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If you went to college, you probably have significant student loan debt. Student loans can be a huge burden, and keeping up with your monthly payments can make it difficult to meet other financial goals. In fact, an MIT AgeLab study found that 84% of American adults said student loans negatively affected the amount they could save for retirement.
If you are struggling with student debt, it can be difficult to decide whether to prioritize paying off your loans or investing for your future. To help you make the right choice for you, we’ve broken down into when you should pay off your 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 generally recommend focusing on two things: paying off debt and saving for retirement. But saving for retirement can be difficult if you’re struggling with student loan debt. To help you decide where to invest your funds, consider the following five factors:
1. Student loan interest rates
The interest rate on your loans should help you make up your mind. Your interest rate affects your monthly payments and the total cost of repayment. If you have high interest rates, interest can add up quickly and add to your loan balance. In this case, it might make more sense to pay off the debt in order to lower your interest costs, and that will free up more money later on.
2. Type of loan
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 offer more benefits and options for borrowers, including alternative payment plans and loan cancellation 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 weigh the pros and cons of investing versus paying off your debt, review your benefits package. If your employer offers their employees a retirement plan, such as a 401 (k), and provides matching contributions, this is an important benefit that you may not be enjoying right now.
4. Financial objectives
Think about your goals. If you are looking to become a homeowner or start a business, you may find that your loans are preventing you from reaching these milestones. On the other hand, you might want to focus on investing if your goal is to retire early.
Your age can affect what you need to prioritize. If you’ve just finished college and you’re in your twenties, you have more time to save for your retirement. But if you’re in your 40s or 50s, you don’t have much time to waste if you don’t have enough money currently being saved in a retirement fund.
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When to prioritize student loan repayments
A common question people ask themselves is, “Should I pay off my student loans or invest?” While there isn’t one right answer for everyone, here are three scenarios in which it may be wise to prioritize paying off 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. Although federal loans tend to have lower interest rates than private loans, their rates can still be high. For example, Direct PLUS loans to parents or graduate students had an interest rate of 6.3% for the school year starting July 1, 2021.
If you have high-interest debt, the amount you pay in interest may exceed what you would earn in stock returns, so it may be a good idea to tackle your loans first.
To see how your interest rates affect your payments and your 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. This is not always the case with private student loans. Some private loans have variable interest rates which can change over time.
While variable rates may start out low, they can go up dramatically. If you have a variable rate loan, paying it off as quickly as possible can save you from having to deal with market fluctuations down the road and you could save money.
3. Your loans cause you stress
Personal finances aren’t always about the numbers; it can also be very emotional. If your student loans are causing you significant stress or preventing you from achieving lifestyle goals like owning a home, you may want to pay off your loans first just to have peace of mind.
When to prioritize investing
If you are unsure of whether to invest or pay off your student loans, here are some situations where it may be wise to prioritize your investments.
1. Your employer offers matching contributions
If your employer offers a pension plan with matching contributions, this is a significant advantage.
According to Vanguard’s 2021 How America Saves study, 59% of employers offered matching contributions in 2019. Sadly, almost 40% of employees do not get the full match by not participating. And if you don’t make enough contributions to qualify for the full game, you are losing money that is part of your compensation package.
In the most common matching structure, the employer will pay $ 0.50 per dollar for the first 6% of the employee’s salary. For example, if you earn $ 50,000 a year and contribute $ 3,000 to your 401 (k) – 6% of your salary – your employer will pay $ 1,500 towards your retirement.
If your employer offers matching contributions, your priority should be to take advantage of all of the company’s matching, rather than paying down debt.
2. Your lag on retirement savings
According to the Federal Reserve, about a quarter of non-retired adults have no retirement savings. If you haven’t started saving for your retirement yet, it probably makes sense to delay prepaying your loans so you can focus on building your retirement fund.
The sooner you start saving for retirement, the less you’ll have to spend your own money on living expenses after retirement. Market returns and compound interest over time are powerful tools that can help you build your nest egg.
If you wait until later in life, like when your loans are paid off, you will have to work a lot harder and save a lot 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 can have low interest rates. For example, the direct subsidized loans for undergraduates that were disbursed between July 1, 2020 and June 30, 2021 had an interest rate of 2.75%.
Compare the interest rate on your loan to your expected investment returns. Conservatively, the annual rate of return you can expect on your retirement investments is generally 4% to 7%. If the expected return exceeds the interest rate on your loan, prioritizing your investments may be a better choice.
Hybrid approach: paying off student loans and investing at the same time
While many people choose one goal or another, it doesn’t have to be all or nothing. You can use a hybrid approach and work towards both goals.
Think about how much extra money you have available each month to meet your financial goals. Divide that amount in half and contribute to each goal. For example, if you have $ 200 left after paying all your bills, invest $ 100 for your retirement and use the remaining $ 100 to make additional payments on your student loans.
Even though you will progress more slowly than focusing on one goal at a time, you will continue to progress and improve your overall financial situation.
Choosing a debt repayment strategy
If you want to start reducing your student loan balance, you can speed up your repayment by using repayment strategies such as the debt avalanche or snowball methods.
Depending on your mindset, focusing on debt with the lowest interest rate may be the best option. Or, you can stay more motivated if you prioritize paying down debt with the lowest balance first. Whichever repayment strategy you use, you’ll pay off your loans faster and reach your goals faster.