Consolidate Student Loans, Is It For Me? Part 2

November 2, 2015

How To Leverage Your Assets By Consolidating Student Loans

For your reference, we will use the loan details from the example provided from my article explaining debt consolidation.  The blended rate from that example is 6.73% (found by taking the weighted average of the two loans and their respective interest rates).  If the loans are consolidated, the cumulative payments would be approximately $183,000 with monthly payments being $762.95.  Current monthly payments without consolidating are $1,149.34.  Therefore, the difference in monthly payments between consolidating student loans and not consolidating is approximately $390.

In this example, we assume that consolidating the loans means you have $390 to “invest” every month.  The financial strategy says the following: if you can get a greater rate of return on your assets than what it costs to borrow the money, then consolidate and invest the difference.  In short, you try to earn a spread over the cost to borrow.  What does that mean?  If you can earn 8.0% on your assets and it only costs 6.73%, then you make 1.27%.  The chart below shows the results of two scenarios.  Scenario 1 is the choice not to consolidate.  Scenario 2 is the choice to consolidate and invest the savings into the stock market.  The assumed annual rate of return for the investment is 8.0% calculated on a monthly basis.

Each month, you take the savings of $390 and invest it in the stock market.  We assume the stock market has annual returns of 8.0%.

Consolidate student loansAs you can see, in this example your net worth would be almost $100,000 greater in retirement.  This amount doesn’t seem like much.  However, let’s take a look at another situation.  Let’s say you were able to refinance your student loans to a lower rate and consolidate them into a 20 year term.  We will assume the new rate on the refinanced and consolidated loan is 5.0%.

Consolidate student loansAs you can see, the greater the spread between the costs to borrow relative to how much you can earn, the greater your net worth will be.

Major Drawbacks To This Approach

There are three significant drawbacks to this approach:

  1. I assume an 8.0% continuously compounded rate of return.  In reality, the stock market does not go up in a straight line.
  2. Life happens.  This means that you may not always be able to contribute the savings from consolidating.  You can get laid off, have a health issue, and the list goes on and on…
  3. This approach requires you to stay disciplined and follow a plan for many years.

So What To Do?

As I said in the beginning, each person has a unique situation so there is no cookie cutter advice.  I can provide you with the following opinion.  The detailed approach above should only be applied if you yourself are a financial professional or if you want to take a more “hands-on” approach to managing your finances.  The reason for this opinion is that each of us has our own behavior biases.  I’ve seen too many people set a plan and not follow it, such as panicking when they see the stock market go down and withdrawing their money.

It is my opinion that if you have the ability, do not consolidate your loans.  Pay them off as quickly as possible.  I am a strong believer that debt handcuffs you and restricts freedom.  Pay-it-off as quick as possible.  This is one of the reasons why FitBUX Income Share Agreements are great.  Payments are tied to your earnings so when you make more money, you automatically pay down your agreement more quickly.

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