. I am planning to be student loan free in 3 more month .

  10. Pingback: Two Key Ingredients In Debt Relief That Are Usually Forgotten

  11. Mike

    I think this is an important question. I do disagree though and think if you thought differently you could be richer. It is assumed you have poor fiscal self control. This is false. You have incredible fiscal self control. You lived an incredibly frugal lifestyle, and cut back on spending incredibly well. So I do not believe it is fiscal self control that is the problem. What I think is the problem is your comfortability and tolerance for the concept of debt and leverage and thus your allocation of that same money into a debt repayment account instead of an investment account.

    It would have been better to think about it as a balance sheet as 90,000 assets and 90,000 liabilities essentially 0 instead, of a 0 bank balance. You would be gaining a free $90000 to invest at market rates passively over a 15 year period, and free money. The difference between that 90000 at an 8% – 5% interest rate would be free profit for you for the duration of the loan. You would be gaining a free 3 % on your money without working by thinking about your money in terms of allocation instead of as a zero balance. Had you put that same money in an investment account instead of a loan repayment account you would be gaining around $3000 free without working for 15 years. I would rather have free money than have to work for it personally. You should have placed that money in an investment account. Your mind is afraid of leverage, and you should learn when leverage is healthy to remove your biases towards it, when in this case it is better to invest that same money than repay your student loans. You also want to buy a home in cash.

    $90000 investment
    at 8 percent
    = 7200 revenue

    $90000 liabilities
    at 5 percent
    = 4500 costs
    7200-4500= $2700 profit or $2700 free money.

    $2700 x 15 years of loan leverage free money = $40,500 free wealth without working

    Normal Case:
    $90000 investment
    at 10 percent (with a Harvard MBA you should be able to make more than 8 (market) for your investment projects)
    = 9000 revenue

    $90000 liabilities
    at 5 percent
    = 4500 costs
    9000-4500= $4500 profit or $4500 free money.

    $4500 x 15 years of loan leverage free money = $67,500 free wealth without working.

    You are basically being given free money you are throwing away without working and need to use the material from your finance course. Learn the appropriate times for leverage and you will be wealthier than you are now.

    • Mike

      This is not to say debt is good, it most often is not, but in this case it is free money assuming you had placed that debt repayment in an investment account versus a debt repayment account. Debt is often stressful if it is out of hand, however in this case, I think reframing it cognitively would have helped you be richer, had you invested that same amount in an investment account versus a debt repayment account. Debt can be scary, but leverage need not be when used appropriately.

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