How good of a driver are you? If you had to rate yourself below average, average, or above average on your people skills, what rating would you give? How honest would you say you are compared to most people?
These are questions that Tali Sharot, associate professor of cognitive neuroscience at University College London, posed to her audience in a TED talk about a phenomenon called “optimism bias.” In Sharot’s words, optimism bias is, “our tendency to overestimate our likelihood of experiencing good events in our lives and underestimate our likelihood of experiencing bad events.”
She says a firefighter in California once told her that fatality investigations done by the fire department “often include ‘We didn’t think the fire was going to do that,’ even when all of the available information was there to make safe decisions.”
In other words, “we’re more optimistic than realistic, but we are oblivious to the fact,” Sharot says.
So what does this have to do with student loan payoff? A lot, it turns out. Read on to learn more about optimism bias and what you need to do to prevent it from derailing your strategic financial plans.
How optimism bias affects your finances
First of all, it’s important to note that you can have an optimism bias even if you don’t feel like you’re a particularly optimistic person. You might simply have this bias if you tend to view the future as something that will have a better outcome than your past or present.
As a whole, there’s nothing inherently wrong with optimism or optimism bias. Without this bias, Sharot, who also wrote a book on this topic, says “we would all be slightly depressed.” But feeling as though we can always beat the average, or even that we’re invincible, can have serious consequences.
When I asked Sharot what she thought the most dangerous thing about this bias might be in relation to finances, she mentioned retirement savings, or the lack thereof. If we feel confident that we’ll be able to save more later, it might be easier to put it off today.
Sharot says this bias can lead us to think that projects will cost less and take less time — something that can blow the budget of wedding planners and house renovators. And, in general, we might spend more than we can afford because we imagine a big bonus or promotion that will help us pay it down later.
All in all, Sharot cautions, this bias can lead to poor planning. And in the case of student loan debt, it could lead to borrowing more than we should, due to the belief that we’ll easily earn enough later to pay it all back.
As for people already in student loan repayment, it’s possible that this bias can prevent them from strategically approaching their payoff. For example, they might stick to payment plans that barely keep their loans above water — the idea being that even if they can afford to pay more now, there’s no need because they can always pay more later.
But even borrowers who don’t feel optimistic about their debt might exhibit similar procrastination. Author and psychotherapist Will Meyerhofer has many clients facing large amounts of student loan debt. And he noticed that they sometimes feel it’s “pointless to try to pay them down” and “better to live for today.”
In other words, some might be YOLO-ing their student loan debt payoff, which can have dangerous effects on their finances. Here’s what can be done about it, whether it’s born of optimism or pessimism.
How to prevent bias from derailing your student loan payoff
So what’s the secret to preventing optimism bias (or any bias) from getting in the way of our goals? According to Sharot, it all comes down to awareness.
“Being aware of it means we can change our decisions. It doesn’t mean we have to change our bias.”
In fact, she says, it might be impossible to change our bias. So rather than worrying about transforming a core aspect of who we are, we can simply understand it and then use it to our advantage when we can, and work around it when we need to.
And for those in student loan debt who have optimism bias, Sharot says “it’s best to take a safer route,” even if your bias leads you to believe you don’t need to.
That might mean paying extra on your student loans when you can. Or it might simply mean staying on top of your payments even if it doesn’t seem important or seems like something you can handle later.
For his part, Meyerhofer takes a pretty extreme view: He thinks of student loans as cancer. “If I ever stopped the ‘treatment’ (paying off as much money as I possibly could), the tumor would start to grow again,” Meyerhofer says.
He calls this approach dramatic, but one that helps his clients see the danger of ignoring student loan debt.
Whichever way you look at it, viewing the future as the best time to handle something as important as student loan debt can be dangerous. Defaulting on your student loans — if it comes to that — can damage your credit for up to seven years. Plus, the fees and interest that add up while in default can drastically increase the cost of your debt.
And if you’re coasting on payments but could do more, you may end up paying more than you have to over the long run. On the other hand, making lump sum extra payments on your student loans once a year with your tax refund or holiday bonus can make a huge difference.
Awareness and planning for the win
As unchangeable as things like our biases can sometimes seem, the fact that awareness can make such a big difference is great news for those who have an optimism bias. And those of us might be a lot — Sharot says in her TED Talk that 80 percent of people have this bias.
Tie your awareness into planning for a future that might look like today — even if you’re hopeful that it will be much better — so you can create a strong financial plan. If you do hit a financial bump in the road, this planning could help you be better prepared (such as by having an emergency fund on hand).
And if things only get better, then you’ve lost nothing from the careful planning — only gained habits that will help you for a lifetime.
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1 Important Disclosures for SoFi.
2 Important Disclosures for Earnest.
To qualify, you must be a U.S. citizen or possess a 10-year (non-conditional) Permanent Resident Card, reside in a state Earnest lends in, and satisfy our minimum eligibility criteria. You may find more information on loan eligibility here: https://www.earnest.com/eligibility. Not all applicants will be approved for a loan, and not all applicants will qualify for the lowest rate. Approval and interest rate depend on the review of a complete application.
Earnest fixed rate loan rates range from 3.89% APR (with Auto Pay) to 7.89% APR (with Auto Pay). Variable rate loan rates range from 2.54% APR (with Auto Pay) to 7.27% APR (with Auto Pay). For variable rate loans, although the interest rate will vary after you are approved, the interest rate will never exceed 8.95% for loan terms 10 years or less. For loan terms of 10 years to 15 years, the interest rate will never exceed 9.95%. For loan terms over 15 years, the interest rate will never exceed 11.95% (the maximum rates for these loans). Earnest variable interest rate loans are based on a publicly available index, the one month London Interbank Offered Rate (LIBOR). Your rate will be calculated each month by adding a margin between 1.82% and 5.50% to the one month LIBOR. The rate will not increase more than once per month. Earnest rate ranges are current as of March 18, 2019, and are subject to change based on market conditions and borrower eligibility.
Auto Pay discount: If you make monthly principal and interest payments by an automatic, monthly deduction from a savings or checking account, your rate will be reduced by one quarter of one percent (0.25%) for so long as you continue to make automatic, electronic monthly payments. This benefit is suspended during periods of deferment and forbearance.
The information provided on this page is updated as of 0318/2019. Earnest reserves the right to change, pause, or terminate product offerings at any time without notice. Earnest loans are originated by Earnest Operations LLC. California Finance Lender License 6054788. NMLS # 1204917. Earnest Operations LLC is located at 302 2nd Street, Suite 401N, San Francisco, CA 94107. Terms and Conditions apply. Visit https://www.earnest.com/terms-of-service, email us at firstname.lastname@example.org, or call 888-601-2801 for more information on ourstudent loan refinance product.
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3 Important Disclosures for Laurel Road.
Laurel Road Disclosures
However, if the borrower chooses to make monthly payments automatically by electronic funds transfer (EFT) from a bank account, the fixed rate will decrease by 0.25%, and will increase back up to the regular fixed interest rate described in the preceding paragraph if the borrower stops making (or we stop accepting) monthly payments automatically by EFT from the designated borrower’s bank account.
However, if the borrower chooses to make monthly payments automatically by electronic funds transfer (EFT) from a bank account, the variable rate will decrease by 0.25%, and will increase back up to the regular variable interest rate described in the preceding paragraph if the borrower stops making (or we stop accepting) monthly payments automatically by EFT from the designated borrower’s bank account.
4 Important Disclosures for LendKey.
Refinancing via LendKey.com is only available for applicants with qualified private education loans from an eligible institution. Loans that were used for exam preparation classes, including, but not limited to, loans for LSAT, MCAT, GMAT, and GRE preparation, are not eligible for refinancing with a lender via LendKey.com. If you currently have any of these exam preparation loans, you should not include them in an application to refinance your student loans on this website. Applicants must be either U.S. citizens or Permanent Residents in an eligible state to qualify for a loan. Certain membership requirements (including the opening of a share account and any applicable association fees in connection with membership) may apply in the event that an applicant wishes to accept a loan offer from a credit union lender. Lenders participating on LendKey.com reserve the right to modify or discontinue the products, terms, and benefits offered on this website at any time without notice. LendKey Technologies, Inc. is not affiliated with, nor does it endorse, any educational institution.
5 Important Disclosures for CommonBond.
Offered terms are subject to change. Loans are offered by CommonBond Lending, LLC (NMLS # 1175900). If you are approved for a loan, the interest rate offered will depend on your credit profile, your application, the loan term selected and will be within the ranges of rates shown.
All Annual Percentage Rates (APRs) displayed assume borrowers enroll in auto pay and account for the 0.25% reduction in interest rate. All variable rates are based on a 1-month LIBOR assumption of 2.5% effective February 10, 2019.
6 Important Disclosures for Citizens Bank.
Citizens Bank Disclosures
|2.54% – 7.12%3||Undergrad & Graduate|
|2.54% – 7.27%1||Undergrad & Graduate|
|2.67% – 8.96%4||Undergrad & Graduate|
|3.23% – 6.65%2||Undergrad & Graduate|
|2.69% – 7.43%5||Undergrad & Graduate|
|2.98% – 9.72%6||Undergrad & Graduate|