Why Paying Off Student Loans Now Is Key to Lifelong Wealth

why paying off student loans now is key to lifelong wealth

When you send that monthly check to your student loan servicer, it’s natural to imagine the many ways you’d prefer to spend it. But you might not have considered the ways your student loans are costing you.

Here’s a look at how student debt might be keeping your net worth down — and what you can do to build wealth anyway.

Student loans tied to low net worth, fewer assets

Young college graduates with no student debt are wealthier than their educated peers with student loans by a lot, found a 2014 survey from the Pew Research Center.

College graduates with no debt had an average net worth of $64,700, which is more than seven times higher than those repaying student loans. This wealth gap exists even though these groups earn similar household incomes.

Student loan debt is also tied to fewer assets, found a recent study led by University of Illinois professor Min Zhan.

At age 30, adults with student debt had, on average, financial and non-financial assets worth $52,300 less than their peers with no student loans. Among homeowners, student loan borrowers’ houses were valued $103,000 lower on average than their peers with no debt.

Additionally, student loans are the most common form of debt that puts Americans’ net worths in the negative, according to an August 2016 Federal Reserve Bank of New York analysis.

Student loans account for 47 percent of all debt for households with negative wealth over $47,500, compared to less than 10 percent of debts in households with non-negative wealth.

Student debt is a “barrier to future wealth building”

It makes sense that student loans are tied to lower net worths, since part of figuring wealth is weighing cash and other assets against debts and liabilities. Graduates with student loans will have more debts that offset savings and earnings.

Interest also means that borrowers are paying more than debt-free graduates for the same degrees. If two graduates face the same costs for an education, but one is debt-free while the other relies on student loans — the latter will pay thousands more for his degree through interest.

Student debt limits borrowers’ financial choices in ways that have far-reaching effects.

“Our findings suggest that in addition to negatively impacting young people in the short term, education loans may also compromise their financial well-being over the longer term,” Zhan said of her study to the Illinois News Bureau. “Both large and small amounts of education debt act as a barrier to future wealth building.”

The opportunity costs of student debt

A big reason for this is that student loan borrowers are working against interest, rather than using it to build wealth. Earning compound interest on savings is a smart strategy to get rich, but paying it on debt can keep you poor.

That lost opportunity might be the most negative aspect of debt. With monthly student loan payments to make, borrowers are not free to save, invest, or take advantage of opportunities to build wealth.

“Student loan borrowers have monthly payment obligations and interest costs” that their debt-free peers don’t, explains Heather Jarvis, a student loan attorney specializing in training for financial professionals.

If you’re putting $400 a month toward student loans instead of a retirement account for 10 years, that’s an earning opportunity you’ll never regain.

How to catch up your net worth

For those with student loans, it’s not all bad news. If you earn a college degree you’re still likely to come out ahead, even with student debt.

“People with degrees have lower unemployment rates and higher incomes,” Jarvis says. “Those who earn college degrees with no debt are a leg up, but many of us have no opportunity to complete a degree without some borrowing … Earning a college degree usually pays off.”

There are some things you should do, however, if you want to make sure your student loans don’t hold back your net worth long-term.

1. Pay off student loans early

Repaying loans ahead of schedule is likely the simplest way to close the gap (though not always easy or possible). Early repayment has the dual benefits of “reducing the opportunity for interest to accrue over time, and completing monthly payments so that you can do other things with your money, like save,” Jarvis says.

2. Reconfigure your student loans

If your student loan balances are too high for early repayment to be realistic, you might want to look into programs or products that can make your debt more manageable.

Student loan refinancing can be an effective way to knock out higher-interest student loans. Alternately, an income-based repayment plan can also give you more breathing room in your budget to make there’s room for important financial goals.

3. Maximize earnings

Another important part of the wealth formula is how much money you’re able to bring in. A higher income will directly translate to a higher net worth.

Working hard to make sure you’re a valuable employee on track for a raise is one way to do it. You can also start a side hustle to generate a second source of income.

“The worst case scenario is having student debt and no degree,” Jarvis says. Borrowers in this situation have monthly payments to keep up, but without a degree to boost their earning potential to match.

If this is you, working toward completing a degree and making yourself a high-quality job candidate might be a smart move to offset the damage of student loans.

4. Educate yourself about money

Even if all your extra funds are getting sucked up by student loans, you still have some irreplaceable resources that can be used to build wealth: your mind and your time. Start listening to financial experts and develop a disciplined approach to your finances.

As you learn more about income, budgeting, debt, investments, and other finance topics, you’ll equip yourself with the know-how to put any extra money you have to good use.

You can figure out the most effective way to build wealth while accomplishing your financial goals, and hopefully avoid some common money missteps along the way.

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Published in Financial Goals, Income, Smart Tips for Saving Money, Student Loans

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