Like so many millennials, I graduated from college in 2009 with tens of thousands of dollars in student loan debt, completely naïve to how it would impact my financial future.
A decade later, things clearly haven’t gotten much better. In 2019, college graduates left school with an average of nearly $30,000 in student loan debt.
I don’t point this out to discourage a pursuit of higher education. College graduates with bachelor’s degrees make on average $1 million more than high school graduates over the course of their lifetimes. College is certainly a worthwhile investment.
But I do believe we need to begin to rethink debt – from student loans to credit cards to car notes.
The burdens of staying in debt are numerous. Monthly payments sap hundreds or thousands of dollars from your bank account, while interest that accrues over time costs you big bucks in the long run.
But there’s a hidden, less obvious, cost of staying in debt.
Carrying debt is like playing defense
Imagine suiting up for a basketball game and having to spend the entire game on the defensive end of the court. You never get the chance to shoot, pass, or dribble, and instead spend the entire game chasing the opposing team as they pass the ball around you.
That’s kind of what it’s like to be in debt, right?
By carrying credit card debt or borrowing money to buy a new car, we remain narrowly focused on making the required monthly payments to keep the lenders off our backs.
And therein lies the problem. If we’re too busy playing defense, we can’t go on offense with our money. The money that we could be growing in the stock market or a high-yield savings account instead goes to Sallie Mae or American Express each month.
The danger of going into debt and staying there is what’s known as opportunity cost – “the potential benefits an individual, investor, or business misses out on when choosing one alternative over another,” according to Investopedia.
This is the hidden cost of carrying debt. We forfeit the opportunity to play offense with our money and instead get stuck on defense.
Don vs. Michelle
Take this simple example to better understand these concepts:
Like the average American college graduate, Don and Michelle both owe $30,000 in student loans when they get their diplomas. They both have 5% interest rates on their loans.
Don wants to keep his monthly payment relatively low so he can afford to live in the city with friends and go on several trips a year. He makes the minimum payment every month and is on track to repay the loan in 10 years. He’ll pay a grand total of $38,183.59 by the end of those 10 years, including nearly $8,200 in interest during that time.
| Don | |
| Monthly Payment | $318.20 |
| Total Interest | $8,183.59 |
| Total Payment | $38,183.59 |
Michelle on the other hand understands the longer she takes to repay her loans, the more it will cost her in the end. She decides she wants to be out of debt in five years.
Using a loan calculator online, she figures she must pay $566 per month to reach her goal. It means she doesn’t have as much cash on hand to go on trips or to live in the city with friends, but Michelle knows it’s going to pay off in the end.
After five years Michelle has repaid her loans and is debt free. Unlike Don, who will pay almost $8,200 in interest over a 10-year period, Michelle saves over $4,000 in potential interest payments by paying off the student loan debt in just five years.
| Michelle | |
| Monthly Payment | $566.14 |
| Total Interest | $3,968.22 |
| Total Payment | $33,968.22 |
Michelle is clearly getting the better deal here, right? But there’s more.
Michelle is really sharp and understands opportunity cost. She knows that being debt-free means she’s ready to go on offense with her money.
She decides to take the $566 she was paying toward her student loans each month and invest it in mutual funds. Over the next five years, the market fluctuates a bit, but her investments average a 5% rate of return during that time.
In five years, Michelle will be sitting on more than $38,000!
| End Balance | $38,382.58 |
| Starting Amount | $0.00 |
| Total Contributions | $33,960.00 |
| Total Interest | $4,422.58 |
Not only is Michelle saving more money than Don by paying her loans down in five years, she’ll have nearly $40,000 more than Don when he finally gets out of debt.
Because she understood opportunity cost and saw debt not only as a monthly obligation – but as as drag on future earnings – she developed the right strategy to get out of debt and move on with her life.
Patrick Villanova 