Lots of people drag their student loans (and other debt) out because they believe they can make more money investing their cash rather than using their cash to pay off debt.
Here’s an example. My post on buying your next car with cash got lots of feedback on LinkedIn. Some of the comments were people supporting my view that buying your next car with cash is smart. Some supported the view that using debt is a better option. Here is a comment in the second category:
“You should generally not pay cash for a car unless the interest rate you would pay for financing is higher than the interest rate you would make investing the cash. I just bought a car with 1.9% interest. I put down 20% (to keep my DTI ratio at a certain level) and financed the rest. I easily had the money to pay for the car in cash but choose to keep my cash in my investments where I earn a lot more than 1.9% a year.”
At the essence of this thought process is the assumption that borrowing money at a lower rate than you can invest the money is wise. Lots of people subscribe to this view of money and debt. Partly because it can work. Partly because it sounds smart. (I have a theory though that many of the people that use this as their rationale for buying cars with debt have almost no money or investments.)
Here’s my question.
If someone offered to loan you $500,000 at 3% interest for two years would you do it?
The principal and interest would be due in a balloon payment at the end of two years. You can invest the money in anything you want. You have two full years to earn more than 3% on the money and pocket the profit.
Would that be wise or foolish? Would you do it?
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