Your Debt-Free ROI: Why Interest Rates Don’t Matter

(Guest Post by Stephanie Halligan while J$ cuddles his new baby :))

When I graduated from college with $30,000 in student loans, I didn’t feel very confident about my financial future. I was confident about one thing, however: I wanted to get out of debt and fast.

I started reading everything I could about getting rid of debt. I researched debt snowballs, APR, ROI, debt consolidation, income-based repayment plans – you name it.

Then one day, I stopped reading and started repaying my loans with my own plan. I paid off $16,000 in debt in a year and a half by ignoring conventional advice and listening to my gut.

How I Got Here – My Debt Story

Like a lot of my peers, I graduated from school with a mountain of student loans. And sadly, like many of my friends, I was in shock when I saw my total debt for the first time: $30,000. I’d never come across that much money in my life, and there was a big minus (-) in front of it.

After the initial shock wore off, I began to panic. When I graduated, I was only making $1,000 a month and living in Boston (read: expensive city). I could barely pay for my prescription medicine, let alone even think about how I was going to pay back my loans. I was freaking out, and with good reason.

“Okay,” I told myself. “I got myself into this mess. Now how the hell am I going to get out of it?”

Given my financial situation at the time, the only realistic answer was “little by little.” I buckled down, faced reality and started paying the minimum.

Calculating My Debt ROI

That same year, I was persistent enough (and darn lucky) to land an entry-level job in Washington, DC. When I started earning a real income, my life instantly felt more secure. I paid off my credit cards, started an emergency fund, and even opened a retirement account. I felt like I finally had a say in my financial destiny.

But there was still the $30K gorilla in the room. It didn’t matter that I was making quadruple my previous salary – my entire paycheck would barely make a dent in my debt. My student loans made me feel anxious and helpless. It was such an intimidating amount that I didn’t even know where to start. So, like anyone else with a question, I turned to Google :)

In my search, I stumbled upon a few personal finance blogs and began reading advice about the best way to start paying off my student loans. One theme came up over and over again in my reading: ROI and interest rates.

The finance experts suggested knowing the APR on each loan. My debts were neatly divided into a federal loan and a private student loan:

  • $16,000 federal, 6.8% APR
  • $14,000 private, 3.5% APR

You then compare your loan interest rates with other investment opportunities, like investing in the stock market. Let’s say that the stock market has a 5% return, conservatively. This means I would have a better return on investment (ROI) on the market than it would paying down a loan with 3.5% interest.

I had a plan to maximize my ROI: I would pay as much as I could afford on my federal loan and start investing in my 401(k) before putting any extra money toward my private loan.

On paper, this plan worked. In my head, this plan made me incredibly nervous.

Why Psychology Matters More than Interest Rates

The logical half of me said, “This makes sense!” The overly-cautious, panicky half of me had a different reaction:

  • “What if the market crashes again?”
  • “What if I get a pay cut or lose my job?”
  • “What if the interest rates on my private loans go up?”

Everything about my debt made me nervous, even my plan to eliminate it. I realized there was only one strategy that made me comfortable: Get rid of my debt, as much as possible, as quickly as possible.

The interest rates on my loans didn’t matter. The possible returns on the market didn’t matter either. The only thing that mattered was that my debt made me feel uncomfortable and insecure.

I realized that how I felt about my debt mattered more to me than choosing the “right” strategy for eliminating it.

I started saving less for retirement and paying back both of my loans with the full force of my disposable income. Both of my loan balances were shrinking quickly.

And I felt great.

Do What Makes You Feel Good and You’ll Get Results

Some people cringe when I tell them I cut back on my retirement savings and focused on paying down a loan with a 3.5% APR instead. I knew the ROI strategy was not going to work for me and my personality, but it might make others feel great knowing they’re maximizing the return on their dollar.

The bottom line is: do what works for you.

Since I made the decision to go with my gut, I’ve paid off almost half of my debt. I still have $15,000 left, but the amount doesn’t make me nervous anymore. I know I’m doing everything I can to get rid of it, and I’ll be able to relax once it’s all gone.

Stephanie Halligan is a blogger at The Empowered Dollar. Her mission: saving kids from financial disaster, one conversation at a time. You can follow The Empowered Dollar on Twitter and Facebook.

[EDITOR’S NOTE:  YES!  Very very important – you have to do what works for YOU even if it technically doesn’t make sense. The experts out there aren’t living your life, you are – so thanks for the great reminder :) It’s exactly why I’m paying down our smaller, but lowest interest, mortgage of the two too – I’ll accomplish it faster and with more vigor!]

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  1. Sean July 11, 2012 at 8:37 AM

    Firstly, congrats on paying half of your debt off so far!! I went to a private university and graduated with $60k in student loan debt. I graduated in 2010 and immediately tried to lower my payments. What I didn’t realize until about a year later, was that on my $19k loan, I was only paying interest. I found this out after I really started to look into how to pay off my debt faster. Needless to say I was angry with myself because I paid about $2,000 in a year and about $90 of that was principal.

    Today, I know all my debts and interest rates. I totally agree with do whatever works for you. My fiancee and I are doing what I like to call the “Opportunity Cost” method. Basically we need to free up monthly payments in order to be able to comfortably afford a house once we are married in a year. Unfortunately, that means we need to pay off a handful of her loans that are only 0.36% which is not what I wanted to do (I prefer paying high interest rate first), but by paying off about $8,000 we free up $225/month with ease. Elsewhere we would have to pay that amount and free up only $25/month on some of the higher interest rates.

    It may not be the best mathematical route to take, but it is what will help us for now to get to our bigger goal of affording our own home. Once we are in a home and affording the mortgage, I am jumping right to high interest rate loans. Great article!!

  2. L Bee @ Money Tree July 11, 2012 at 8:46 AM

    This is why I love personal finance sites-each one has a different and personal perspective on how to get rid of debt and save for important things-you have to do what feels right for you-it’s the only way anything will ever “stick”. :)

  3. Stephanie @ Empowered Dollar July 11, 2012 at 8:51 AM

    @Sean – I love how you phrased that. It’s all about Opportunity Costs, and the monthly payment is a huge one! I’m totally for bad math when it comes to paying back loans :)

    @L Bee @ Money Tree – “Stickiness” is as important as anything!

  4. m1nts July 11, 2012 at 9:03 AM

    I’m proud to inform that I’ll be student loan free next month. I’ve been dreaming with this day since forever!
    It took me 5 years, moving in with my parents for 6 months (at the beginning) and living with less than half of my paycheck.
    Since what I owe it’s about $450, for the first time I’m taking a real good vacations starting tomorrow, when I get back I’ll receive my paycheck, pay the loan and make plans for the “new” income. I’m thinking on either saving it all, or buying stocks, or adding it to my retirement plan… I don’t know yet… but whatever I end up doing I know it will be great! (and any recommendations are welcome!!!)

  5. Kevin @ July 11, 2012 at 9:07 AM

    I was in a similar situation, although I’d never trade a 3.5% guarantee for a 5% potential return. Yes 5% is bigger than 3.5%, but that’s not worth it when the 5% isn’t guaranteed and holding the debt is riskier.

    If you had a relatively “safe” investment at 7-8% then I’d consider it, but I don’t know if that investment exists today (at least not in the stock market). That’s why I ended up paying off all my student loans, even the low interest ones.

  6. Lance@MoneyLife&More July 11, 2012 at 9:28 AM

    Peersonal finance is all about doing what works for you. I think it is great that you are kicking the debt down and honestly that 2% wont make a big difference in the long run because it isn’t like you have to make these payments for 30 years. Congrats and I look forward to the update where they are all paid off!

  7. Stephanie @ Empowered Dollar July 11, 2012 at 10:45 AM

    Thanks for the comments, everyone. I cannot WAIT until I’m debt free and can use my monthly student loan payments toward something more fun :)

  8. Bridget July 11, 2012 at 12:16 PM


    It’s all about doing what’s right for you.

    Personally I get too nervous to forego savings to attack my debt. I owe about $15,000 (down from nearly $21,000) but I still put money into my mutual funds and brokerage accounts regularly even though I’m paying down my debt. Many disagree with my strategy, but having savings means having choices. I like knowing that if I was in a bind I can use my financial assets to continue to make payments to my debt and still manage my expenses. It provides a lot of security.

  9. retirebyforty July 11, 2012 at 12:19 PM

    Doing what’s right for you is the bottom line. If you feel paying off the debt will give you freedom and peace of mind then do that. Other people may want to invest in retirement fund or for a house and that’s good too. I think as long as you’re making progress, you’re doing a lot better than most people. Good luck!

  10. Jenna, Adaptu Community Manager July 11, 2012 at 12:39 PM

    Alright – I just wanted to say hi and tell you how great it was to meet you at WDS this weekend!

  11. Marc @ FatAndBroke July 11, 2012 at 1:28 PM

    I did the same thing. I Googled the best ways to get out of debt, how to set up a budget, how to lose weight, etc… I tried methods I found on line and I liked some of them and hated some of them. I finally decided to combine several different approaches and I am liking it. I am seeing improvement in my diet and in my finances.

    It seems the best thing to do is whatever works best for you. If you are nervous or uncomfortable doing something, there is a pretty good chance that you will stop doing it.

    Congrats on being halfway there and good luck on the rest of it!

  12. Kris July 11, 2012 at 3:55 PM

    Well done paying down half your debt so far! I know I have a far lower tolerance for debt than my husband does – I want it gone, he’s less concerned. Makes it difficult to balance where the money goes. Good luck paying down the rest of your loans.

  13. Derek July 11, 2012 at 4:30 PM

    Do what you gut says as long as your gut isn’t telling you to spend more than you make because “you just gotta have it now” (whatever “it” is). If you let your debt linger too long or accumulate more debt, it will turn into an even bigger gorilla than it is today.

  14. Romeo July 11, 2012 at 7:13 PM

    My personal strategy for debt is to save up the amount in a separate account and then pay the debt off in full with one check. Again, it’s my personal strategy. I like the security of having $15,000 in a separate account just in case “life happens.” Great post!

  15. Mr. Pop @ Planting Our Pennies July 11, 2012 at 8:08 PM

    Ditto Romeo-way better to have a cash cushion while you’re paying the debt down. A co-worker recently had their income cut by 25% for the next 6 months; because they were putting everything they had to paying down their house debt its going to be a struggle for them.

  16. RichUncle EL July 12, 2012 at 9:11 AM

    Lately my school loans have been making me anxious as well, I rushed to get my MBA thinking that I will get a better job and higher paying opportunites. So just like you I have to pay down this annoying direct loans that is just dragging me down to the tune of 6.8%.

  17. amanda July 14, 2012 at 10:01 AM

    Great post! I completely agree. If you look long enough your sure to find 100 *right* ways to do it and there are cool-aid drinkers from every camp convinced that it always has to be done one way. My husband and I are paying off our house this year, which depending on who you ask is really great or really stupid.

  18. K.C. July 14, 2012 at 8:17 PM

    There is no magic to getting out of debt. Make regular and timely payments on existing debt and do not take on any new debt. Eventually, the debt is paid off. How does one avoid taking on new debt? Cash is the answer. In other words, liquid savings. Cash precludes the need for new debt. For me, it is more important to avoid new debt than to accelerate repayment of existing debt. If I avoid new debt by having sufficient savings, I guarantee that I will become debt-free and remain that way. Romeo has the right idea. I’d rather have savings and a lot of debt, than less debt and no savings. That goes against conventional personal finance advice, ROI and such, but it works for me. Being broke is definitely worse than being in debt.

  19. Matt July 19, 2012 at 4:44 PM

    Great post. Keep up the good work!

  20. Kris July 20, 2012 at 11:58 AM

    Good post! For me, the defining moment was making a commitment to getting out of debt. Then the rest fell into place. It still wasn’t easy, but at least it was a strategy and decision that was meaningful to me, so I stuck with it.

  21. Austex July 22, 2012 at 10:12 AM

    I agree that there is not necessarily one right way and that everyone should find and do what works for them, but with one big caveat: do your homework and collect all the relevant information before making any decisions. You obviously did that, which is commendable. So you knew exactly what trade-offs you were making to go the route you did. But I think it can be very dangerous to adopt a “do what feels right for you” strategy without first thoroughly educating yourself about the true costs and benefits of all the available options. For example, many people feel really uncomfortable keeping their money invested in equities during times of great market volatility. But if they never invest in equities or get into and out of the stock market according to their gut feelings, they are likely to come up short and often significantly. With some research and education, however, one can learn to choose an asset allocation they will be able to stick with and when things get bumpy in the markets, they can remind themselves that despite their temporary discomfort, they really are doing what’s best for them. So I agree with you but only for those who have done their homework and are aware of the true costs and benefits of their choices.

  22. J. Money July 24, 2012 at 3:45 PM

    Thanks again for helping me out while I was away, Stephanie! Glad to see your post start some good discussions! See you around another blogging event at the bars for sure :)

  23. Arthur August 2, 2012 at 4:50 PM

    Great post! I am somewhat in the same situation and like you I have decided that socking away money to invest is a better use of my money at this time. I wanted to point out two more things that support my decision:

    -Unless you make a lot of money (over $75k for a single person), the student loan interest is tax deductible up to $2,500. So, with the balances you have, all of it will be deductible. At your income level, the 6.8% and 3.5% become 5.8% and 3.0% after tax! Even better, if you bump up to the 25% bracket (making over $35,350 in 2012), those rates become 5.1% and 2.6%. And don’t worry, it’s an “above the line” deduction, so you don’t need to itemize to reap the benefit.

    -As long as you keep your investments relatively liquid (i.e. not in an IRA or 401(k)), you can always draw them down to pay off debt if need be. However, as Mr. Pop pointed out above, the reverse is not true. You can’t call up the loan company and say “Hey, I could use some extra cash for investing/living expenses/vacation/etc. Can I have some of those payments back?” (although that would be awesome).