Home>Video>Saving vs. Paying Off Student Loans--What's More Important?

Saving vs. Paying Off Student Loans--What's More Important?

Sat, 27 Sep 2014

Consider employer matches and potential returns for retirement savings along with student loan interest rates to find the right balance, says David Blanchett of Morningstar Investment Management.

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Video Transcript

Adam Zoll: For Morningstar, I'm Adam Zoll. These days, so many young adults are wrestling with large amounts of student loans--tens or even hundreds of thousands of dollars. How can they go about paying those loans and also saving for other major life goals? Here to have that discussion with us is David Blanchett, he is head of retirement research for Morningstar Investment Management.

David, thanks for being here.

David Blanchett: Thanks for having me.

Zoll: Research shows that the average student borrower is leaving school with about $30,000 in debt these days some have many higher multiples of that amount. What advice would you give for somebody who is facing this giant debt challenge--maybe not just student loans but also credit card loans or other borrowing that they have done? How do they tackle this huge challenge of paying this down?

Blanchett: It can obviously be daunting when you first graduate college to have a very large amount of debt and possibly no job; you have to balance your priorities. Luckily, you can choose your repayment plan with a lot of loans. You can do income-based repayment; you can do an extended repayment plan. So, there are options for delaying that. There is also deferment, if you are not working.

I'd say that for individuals who do have a job, they do have choices; pay it down as soon as you can. And obviously, be reasonable with your approach. But student debt doesn't go away. You can't go into bankruptcy and get rid of it. So, it is a very dangerous type of loan that will always follow you around unless you are careful with it.

Zoll: What about prioritizing debt? You may have different interest rates. Do you just want to pay off the higher interest-rate debt first?

Blanchett: I think it's interesting with a lot of loan-consolidation programs out there. A consolidation program is one where you can take all your loans and consolidate. It might actually not make sense for a lot of people to do that because you may have some loans that have actually lower rates than the rate you are consolidating at. And so, in theory, if you can prepay your loans, you prepay the ones with the higher interest rates. So, there can be a spectrum. I think about myself personally; back when I was in school, I got loans at rates of less than 2% interest--very low. I have others from graduate school that were more like 8.6%. So, if I were looking to say, "Which ones do I repay early?" You want to pay down those 8%-plus loans versus those 2% loans because it will actually increase your wealth over time.

Zoll: Are there certain strategies that will help your long-term credit rating. I know that some people say that taking out a student loan can actually have a positive benefit because you are establishing a positive credit rating, assuming you are making your payments on time. Are there certain strategies associated with that?

Blanchett: I'm not too sure about the credit rating stuff. I know that, obviously, having that repayment monthly is good for credit purposes. I've heard people say before that possibly prepaying loans can be bad for you, but I would urge you to repay loans as fast as you possibly can because debt can be a dangerous thing, especially a student loan. So, if you can get out of that as soon as you can, I'd say go for it.

Zoll: What about parents helping their children pay down their debt? Is that a good idea?

Blanchett: It can be. One question you have to ask yourself, if you are a parent or an investor in general, is what is my rate of return on these things? So, if you trust your child, for example, and they have loans at 6% or 7%, could I pay these down for them and have my child pay me back at a 5% interest rate? And there are options out there that can really help someone, I think, reduce that cost of debt because, while 1% interest difference may not sound huge, it can be a big deal over a 20-year repayment period.

Zoll: And some people who are still paying down their student loans are maybe pushing off saving for retirement for down the road, thinking that they'll have plenty of time to get to that later. Is that a good idea? Should you prioritize paying off student debt or other debt over saving for retirement?

Blanchett: So, I have personal experience with this question. My wife and I have quite a bit of student loans. We also are trying to save for retirement. And so, we do save a lot for retirement, but it's also important for us to repay those loans because the money in a 401(k) you really can't access until you are 65. But student loans will be with us until we pay them off. So, we are definitely maxing out the employer match; but beyond that, you want to ask yourself, "What will I earn in my 401(k) plan versus what I will earn if I pay off my student loans?"

Now, I wouldn't say don't save for retirement. I'd say the best policy is to balance the two objectives, but the key question is, "What is the rate you are paying on your loans?" If you are paying 8% pure on your student loans after taxes, that's a really high interest rate. Look to pay those off early. If it is closer to 2%, maybe hold on to those things a little bit longer and put more in your 401(k) plan.

Zoll: David, I know this is a topic on many young investors' minds these days. Thank you so much for sharing your thoughts with us.

Blanchett: Thanks for having me.

Zoll: For Morningstar, I'm Adam Zoll. Thanks for watching.

* Disclosure
The Morningstar Investment Management group, a unit of Morningstar, Inc., includes Morningstar Associates, LLC, Ibbotson Associates, Inc., and Morningstar Investment Services, Inc., which are registered investment advisors and wholly owned subsidiaries of Morningstar, Inc. All investment advisory services described herein are provided by one or more of the U.S. registered investment advisor subsidiaries. The Morningstar name and logo are registered marks of Morningstar, Inc.

The information, data, analyses, and opinions presented herein do not constitute investment advice; are provided as of the date written and solely for informational purposes only and therefore are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Past performance is not indicative and not a guarantee of future results.

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