Is he really a clever dude?

[Disclaimer: Artist's rendering of AJC ... any resemblance to other bloggers living or dead is purely coincidental]

Have you noticed that I don’t have a category for debt on this blog?

[AJC: you can click on any of the keyword/categories in the orange header-banner above to see a list of blog posts focusing on that subject]

It’s not because we don’t talk about debt, as we clearly do …

…. it’s because, to me, creating or paying off debt is just the same as investing (after adjusting for tax: a dollar saved in interest, is the same as a dollar earned in interest or investment income, right?).

That’s why I was genuinely interested in finding out what was going through fellow-blogger Clever Dude’s mind when he loudly proclaimed:

We’re Free of Consumer Debt!!!!!!

As of today, we have paid off all $113,000 of our student loans, auto loans and credit card debt.

We are debt free!!!

My fellow blogger is right to be proud of his achievement … but, does that make it the right investment choice?

Check it out:

He paid off $113k … now, this is no small achievement, some people don’t even save that in their entire lifetime! Still I couldn’t resist asking Clever Dude for some details:

The rate on the student loans was 6.25%. The 2nd mortgage is 7.875%. First was 5.25%.

I chose to pay off the student loan because it was more manageable and I could get it off the books faster than the 2nd mortgage. Mathematically, the 2nd mortgage makes more sense until you factor in the tax deduction which brings them down to about equal.

I also wanted to know a little about his current net worth (after the mammoth debt-payoff feat) – nosey, aren’t I?! Anyhow, Clever Dude was happy to share:

Don’t mind the math as I rounded:

Cash: 17%
Investments: 37%
Home Equity: 6%
Autos: 17%
Personal Property: 12% (if I could sell it all right now)
Whole Life Insurance: 5% (yep, I got it, it’s expensive, but I’m not giving it up!)

So, Clever Dude has ‘invested’:

-> $113k in loans returning (by avoiding having to pay) around 6.25% after tax

-> 17% of his net worth in cash returning (I’m guessing here) 2%?

-> 6% of his net worth in his home returning some unknowable amount in future (potential) capital gains

-> 5% of his net worth in insurance ‘investments’ of dubious value after (often) exorbitant fees

-> 29% in (presumably) depreciating ‘assets’ such as autos and personal property

Now that he is debt-free, what  will drive Clever Dude’s investment strategy from here on in? He says:

Investing and savings are next up in our planning. Honestly, we’ve spent so much time just thinking about debt, we haven’t spent much time on the future. Now is the time.

Now, I’m not here to pick holes in Clever Dude’s investment strategy as he had a strategy and moved mountains to achieve it – not to mention, that we know so little about Cleve Dude’s true financial situation that we are in no position to advise / criticize …

…. but, I do want to use this example to show why following a blind – and, in my mind totally arbitrary – investment goal such as “reducing debt” is not always the best idea:

Clever Dude has only 37% of his net worth in investments right now (OK, he is working on his Master’s Degree, so he has had other things on his mind) and has limited the bulk of his net worth’s returns to only 2% to 6% (or so) by almost-totally focusing on paying debt.

Why?

So, that he can start “investing and saving”!

Now, does that make sense to you?

Even more on the debt-free fallacy …

I’m not a Ramsey fan, and I am equally not a fan of pithy statements that are supposed to make us financially secure, both for the simple reason that they are unlikely to help me – or, you – achieve a Number (i.e. retirement nestegg) amount that is large enough to live my – or, your - Life’s Purpose.

Now, if you don’t have a lot of travel and free time associated with your own Life’s Purpose, then you may be able to live nicely off $50k a year indexed (assuming that you have a $1 mill. nest-egg, in today’s dollars)  … but not me!

I aimed for – and, achieved – a $7 million in 7 year target (starting $30k in debt) because that’s what I decided that I needed (actually, calculated) … and, this blog is written primarily for those who want to achieve the same.

So, it shouldn’t come as a great surprise that I both agree and disagree with Jesse – the Debt Go To Guy- who says:

Risking $1,000 a month on a possible 8% return instead of a guaranteed after-tax ROI of 5% by paying down mortgage debt is NOT such a “Duh” decision. If you do get 8% you must pay taxes, and if you live in a state like CA, then after taxes you’re about even. Plus you have slippage… transactional fees etc for the investment / trade. So risking your $1,000 a month on 8% instead of a guaranteed after tax return of 5% is not always so smart, and a bad example.

People with double-digit interest rates on credit card debt, especially the many folks paying 20-30%+ interest, are not likely to find a better investment opportunity in their entire life than inside their own liability column. Every dollar in debt paid off is a guaranteed after tax ROI of 20-30%. Warren Buffet, Peter Lynch and Sir John Templeton would all agree and even George Soros couldn’t produce a better ROI over time. What makes you think someone in debt could pull off such a stunt?

OK, that’s sound commonsense advice and hard to argue with:

- Sort your debts into high interest and low interest, and have a good crack at the high interest ones first, because the money that you save on interest is probably way higher than you could earn elsewhere. A dollar saved is a dollar earned, right?

- Now, when comparing the lower interest debts and investments, you really need to look at all the factors, such as risk, taxes, costs, etc. Often, it will be paying down the debt that wins, although I would be surprised if paying down a 5% mortgage ‘wins’ over any sensible RE, value stock, or business strategy in terms of serious wealth building.

But, I don’t really think that “Warren Buffet, Peter Lynch and Sir John Templeton would all agree and even George Soros couldn’t produce a better ROI over time”. I know that Warren Buffett has produced 20%+ compound returns, and George Soros didn’t become a billionaire on less than 20% – 30% compounded returns.

That doesn’t detract from Jesse’s statement that “every dollar in [credit card] debt paid off is a guaranteed after tax ROI of 20-30%” and I do agree that it would be almost impossible for anybody except [insert: Forbes Rich 1,000]

But, here’s where I disagree with Jesse:

I think Dave Ramsey provides sound advice for most people, and while I think it’s better to expand your means and increase your income instead of living like a popper, his advice has proven to help many hundreds of thousands of people to stop paying interest and start earning interest, and that’s the key.

- readers attracted to this blog are not in the same position (at least, no longer wish to be in the same position) as the ” hundreds of thousands of people” that Dave Ramsey has helped, and

- “stop paying interest and start earning interest” is not the key to reaching a large Number by a soon Date.

Look, there is nothing intrinsically right or wrong about paying interest, it’s merely a by-product of a loan that you have taken out. Just make sure that the loan produces more income than the interest expense that you paying, by a wide enough margin to account for the risk, taxes, and costs that may be involved.

This is a ‘no brainer’ when you realize that a rental property can produce income (assuming that your calc’s prove that it is all worth while … by no means the case on all – or even many – properties), and it is equally a ‘no brainer’ when you realize that borrowing money on your credit card to buy an LCD TV produces NO income, so why would you do it?

But, it takes a giant leap to suddenly realize that – for any existing debt that you may already have – paying down debt on a mortgage that costs you 5%, or a student loan at 2% may not be such a brilliant idea when an investment that can produce 15% compounded comes along and you now need to decide where to put your cash: into paying off those loans (to blindly achieve a ‘no interest’ outcome) or into the investment (hopefully, to produce an income-producing asset with excellent cashflows).

Of course, we’re making an assumption that reasonable people can achieve reasonable investment returns … but, if you think those kinds of investments are almost impossible to come by, take another look at:

- Value stocks (read Rule # 1 Investing by Phil Town),

- Real-estate (read Multifamily Millions by Dave Lindahl),

- Business (read The E-Myth Revisited by Michael Gerber).

[AJC: and, if these all sound too scary for you, just remember that over a 20 to 30 year period a low-cost index fund that tracks, say, the S&P500 will return circa 11% to 12% (yes, before taxes and ultra-low fees), and - if you are worried about risk - has NEVER produced less than an 8% return over 30 years]

I didn’t become a multi-millionaire by blindly entering into debt, but neither could I have become a multi-millionaire by blindly avoiding it … debt, for me, was a tool that I used sparingly, yet wisely.

I recommend that you do the same :)

Peer to Peer Lending. A 7m7y tool?

In my last post, I suggested that banks are profitable businesses because they have such a large mark-up. If they’re so great, my son asked, why don’t I simply plonk my cash into a safety deposit box and dole it out to willing borrowers like some kid with a lemonade stand?!

Why not, indeed?

The simple and obvious answer is risk, which the bank handles, I said to my son, with a combination of volume (to spread risk), people (to manage risk), and systems (to assess and ‘price’ risk).

However, Rick Francis offers perhaps a better-lemonade-stand-solution (?) … Peer-to-Peer Lending:

There is a fairly easy way to become the bank- peer to peer lending. It doesn’t remove the risk of default but does allow for diversification and there is a framework to asses the risk. They break loans into many small pieces that different individuals fund, so you don’t risk too much on any one loan.

Yep, P2P Lending certainly helps to address one of the banks’ three mechanisms for handling risk: you can spread your loans (the bank lend $400k many/many times over … you lend $40 many/many times over).

But, what about the experienced PEOPLE? It can take some time/trouble to sift through all of those loan apps listed on the leading P2P sites, as Jake points out:

P2P lending requires you to pick through hundreds of loan apps, and filter it to the set that you believe has the best risk / return ratio.

Then you have to diversify – invest in many loans so that a single default will not wipe you out. I think that you should invest no more than 1% of your portfolio into a given loan – so lets say you need to invest in at least 100 loans. Unfortunately, that requires you to pick through probably 1,000 applications hand-by-hand (you already discard the vast majority based on search criteria).

That’s frankly just too much work to be worth it, no?

it’s worth it for the bank, but probably not worth it for you and me (even though you can filter/sort the loan applications by various criteria) ‘just’ to get that 10% return that Rick has experienced …

And, we still haven’t addressed the risk management SYSTEMS that the bank applies, what does P2P offer there? Many sites, as Rick pointed out, offer some sort of FICO-based ranking, but banks rely on a lot more than that (for example, where’s that little thing called ‘collateral’?!) …

The only compensation for these last two (PEOPLE and SYSTEMS), that I can see, is that P2P borrowers may not want to default for a combination of:

- Getting locked out of the P2P sites … perhaps a similar mechanism to eBay’s Rating system is available?

- Perhaps it’s enough that P2P borrowers appreciate the opportunity that they have been given and don’t wish to abuse it by defaulting?

It is perhaps these two reasons that help to explain why micro-lending in 3rd world countries has such a low default rate?

But, it’s the simple logistics that Jake pointed out that put the kibosh on P2P for me …

Have you had any experience with P2P and would you use it again?

The time of your life?

I’ve been spending the last few days reacquainting myself with Millionaire Mommy’s excellent blog, but I do see some differences in perspective – even though we are both millionaires …

…. but, I suspect that the differences come from degree: she describes herself as a ’self made millionaire’ … and me a ’self made multi-millionaire’.

IF this is the case, then I suspect that my point of view and that of, say, Felix Dennis (who is worth hundreds of millions) will equally vary from time to time. Which leads me to my first Rule of Advice:

Only seek financial advice from those who have made at least 10 times what you have already achieved, doing exactly what it is that you are attempting to do.

A long winded-way of saying: only listen to somebody who’s already been-there-done-that …

…. but, more than that: when you get to, say, $3 million or $4 million of your own, you should probably stop reading this blog, as my ideas and your may become self-reinforcing – hence self-limiting.

At that point, it will be time to move on and find some new mentors (maybe even Felix Dennis, himself?!).

The flip-side is that if you are still working towards your first million (say, $100k or networth or less) you probably should be reading Millionaire Mommy’s blog as well as (dare I say, instead of?!) mine; to help you decide which is right for you, let me give an example from a recent Millionaire Mommy post:

Today, I’m sharing a trick that can completely revolutionize your spending habits by changing the way you see the cost of the goodies that merchants want to sell to you.

Here’s the trick: Translate the number of dollars you see printed on a price tag into the number of hours the purchase will require you to work for it. By doing so, you’ll make well-informed decisions regarding what you’re willing to pay for with your irreplaceable life energy.

You should read her post thoroughly to understand it properly – and it’s another excellent “hold back your spending” technique to go along with others such as the Power of 10-1-1-1-1.

But, I wouldn’t use it …

… now.

I may have – if I knew of it – before … but, not now.

You see, when I was concentrating mainly on MM101 (getting my financial house in order), this time value of money approach would make perfect sense, but now that I am transitioning from focusing mainly on MM201 (income and wealth acceleration) and MM301 (protecting my wealth) I think the idea doesn’t make great sense:

I ‘pay myself’ a notional salary of $250,000 a year – this is really a budget for now, as we get our financial house in order after a transition from business to retirement and from the USA to Australia – and have few, if any, ‘business expenses’.

But, for the sake of the calculator, I said that I worked about 20 hours a week on ‘work’ (business/investment projects), and probably spend another 5 hours a week in social activities related to this ‘work’.

Given all of that, the calculator says that my time is worth about $105 an hour … poppycock!

The test is: would I take a job, consulting activity, etc. that paid me $105 per hour? Of course not!

Would I spend time on an activity that could produce me $105 per hour passively? Probably … but, then I wouldn’t be working 20 hours a week to get it, so the calculator doesn’t work.

In other words: I ‘work’ 20 hours a week for (a) fun and (b) a potential future payback in the millions. So the calculator doesn’t work.

Secondly, if I work 40 hours (i.e. 2 weeks), I can afford $4k worth of goodies …. even I don’t buy $4k worth of consumer cr*p every 2 weeks, and on this calculation, I only have to ‘work’ for 30 weeks to buy a Ferrari … cool! Yet, right now, I don’t think I can really afford one

Thirdly, and this is for everybody, the calculator only takes into account work-related expenses; it should really also take into account your living expenses, as well … in other words how many hours of work WILL you have to put into saving up enough to pay for that thing that you are considering buying?

If none of this makes sense, here’s some more white noise for you

Safe as houses?

Well, I did ask for it, and the first cab off the rank for the ‘diss Adrian party’ is Dan who thinks that one of my favorite posts – Contrary to Popular Opinion, Paying Off Your Mortgage Is The Dumbest Move You Can Make – is ‘ridiculous’. Seriously, thanks for opening up an important new discussion with this comment, Dan:

This is ridiculous. The author apparently believes he is untouchable and will never lose his job, get sick, or die.

You can do all the complex math you want, but the simple fact of the matter is that Risk is the biggest variable, and I don’t see it show up in your equation once.

Don’t be stupid America, and dont prescribe to a system that encourages you to continue owing people money long after you need to.

Pay off your house, free up some income, then pay off your credit cards, pay off your car, and be a happier, less stressed individual.

Hmmm …. paying off your mortgage as a ‘risk management tool’?

Before we even consider why anybody in their right mind would pay off a (say) 8% mortgage before paying off a (say) 19% credit card or car loan, let’s review the substance of my “don’t pay down your mortgage early” argument:

Look at everything that you own as a business: if it’s your own home, separate the ownership of the property in your mind from it’s use …

… for example, even if it’s your own home, treat yourself as your own tenant and figure the rent that you would otherwise had to pay when doing the sums.

Then evaluate the investment against any other investment or ‘business’ …

… but, if you’re still trying to get rich(er) quick(er)?

If you own a home, don’t pay it off … use the upside to help you buy more and more of these wonderful, one-of-a-kind, almost-too-good-to-be-true ’businesses’ …

If you have other sources of income (businesses, investments) don’t spend it or reinvest all of it … use some of the spare cash to help you buy more and more of these wonderful, one-of-a-kind, almost-too-good-to-be-true ’businesses’ …

That’s my advice to you, but only take it if you want to be rich!

But, Dan says that the ‘math’ matters not, you should consider what happens if you “lose [your] job, get sick, or die”. Well, what happens?

If you have paid out your mortgage, your money is locked in the safest bank vault imaginable … all you have to do it sell the home to access the cash. Just pray that the market is an up market and not a down market, when these events outside of your control force you to sell. Or, would YOU prefer to choose the timing? Hmmm …

Of course, you could just borrow some money against the house; but then, aren’t you now putting yourself in EXACTLY the financial situation that Dan wants you to avoid: i.e. “owing people money long after you need to”?

And, even if you still do want to use your Zero Mortgage Bank, what are the chances of the bank actually lending you (or your survivors) any money when you are jobless, sick, or dead?

Oh, and let’s say that you do happen to be unfortunate enough to “lose [your] job, get sick, or die” while you are still in the 10-15 year period when you are well ahead of the 30-year payment curve, but haven’t paid off the mortgage in full, yet? How easy will it be to refinance, or even convince your bank to hold payments for you? Even if you THINK they will, you had better be certain

What do you reckon? Dan’s on the right track? C’mon, be honest … would you feel safer paying off your mortgage early, or letting it ride?

Not a fan?

It’s fairly safe to say that Mike is NOT a fan:

I happened to stumble on this site doing some research on debt free. No wonder I’ve never heard of this site or even the radio show apparently associated with it. Anyone who thinks that living debt free is the wrong thing to do needs to have their head examined. That’s like saying Ohh we shouldnt live debt free we’re on the planet to make banks rich on our hard earned money. Nice mentality you got there. It just doesn’t hold any water. The question you should be asking yourself is would you rather live be constantly paying out your hard earned cash to banks making money off you not paying for your own assets or should you own your assets outright and control a greater portion of your hard earned cash? The choice IS obvious.

But, what of Mike’s aversion to paying the banks interest?

I look at banks a little differently to those like Mike who are averse to paying their interest, fees and charges …

… sure, I don’t like how they can mount up. And, I don’t like how the banks can make ’super profits’ in good times and seem to get away with it. And, I don’t like those snooty tellers who look over their glasses at you, when you want to make a withdrawal, like they’re doing you some sort of favor by letting you have your money

But, I can put that aside, when I realize that here is a partner who is willing to put up some – or even most (if it’s a real-estate transaction) of the capital to fund my latest entrepreneurial or investment endeavor, yet they want virtually no say in how I manage that business / investment once they have put their money in … and, I even get virtually 100% control over all of the daily management decisions and even, pretty much make the ’sell’ decision on my own.

And, all they want is a few % per year return on the money that they put in … no share of the speculative upside!

Where else can you find a partner like that?

So, Mike, I ask you: what’s your objective?

- To get rich(er) quick(er)?

- Or is it to avoid putting any of your money into somebody else’s pocket?

I don’t mind which path you choose, as long as it gets you to your financial objective i.e. Your Number by Your Date …

… if not, you will do well in life – not just your financial life – to stop obsessing about what the other guy might be getting out of the deal, and start obsessing about what you might be getting out of that same deal

I wonder what our readers think? Tell us about your good/bad experiences with bank funding …

I think we’re screwed …

If you needed any evidence that the ‘global financial crisis’ – on a global macro level – and problems with the US real-estate market – on a global micro level – are still affecting people in the their day to day lives, you need read no further than Rischa in Seattle’s comment [AJC: I've added punctuation for your reading pleasure]:

From what I’ve read I think we’re screwed, but I’m not even sure what we can do. Here is the scenario: my husband and I bought this house about 10 years ago in the boom here; with both of us working we could afford the mortgage and our lifestyle easily. I’ve [since] been laid off and we’ve been living on my savings, which is now gone and I’m on unemployment, which is fast running out.

We’re about $100K upside down, we got a trad. loan 30 yr fixed, but without 2 incomes we’re sinking fast. We don’t necessarily want to stay in this house, in fact we want to move to a part of the country where the cost of living is less.

Any clues? What should we do? How do we get out of this when getting out would cost more than we have, even if we spent our retirement to get out? We would have less than nothing left!

Of course, it’s difficult to give Rischa personal advice – and, I wouldn’t do it – but, I could suggest that she go back to that post and reread the bit where I said:

Ask yourself the following TWO questions:

i) Can I afford the payments? If so,

ii) If I were to invest in a house right now, given my current net worth, is this the house that I would invest in ?

If the answer to both questions is YES, then stay. If the answer to either question is NO, then sell/move … be it into a rental or to purchase another (provided that the changeover costs/hassles are worth it).

In Rischa’s case, the answer to the first question appears to be NO … and, she would prefer to be moving to a cheaper part of the country (and, cheaper house?), anyway …

So, it’s obvious that she can’t afford her existing house, but what would you do? Hang on to a losing proposition? Or, cut your losses?

Debt as a hedge against inflation?

Flexo (at Consumerism Commentary) wrote an interesting piece on debt reduction; in promoting his Debt Avalanche over the Dave Ramsey’s Debt Snowball, Flexo said:

One major problem I have with the snowball approach is that your largest balance may be significantly more expensive than your smallest balance. Today it is not difficult to find a default interest rate on a credit card north of 30%. There is no way in good conscience I could recommend holding off on eliminating a debt this expensive in favor of paying off a small balance with a 7.9% interest rate. The same goes for payday loans, whose fees can border on usurious if interpreted as interest rates.

I agree totally, but then reminded Flexo that there is a third method – one that I humbly invented – called The Cash Cascade which encourages you to consider what you will do AFTER you have paid off your debt … and, perhaps do some of that instead!

Flexo sent me an e-mail and asked me to to “describe at least a summary of [my] method in the comment”, which I did as follows:

We are all familiar with the concept of ‘good debt’ and ‘bad debt’, but most don’t realize that this is only a way of avoiding getting INTO (bad) debt … once we have acquired the debt, then we need to start thinking of debt simply as ‘cheap debt’ or ‘expensive debt’. The Debt Avalanche is clearly ideally suited to attacking the ‘expensive debt’ first.

However, there is another part to this: our ultimate financial goal is usually not to become ‘debt free’ (although, that may be a tactic that some would choose … not me!), rather to achieve financial independence, or wealth, or [insert your life-supporting goal, here], and often a part of the strategy will be to acquire SOME debt in order to get there while you are still young enough to enjoy life e.g. you might decide to take out a mortgage on an investment property, or a margin loan on stocks, or a small business start-up loan, etc.

Clearly, it would make NO sense to delay investing just so that you can pay off relatively cheap debt (e.g. student loan, mortgage, etc.) i.e. just to take out more expensive debt later (e.g. the small business loan) … instead, leave the cheaper loan in place and “pay off’ the more expensive loan by not taking it out in the first place!

Once you think about debt and investment as ‘cheap’ v ‘expensive’, it becomes easier to apply the principles of the Debt Avalanche to both debts AND investments

Not sure if my thought process was very clear, but it certainly stimulated an unbelievably clear comment, from another reader – Kitty – who said:

I would like to second 7million7years in that keeping fixed low interest debt around instead of repaying could be a valid investment strategy. One thing to keep in mind always is the possibility of future inflation and/or higher interest rates – a reasonable expectation nowadays.

If your debt is at 4.5% now, it may seem like higher than you can get on a normal CD. But what about 5 years from now? During the early 80s where you could get double digit returns on normal bank CDs people who had 30-year fixed mortgages at 9% were feeling very lucky… Long term fixed low interest debt is as much a hedge against inflation as buying commodities or TIPs. In fact I have a couple of multi-millionaire friends who took a mortgage on their vacation home when they could’ve paid for it in cash.

I don’t know if I would finance my vacation home – unless, I had something MUCH better to do with the money – but: “long term fixed low interest debt is as much a hedge against inflation as buying commodities or TIPs” …

… using debt as a Making Money 301 tool? Brilliant, Kitty!!

I only wish that I had thought of it, first

How the (not quite as) poor (as other) people make budgets …

OK, there’s no doubt about it: the financially dead do NOT keep budgets and do NOT control their spending, so you are definitely better off by following the Three Step Plan to budgeting simply explained in this video:

1. Have a Goal

2. Make a Plan (i.e. your budget)

3. Keep Track of every dime that you spend.

Simple!

Except, that it won’t make you rich …

… because you can’t save your way to wealth.

So, here is the Patented 7million7year 3 Step Plan To Budgeting Your Way To Wealth:

1. Work out what wealth means to you: i.e. find Your Number and Your Date

2. Choose your required Growth Engine

[hint: it will have a lot more to do with increasing income than it does to do with controlling expenses]

3. Do the No Budget Budget … once … that’s it!

Which method do you prefer?

New Reader Question about debt …

I am always pleased to receive questions and comments from readers – and, new readers in particular. For example, recently I have been in e-mail conversation with David, a new reader, who asks:

After spending half of my day reading various posts and links I have a better idea of where I need to be.  I do have a question – I have student loans that I unfortunately locked at a 9.9% interest rate back in the mid 90’s.  I still carry about 30k and I make about a $330 payment a month.  What is the best strategy for those?  I can’t refi them.  I can pay them off “quickly” but the money that I would be lopping off that is taken away from my nest egg and emergency funds.  If I pay them off on their schedule, it will cost me around $79k in the long run. What would you suggest?

While I’m not qualified to – therefore, don’t – give give direct personal advice of the financial or any other kind, I can use this question as ‘inspiration’ for this, more general, post …

This is a common problem, facing most folk these day … not specifically the student loan, but debt in general. And my response is generally the same: it depends

And, the thing that it depends on is actually two things, not one:

1. Do you have ’spare income’ or cash floating around that you COULD be applying to this loan?

If not, then you need to keep paying the loan according the schedule and doing your level best to find some additional money through increasing income (MM201) and/or better personal money management (MM101). But, if you do have some spare cash floating around then you need to ask yourself the following question …

2. Where else could you put the money that would return more than 9.9%?

This is really a simple question, so you don’t need to beat yourself up about the answer …

If you want to start a business that can return, say 50+% if it’s successful, then you may be better off keeping the loan in place – making just the required payments, for now – and putting your spare cash towards startup/working capital for your business.

But, if you are thinking (instead) of paying down your home loan, with its current interest rate of 6% (probably at least partly tax deductible) then I would suggest that you instead pay off the student loan.

And, if you had a car that you absolutely had to purchase and were thinking about financing it at, say, 11%, then I would instead suggest that you pay cash for the car and keep the student loan in place.

The decisions, to me, only become more ‘difficult’ if you have no clear idea of a better use for your money other than “Maybe investing in something one day” … in which case, I would take the ’sure thing’ i.e. pay off the ’student loan’ debt,

OR

The available options are so close in interest rate earned or spent e.g. should I pay down the 9.9% student loan or buy some units in an Index Fund that should return a bit over 9.9% over the next 10 or 20 years …  in which case, I would again take the ’sure thing’ i.e. pay off the ’student loan’ debt.

Other than that, simply apply the principles in this recent post and you won’t go too far wrong …

BTW: don’t forget to compare interest earned and/or spent AFTER TAX. To me, a rough estimate (rather than paying for a consultation with your accountant UNLESS the decision is major or strategic) is probably usually good enough … but, when in doubt, work it out WITH YOUR ACCOUNTANT.

Oh and one more ‘trick’; if you have another asset that you can acquire new debt on to pay off the more expensive old debt, can/should you do it?

For example, if David has a house with ’spare equity’ can/should David refi the house and pay off the student loan entirely. At an effective current (tax deductible) interest rate on the refi of, say, 6% (compared to a ‘locked in’ 9.9%) the answer is most likely a resounding YES, however, now we have to think about locking in and term:

The student loan is likely to be locked in to a repayment schedule that will see it paid off in just a few years, but a mortgage will probably be offered at 15 to 30 years to keep the repayment schedule low … if the purpose if simply to repay the student loan, then you should divert the money that you would be using on a monthly basis to repay the student loan to repaying the mortgage (i.e. pay off the mortgage with the original mortgage payments PLUS the former student loan payments).

Because the combined interest rate is now lower but your repayments are the same as before, you should actually be paying debt off at a slightly faster rate …

Of course, if you do have a hot new business or investment idea, then you may instead refi the house, pay off the student loan and apply any spare cash (over and above what the bank says that you HAVE to pay on the mortgage) to building that little ol’ warchest … but, this is an advanced – and more risky – Making Money 201 concept … only needed if your Number says so