If you went to college, you likely have a substantial amount of student loan debt. Student loans can be an immense burden, and keeping up with your monthly payments can make it difficult to achieve other financial goals. In fact, a study by MIT AgeLab found that 84% of American adults said that student loans negatively affected the amount they could save for retirement.
If you’re dealing with student loan debt, deciding whether to prioritize repaying your loans or investing for your future can be difficult. To help you make the right choice for you, we broke down when you should pay off student loans or invest your money.
Should I Pay Off Student Loans or Invest? 5 Factors to Consider
When it comes to personal finance, experts usually recommend focusing on two things: paying off debt and saving for retirement. But it can be tricky to save for retirement if you’re saddled with student loan debt. To help you decide where to put your funds, consider the following five factors:
1. Student Loan Interest Rates
The interest rate on your loans should help guide your decision. Your interest rate affects your monthly payments and total repayment cost. If you have high interest rates, interest can accrue rapidly, adding to your loan’s balance. In this case, it might be smarter to pay down the debt in order to lower your interest rate costs, and it frees up more cash down the road.
2. Loan Type
There are two main types of student loans: federal and private. Federal student loans are issued by the government and tend to have lower interest rates than private loans. They also have more benefits and options for borrowers, including alternative payment plans and loan forgiveness programs.
Private student loans are riskier forms of debt. They offer fewer protections and repayment options than federal loans and often have higher interest rates.
3. Employer Contributions
If you’re weighing the pros and cons of investing versus paying off your debt, review your employment benefits package. If your employer provides its workers with a retirement plan, such as a 401(k), and provides matching contributions, that’s a significant perk you may not be taking advantage of right now.
4. Financial Goals
Think about your goals. If you want to be a homeowner or start a business, you may find that your loans hold you back from achieving those milestones. By contrast, you may want to focus on investing if your goal is to retire early.
5. Age
Your age can affect what you should prioritize. If you’re right out of college and are in your 20’s, you have more time to save for retirement. But if you’re in your 40’s or 50’s, you don’t have a lot of time to waste if you don’t have enough money currently saved in a retirement fund.
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When to Prioritize Paying Off Student Loans
A common question people have is, “Should I pay off my student loans or invest?” While there is not a single right answer for everyone, here are three scenarios where it might make sense to prioritize repaying your loans before investing your money.
1. Your Loans Have High Interest Rates
Student loans can have very high interest rates. According to The Institute for College Access & Success, private student loans had rates as high as 14.24% in 2019. While federal loans tend to have lower interest rates than private loans, their rates can still be high. For example, Direct PLUS Loans issued to parents or graduate students had an interest rate of 6.3% for the school year beginning July 1, 2021.
If you have high-interest debt, the amount you pay in interest might outpace what you’d earn in stock market returns, so it might make sense to tackle your loans first.
To see how your interest rates affect your payments and total repayment, use the Forbes Advisor student loan payment calculator.
2. Your Loans Are Variable
Federal student loans always have fixed interest rates, so your rate stays the same for the duration of your repayment term. That’s not always the case for private student loans. Some private loans have variable interest rates that can change over time.
While variable rates can start out low, they can increase a great deal. If you have a variable-rate loan, paying it off as quickly as possible can prevent you from having to deal with market fluctuations later on, and you could save money.
3. Your Loans Cause You Stress
Personal finance isn’t always about numbers; it can also be very emotional. If your student loans cause you significant stress or hold you back from lifestyle goals like owning a home, it may be worth paying off your loans first just to get some peace of mind.
When to Prioritize Investing
If you’re not sure whether to invest or pay off student loans, here are some situations where prioritizing your investments may be wise.
1. Your Employer Offers Matching Contributions
If your employer provides a retirement plan with matching contributions, that’s a significant benefit.
According to Vanguard’s 2021 How America Saves study, 59% of employers offered matching contributions in 2019. Unfortunately, nearly 40% of employees miss out on the full match by not participating. And not making enough contributions to qualify for the full match means you’re losing out on money that is part of your compensation package.
Under the most typical matching structure, the employer will match $0.50 on the dollar for the first 6% of the employee’s salary. For example, if you make $50,000 per year and contribute $3,000 toward your 401(k)—6% of your salary—your employer will contribute $1,500 toward your retirement.
If your employer offers matching contributions, you should prioritize taking advantage of the full company match over paying down debt.
2. Your Behind on Retirement Savings
Approximately one-fourth of non-retired adults have no retirement savings at all, according to the Federal Reserve. If you haven’t started saving for retirement yet, it likely makes sense to hold off repaying your loans early to focus on building your retirement fund.
The earlier you start saving for retirement, the less of your own money that you will have to spend for living expenses after retirement. Market returns and compound interest over time are powerful tools that can help build your nest egg.
If you wait until later in life—such as when your loans are paid off—you’ll have to work much harder and save much more to meet your retirement goals.
3. Your Loans Have Low Interest Rates
Depending on the type of loans you have and when you took them out, they may have low interest rates. For example, Direct Subsidized loans for undergraduate students that were disbursed between July 1, 2020 and June 30, 2021 had an interest rate of 2.75%.
Compare your loan’s interest rate to your expected investment returns. Conservatively, the annual rate of return you can expect from your retirement investments is typically 4% to 7%. If the expected return outpaces your loan’s interest rate, prioritizing your investments may be a better choice.
Hybrid Approach: Pay Off Student Loans and Invest at the Same Time
While many people choose one goal or the other, it doesn’t have to be all or nothing. You can utilize a hybrid approach and work toward both goals.
Think about what extra money you have each month to put toward your financial goals. Split that amount in half and contribute to each goal. For example, if you have $200 left over after paying all your bills, invest $100 for retirement and use the remaining $100 to make extra payments toward your student loans.
While you’ll make slower progress than you would if you focused on only one goal at a time, you’ll still make progress and improve your overall financial picture.
Choosing a Debt Payoff Strategy
If you want to start chipping away at your student loan balance, you can accelerate your repayment by using repayment strategies like the debt avalanche or debt snowball methods.
Depending on your mindset, focusing on the debt with the lowest interest rate may be the best option. Or, you may stay more motivated if you prioritize repaying the debt with the lowest balance first. Regardless of which payoff strategy you use, you’ll pay off your loans faster and accomplish your goals sooner.
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