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This post comes from Gerri Detweiler at partner site Credit.com.
If you’re like most college students with student loan debt, you can’t wait until the day that you pay down those balances to zero. In fact, you may think it wise to do everything you can to pay off your student debt as fast as possible, even if that means moving back into your parents’ basement and living on PB&Js.
Not so fast, says Chris Camillo, the author of “Laughing at Wall Street,” the book where he recounts how he turned a $20,000 investment into $2 million by spotting market trends. He believes there are times when paying off your debt faster may not be the smartest move.
The first thing he says students need to educate themselves on is the difference between good debt and bad debt. “Kids coming out of school need to be able to define what is good debt and what is bad debt for them,” he says.
Good debt helps you build wealth, he says, whether that’s through a physical asset such as a house or investment portfolio, or a “soft” asset such as an education that helps you increase your earning power. “What makes it good debt,” he says, “is that it will bring a return that exceeds the cost of the asset itself.”
Once that’s established, he suggests there are three times when you should hold off on throwing all your available funds at your student loans, which are often good debt.
1. You haven’t built an emergency fund
At the top of Camillo’s to-do list for college grads is to build an emergency fund. And not just a wimpy little account that would only cover a bill or two in a pinch. He wants students to aim for a “robust” emergency fund. That way, he says, you know you’ll be able to make the minimum payments on your debts and maintain a good credit rating no matter what life throws your way.
“That’s the No. 1 highest priority,” he insists. “So until you get a comfortable emergency fund, you shouldn’t look at doing anything else.”
One bonus of building up a healthy savings account: You may be able to avoid taking on additional debt at higher interest rates.
2. You aren’t maxing out your 401(k) employer match
If your employer offers a 401(k) with an employer match, that’s free money and it’s “hard to make the case that it would have a higher return (elsewhere). In addition to your emergency fund, it’s the one big area every graduate should look at,” Camillo says.
One March 2013 survey by WorldatWork in partnership with the American Benefits Institute found that about a third of employers surveyed said that at least half of their employees aren’t taking full advantage of the employer match. At a minimum, Camillo suggests young workers try to save enough to take full advantage of this opportunity.
3. You can generate a higher return elsewhere
The other concept these debtors should educate themselves about is return on investment or ROI. They can then ask themselves whether the money they plan to use to accelerate debt repayment could be used elsewhere to earn a higher return.
Student loan debt often carries low interest rates (though some private student loan debts have high interest rates and some federal loan rates will be rising soon). And that means students with lower rates may be able to invest their money for a higher return elsewhere.
That’s what happened to Camillo. He says a close friend started a software company and came to him for investment capital. “I had debt, but I also had an investment portfolio and was able to invest in his company,” he explains. When the company sold several years later, his return was 40 to 50 times what he had invested.
A golden opportunity like that won’t come everyone’s way, of course, but Camillo still suggests graduates develop an investment habit early in their careers and not “wait seven or eight years to get started.”
The good news is that as long as students make the required monthly payments on their loans, these balances will likely be a plus for their credit scores. You can get your credit score for free at Credit.com and find out exactly how your debt is impacting your scores. Paying student loans off faster or becoming debt-free alone won’t boost your credit scores.
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