Good debt - a fallacy?

Discuss all general (i.e. non-personal) investing questions and issues, investing news, and theory.
Post Reply
Topic Author
nyblitz
Posts: 354
Joined: Mon Apr 09, 2007 7:33 am

Good debt - a fallacy?

Post by nyblitz »

I’ve read the many posts, polls, and the wiki about paying off low interest debt versus investing, and to this point, have been perfectly happy paying the minimum payment on our large student loans (over 250k) of 1.75% (it’s really 1.75, as my income is too high for it to be deductible).
However, as our net worth has increased (thanks to you guys and gals), I wonder if my family is no longer really using the loan to invest, but to fund a semi-consumer lifestyle. For me, I’m perfectly happy not spending money on anything other than basic necessities, and seeing the value of the spreadsheet go up. For my wife, the spreadsheet doesn’t do much.
As a result, housing, minivans, furniture, and vacations are becoming family goals. I think if presented correctly to my spouse, I’m starting to believe that knocking out the low interest student loan (something that I think she’d really be on board with) may outgain the opportunity cost of investment because it has the potential to really boost our savings rate.
Anyone have ideas/criticisms of my thought process or gone through something similar?
User avatar
nisiprius
Advisory Board
Posts: 52211
Joined: Thu Jul 26, 2007 9:33 am
Location: The terrestrial, globular, planetary hunk of matter, flattened at the poles, is my abode.--O. Henry

Re: Good debt - a fallacy?

Post by nisiprius »

The problem to be solved is not "how do I analyze my family's financial situation?"

The problem to be solved is "how do my spouse and I somehow find a mode of communication that enables us to do joint financial decision-making."

A good way that can happen is if both individuals each can look at the situation independently and come up with independent, individual answers that are close enough that either of them is tolerable to the other.
able.
Annual income twenty pounds, annual expenditure nineteen nineteen and six, result happiness; Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery.
af895
Posts: 116
Joined: Sat Feb 18, 2012 9:15 pm

Re: Good debt - a fallacy?

Post by af895 »

$4,375 per year is 1.75% of $250,000. (10 years: $43,750 etc)
Is that interest rate fixed?

I see your dilemma. If that rate is fixed and you can net a higher rate on investments (5%-8%?), the numbers don't support paying it off.

I think you've touched on the key point - the psychology of that debt. Using the low interest rate to justify not paying it off makes it equally easy to justify spending on "stuff."

For what it's worth, I paid off my (much smaller!) student loan early this year. I could have invested the money instead but debt keeps me up at night so I focused on paying it down. Whenever I had extra money, it immediately went to the student loan. I can't tell you how satisfying it was to see that debt erased, thousand by thousand.
coalcracker
Posts: 1076
Joined: Sat Feb 04, 2012 11:25 am

Re: Good debt - a fallacy?

Post by coalcracker »

I've struggled with similar issues as I also have high student debt between my wife and I at a low interest rate (<2%). We actually had a windfall earlier this year with which we could have paid off our mortgage and student loans, but decided to invest the money instead as our mortgage rate is also very low at 3% and had recently been refinanced to a 15 year loan. In the end, I felt that the likelihood of earning >2-3% on our investments was high enough to justify not paying the debts off.

I had brought up this dilemma here and on other message boards, and received different opinions. In the end I think it comes down to how well you sleep at night with debt hanging over your head. I seem to sleep just fine, maybe because I am used to it :) If it keeps you up at night, just pay it off.

You should think of the debt payoff and consumer spending as separate issues. I am not sure I understand how paying off a big debt will help decrease consumer spending and increase your savings rate. We do our share of consumer spending, mostly on food/eating out and travel. Could we save more for retirement and probably retire earlier if we ate ramen all the time and vacationed in Erie instead of Nepal? Sure, but for us the trade off is well worth it.
555
Posts: 4955
Joined: Thu Dec 24, 2009 6:21 am

Re: Good debt - a fallacy?

Post by 555 »

It seems that the choice is between loan payoff and excessive spending. Money not used to pay off loan is becoming available for extra spending and not extra investment.

So regardless of the low interest, just pay down the loan.
Leesbro63
Posts: 10638
Joined: Mon Nov 08, 2010 3:36 pm

Re: Good debt - a fallacy?

Post by Leesbro63 »

I don't have a student loan, but do have a house that's paid for. And has been so for years. I like the psychological comfort of not having debt. That being said, if there was something that was close to guaranteed that paid a few points higher than a home mortgage, I'd do it. I've been looking for that for years and years....
allsop
Posts: 1046
Joined: Sun Jun 15, 2008 7:08 am

Re: Good debt - a fallacy?

Post by allsop »

555 wrote:It seems that the choice is between loan payoff and excessive spending. Money not used to pay off loan is becoming available for extra spending and not extra investment.

So regardless of the low interest, just pay down the loan.
+1
User avatar
momar
Posts: 1359
Joined: Sun Nov 13, 2011 11:51 am

Re: Good debt - a fallacy?

Post by momar »

555 wrote:It seems that the choice is between loan payoff and excessive spending. Money not used to pay off loan is becoming available for extra spending and not extra investment.

So regardless of the low interest, just pay down the loan.
WIthout knowing the details of each, it's quite possible that the "housing, minivans, furniture, and vacations" are not excessive but are reasonable expenditures for a middle class lifestyle. Especially considering the size of the debt; if it was a situation where they could focus and knock the debt out in a year or two, that's one thing. If, however, it would take them 10 years of forgoing anything to pay it down as fast as possible, I would consider carrying it while accelerating pay offs as much as possible without living a threadbare life.

Of course, this doesn't apply if the house is 4000 sq ft, the minivan costs 45k, the furniture is custom, and the vacations are the Monaco.
"Index funds have a place in your portfolio, but you'll never beat the index with them." - Words of wisdom from a Fidelity rep
User avatar
NightOwl
Posts: 664
Joined: Fri Feb 06, 2009 1:08 am
Location: New York, NY

Re: Good debt - a fallacy?

Post by NightOwl »

I've been doing something that I learned to do here at Bogleheads: splitting the difference to minimize regret. After setting aside enough money to max 401k and backdoor Roth IRA (I wouldn't skip tax-advantaged investing to pay down low-interest loans, but it doesn't sound like you'd have to do so either), I split any remaining investable money evenly between taxable investing and student loan payoff. If the market zooms, I'll have been putting money in the market. If the market stays flat or tanks, I'll have been paying down debt.

That said, my interest rate is a non-deductible 3.1% -- at 1.75%, I don't think I'd use half of available funds to pay off loans. Maybe 1/4 or 1/3, just to be making some progress?

NightOwl
"Volatility provokes the constant dread that some investors know more than we do, making us fearful of ignoring such powerful price movements." | Peter Bernstein, "The 60/40 Solution."
sscritic
Posts: 21853
Joined: Thu Sep 06, 2007 8:36 am

Re: Good debt - a fallacy?

Post by sscritic »

I’m perfectly happy not spending money on anything other than basic necessities, and seeing the value of the spreadsheet go up. For my wife, the spreadsheet doesn’t do much. As a result, housing, minivans, furniture, and vacations are becoming family goals
Read that again. Your goal is not "housing, minivans, furniture, and vacations"; your goal is investing. Your wife's goals are "housing, minivans, furniture, and vacations." The problem is that you don't have any family goals; you just have individual goals.

You need to sit down and talk about goals. As nisiprius said: "the problem to be solved is 'how do my spouse and I somehow find a mode of communication that enables us to do joint financial decision-making'." He suggests starting with individual plans for family goals, but how you get there isn't as important as getting to the point where you can talk to each other and agree on some compromise that satisfies enough of each of your goals that they can indeed be called family goals.
xerty24
Posts: 4827
Joined: Tue May 15, 2007 3:43 pm

Re: Good debt - a fallacy?

Post by xerty24 »

Remember student loans also act as life insurance - they don't need to be repaid if you die. Preferred rates on 20 year term are around 1% per year (after tax money), so to the extent you want $250k+ of life insurance for your family, keeping the loan is almost free. Investing the potential loan payments even in a FDIC account at 1% will come out ahead after the insurance benefit.

It's financially wrong to pay down the loan. Of course if you're going to blow the money instead, well, paying down your debt is probably less wasteful than buying new cars every year, etc.
No excuses, no regrets.
User avatar
burnsh
Posts: 145
Joined: Sat Jan 10, 2009 2:09 pm
Location: San Antonio, TX

Re: Good debt - a fallacy?

Post by burnsh »

Another thing to consider, is that Student Loans are not dischargeable in bankruptcy. Everything may be perfect now, but you never know what the future may bring. Injury, medical bills, Lawsuits, etc...and your ability to pay the loan changes.
Burnsh | ______________________________________ | VFIAX 17%, VVIAX 17%, VEXAX 16%, VTIAX 21%, VGSIX 9%, VIPSX 10%, VBMFX 10%
User avatar
NightOwl
Posts: 664
Joined: Fri Feb 06, 2009 1:08 am
Location: New York, NY

Re: Good debt - a fallacy?

Post by NightOwl »

xerty24 wrote:Remember student loans also act as life insurance - they don't need to be repaid if you die.
This is certainly true. But if instead of dying, you get very sick and are bankrupted by medical expenses, the $250k is a huge anchor that cannot, under most circumstances, be discharged in bankruptcy.

Edit: the above comment beat me to it.

NightOwl
"Volatility provokes the constant dread that some investors know more than we do, making us fearful of ignoring such powerful price movements." | Peter Bernstein, "The 60/40 Solution."
German Expat
Moderator
Posts: 961
Joined: Fri Oct 16, 2009 10:49 pm

Re: Good debt - a fallacy?

Post by German Expat »

I am with a previous poster that splits the difference. After we fund all tax deductible accounts we put approx. 50% of the remaining money into taxable accounts and the other 50% is used to pay off debt (home mortgage at currently 2.875%). I want to have it fully paid off way before I retire but at the same time still like to see my balance grow. Also our hose is too big when our son moves to college in 12 years (ok long time but about the same time I plan to retire) and we will downsize. So technically we will have then some money back from the house.
wander
Posts: 4424
Joined: Sat Oct 04, 2008 9:10 am

Re: Good debt - a fallacy?

Post by wander »

Unless you have doctor degrees, $250k loan is pretty bad.
xerty24
Posts: 4827
Joined: Tue May 15, 2007 3:43 pm

Re: Good debt - a fallacy?

Post by xerty24 »

NightOwl wrote:
xerty24 wrote:Remember student loans also act as life insurance - they don't need to be repaid if you die.
This is certainly true. But if instead of dying, you get very sick and are bankrupted by medical expenses, the $250k is a huge anchor that cannot, under most circumstances, be discharged in bankruptcy.
Sure, but that's an argument for keeping the cash on hand or investing it, rather than blowing it on new cars. If you're going to get disabled or sick, you'd rather have the cash and the student loans (which can be put into forbearance), rather than nothing and no debt. No one is going to loan you $250k for some expensive medical procedure, and while the student loans may not go away if you spent the money on treatments, they can't make you pay them if you don't have the money.
No excuses, no regrets.
Topic Author
nyblitz
Posts: 354
Joined: Mon Apr 09, 2007 7:33 am

Re: Good debt - a fallacy?

Post by nyblitz »

Wow! Thank you all so much. I’ve gone back and reread all responses at least 3 times, and they are all helpful. Special thanks to Nisi and SScritic for opening my eyes – I think perhaps I did try to answer an easier question, “should I pay down the low interest student loans” instead of the difficult “how do I align my wife’s goals TO mine?” and I didn’t even realize it consciously. We will have some talking to do.
To answer some direct questions:
CJOttawa: yes, it’s a fixed rate, non-callable student loan for both of us
Neal: we sleep fine with the debt
Anyways, thanks to all.
Easy Rhino
Posts: 3278
Joined: Sun Aug 05, 2007 11:13 am
Location: San Diego

Re: Good debt - a fallacy?

Post by Easy Rhino »

nyblitz wrote:For my wife, the spreadsheet doesn’t do much.
I hear ya brother.
User avatar
NightOwl
Posts: 664
Joined: Fri Feb 06, 2009 1:08 am
Location: New York, NY

Re: Good debt - a fallacy?

Post by NightOwl »

xerty24 wrote:
NightOwl wrote:
xerty24 wrote:Remember student loans also act as life insurance - they don't need to be repaid if you die.
This is certainly true. But if instead of dying, you get very sick and are bankrupted by medical expenses, the $250k is a huge anchor that cannot, under most circumstances, be discharged in bankruptcy.
Sure, but that's an argument for keeping the cash on hand or investing it, rather than blowing it on new cars. If you're going to get disabled or sick, you'd rather have the cash and the student loans (which can be put into forbearance), rather than nothing and no debt. No one is going to loan you $250k for some expensive medical procedure, and while the student loans may not go away if you spent the money on treatments, they can't make you pay them if you don't have the money.
Fair enough -- and I would agree that new cars are at the bottom of the priority list. I think OP does raise an interesting behavioral finance point when he says:
nyblitz wrote:I wonder if my family is no longer really using the loan to invest, but to fund a semi-consumer lifestyle.
OP, I agree that whether or not you pay off the loans aggressively, you certainly can't adopt a lifestyle that pretends that they're not there. If you're investing instead of paying down loans, fine -- that's the move that has the highest expected value. If you're consuming rather than paying down loans, that's a bigger problem, especially because your retirement savings will become less and less able to support your lifestyle once you retire.

I get that OP and his wife are going to have some consumption needs, but I think that negotiating a way for some of the money that would otherwise go to consumption be put toward the student loans would be a good thing. I know that I'm engaging in "mental accounting," but it sounds like some of that may be necessary in this conversation between OP and his wife.

By the way, regarding the title of the thread, I don't think that "good debt" is a fallacy (taking on student loan debt turned out to be a very good financial move for me), but I think that most debt is not good debt.

NightOwl
"Volatility provokes the constant dread that some investors know more than we do, making us fearful of ignoring such powerful price movements." | Peter Bernstein, "The 60/40 Solution."
Default User BR
Posts: 7502
Joined: Mon Dec 17, 2007 6:32 pm

Re: Good debt - a fallacy?

Post by Default User BR »

Leesbro63 wrote:I don't have a student loan, but do have a house that's paid for. And has been so for years. I like the psychological comfort of not having debt. That being said, if there was something that was close to guaranteed that paid a few points higher than a home mortgage, I'd do it. I've been looking for that for years and years....
I'm looking into the Penfed 5-year loan at 1.99% fixed. My stable-value fund currently pays 2.71% tax-deferred.


Brian
User avatar
Spades
Posts: 286
Joined: Fri Apr 22, 2011 3:04 pm

Re: Good debt - a fallacy?

Post by Spades »

Nyblitz,

I think what it comes down to is what is the interest rate on debt that determines debt that you will tolerate or focus on reducing.

Personally, mine is the 10 year treasury yield, 1.75% right now. Everyone has a different number it's important to find the number for your family. I'm finishing my last loan at 1.0% this July.

:sharebeer
Muchtolearn
Posts: 1563
Joined: Sun Dec 25, 2011 9:41 am

Re: Good debt - a fallacy?

Post by Muchtolearn »

You've married a spender and you're not one. Many people share this dilemma. When I was married I didn't care in that I wanted to (and did) pay off all debts. I didn't care about interest rates on the loans. I was determined to not pay anybody a penny of interest and I get out of it and never have in over 30 years. And never will. Its cash or nothing.
User avatar
market timer
Posts: 6535
Joined: Tue Aug 21, 2007 1:42 am

Re: Good debt - a fallacy?

Post by market timer »

Do you have a mortgage you could pay down instead of these student loans?

Financially, it's a bad idea to pay down this debt instead of invest. The debt is so low you can earn a profit just from arbitrage. I agree with the others that you and your spouse should be on the same page. It might help to invest with a purpose in mind. Instead of seeing a number growing in a spreadsheet, you could have accounts with different goals at different levels of funding: college fund, house fund, 2012 vacation fund, 2013 vacation fund, next car fund, etc.
Post Reply