Make Minimum Payments and Invest for Higher Returns

I paid off $33,850 of student loan debt in just over four years. Here’s Part 2 of how I did it.

My first step in paying off my student loans was to spend $500 a month paying off one high interest student loan that I transferred to a 0% APR credit card. This was in addition to paying $300 a month to meet the minimums on my other student loan payments.

The next step to paying off my student loans was a controversial one: make only minimum payments for years.

Make Minimum Payments and Invest at Higher Returns

I became somewhat infamous in the personal finance world with one of my first blog posts entitled Don’t Pay Off Your Student Loans. In this article I explained how it is possible to make extra money if you can invest money at a higher interest rate than you pay on your debt.

It was true then and it’s true today.

If the interest rate on your student loans is less than 3% (which mine were, thanks to variable interest rates and the Federal Reserve), all you need to do is find an investment that gets more than a 3% return and you’re better off investing than paying off the loans.

The stock market is one way to try to get big returns on your investments, but it is very risky and you can lose a lot of money there. I used to do a lot of active investing and trading, but I found that I was doing a lot of work and wasn’t making any money.

I still have a lot of money in the stock market between my Roth IRA and 401k, but my rate of return has been pretty crappy ever since I made 28% back in 2010.

I’ve found I can get better and safer returns with peer to peer lending, such as LendingClub.com. As you can see, I’m getting returns better than 13% in my Lending Club account, which is more than 10% greater than my student loans.

A lot of people (including most personal finance bloggers) ignore the math behind this reality and claim that all debt is bad debt. They are wrong.

If you are confident in your ability to invest your money at a higher rate of return then you are paying on your debt, mathematically it makes perfect sense to do so.

The problem is that investment returns are never guaranteed, while paying off debt is essentially a guaranteed return. It is also much easier to pay down debt than it is to successfully invest money.

Finally, there is a mental aspect of being debt free that each person must consider. If the idea of owing someone money makes you lose sleep at night, then a higher rate of return isn’t worth it.

If I Could Do it All Over Again…

I spent about two years making only minimum payments and investing what I would have used to pay off debt. And if I could do it all over again, I would have done things a little differently.

• I would have had a more balanced approach of paying down debt as well as investing, instead of investing everything over the minimum payments
• I would have put more in Lending Club and less in the stock market
• For my stock market investments, I would have invested more in index funds and less in call options

Overall I tried investing aggressively and I probably would have been better off paying down debt. This brings me to the third and final step of paying off my student loans, which I’ll discuss tomorrow.

Readers: How do you feel about debt? Would you rather pay off low interest debt, or make minimum payments and try to invest for a greater return?

Kevin McKee

Kevin McKee is an entrepreneur, IT guru, and personal finance leader. In addition to his writing, Kevin is the head of IT at Buildingstars, Co-Founder of Padmission, and organizer of Laravel STL. He is also the creator of www.contributetoopensource.com. When he’s not working, Kevin enjoys podcasting about movies and spending time with his wife and four children.