In the United States, total educational debt sat at about $600 billion a decade ago. Today, it's above $1.5 trillion. That's a whole lot of college loans dragging on young workers -- and many older ones, too. On a more individual level, according to recent analysis, the average college graduate now picks up their diploma with about $37,000 in debt. Needless to say, plenty of them want to shed that burden as soon as they can. Recently, one such debtor wrote to Motley Fool Answers with a conundrum. The 26-year-old listener has been making headway on his finances, and has reached a point where he could wipe away his student loans in one fell swoop -- if he drained his brokerage account and emergency savings.
In this segment of the podcast, host Alison Southwick is joined by senior analyst Jason Moser and Motley Fool Wealth Management's Ross Anderson to discuss how far he'd be wise to go to put those loans behind him.
A full transcript follows the video.
This video was recorded on Nov. 27, 2018.
Alison Southwick: The next question comes from Ricky. "I graduated college almost four years ago and still have about $25,000 in student loan debt. Knowing it would not be wise to touch my home equity or 401(k) account yet [I just turned 26], I finally reached the point where I could empty my brokerage account and emergency savings and completely pay off my student loans.
"I just feel like emotionally it would feel defeating, as those would basically be empty after working hard to build those over the last three years. Would it be wise to pay off the student loans now or would it be better to make aggressive payments for the next several years? Also a side note. About a year ago I moved to Nampa, Idaho and heard Alison mention on the show that she grew up in Caldwell. Small world." Yes. It's a small Idaho, that's for sure. Enjoy Nampa!
Ross Anderson: Ricky, first of all I love that you're a listener. I love that you're thinking about this stuff. At 26 you are well ahead of the game...
Southwick: Right! Way ahead of my game!
Anderson: ... of many of your peers. Congratulations! The one detail that I don't have here that I would like to have to answer your question is what you are paying in interest on the student loan debt. I know what you have resource-wise that's available. The first thing that I would say is don't drain your emergency fund. That emergency fund is just that. This is not an emergency. This is a strategic decision, but not an emergency and the reason that that's there is if you have a loss of income. If you have a big, unexpected bill you still want to have that liquidity.
Now whether or not you pay off some of that student loan debt using the brokerage account I think depends on what you're paying in interest. I'll try and give you at least a guideline. If you were paying sub 5% -- if your student loan debt is under 5% -- I'd probably keep it. I think you're ultimately going to do better in a long-term investing strategy than 5%. If you were somewhere between let's call it 5-7%, you're kind of on the bubble. If you're paying north of 7% interest on that student loan debt, I probably would take the money out of the brokerage account and pay it off.
Again, you may have a different tolerance for risk than I do, but for me I wouldn't bet hard that I'm going to earn way more than 7%, even though I hope that I would on long-term investments. That, for me, would be my threshold where I would pay off the debt. At least get rid of half of it and then make as aggressive payments as you can over the next few years to get it totally out and off your mind so that you're not worried about it anymore. But how much that debt is costing you is the big variable there.
Jason Moser: And that's why we say that not all debt is bad debt. It drives me nuts when people say that because there is good debt out there. If you have a mortgage that's good debt. It enables you to live in a house and you're probably paying less on that mortgage than you would earn over a long-term investment strategy...
Moser: The blanket statement that all debt is bad -- I hear that often and I don't like it. You've got to be careful with that.
Anderson: I like to spar with Bro on this. Sadly, Jason, you're not Bro...
Moser: Pretend I am!
Anderson: ... but Bro is always talking about paying off your mortgage going into retirement. For a lot of reasons it is a satisfying thing to do. To me, at the interest rates we've been at, I can't make the math work for that case. I just can't. If I've got sub 4% debt I'm going to keep it as long as I can. That's cheap money, but I'd rather have the money elsewhere.
Moser: I'll give you a real-life example. I have a car loan. I got a new car in 2015 and Ford gave me a 0% interest loan to pay off over five years. So I'm sitting here for five years with a 0% loan. Now, I could pay that off tomorrow, and it would be very satisfying to know that obligation is fulfilled. However, month by month I'm finding, and I've seen this over the course of the last three years, that money to be better served over all different types of investment opportunities that come up. So yes, while it could be satisfying to pay that off, it doesn't really cost me anything. If I eliminate it I get the satisfaction and I don't have to worry about that in the future. It's another uncertainty that's erased, but I like my chances over the next couple of years to be able to satisfy that debt regardless, so string it out as long as you can.
Southwick: And then once the five years are over, are you going to pay it off in full?
Moser: Well, it will all be done. The whole thing will be done. It's just that every month I have to make a payment toward the car, but the auto company is not charging me at all for the loan.
Anderson: If I can use somebody else's money for free, I'll always do it.
Moser: That's the definition of free money. You might as well string it out for as long as you can.