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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 track of your monthly payments can make it difficult to achieve other financial goals. Indeed, a study of MIT AgeLab found that 84% of American adults said student loans had a negative impact on how much they could save for retirement.
If you’re 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 explained when you should pay off your student loans or invest your money.
Should I repay 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 put your funds, consider the following five factors:
1. Student Loan Interest Rates
The interest rate on your loans should guide you in your decision. Your interest rate affects your monthly payments and the total repayment cost. If you have high interest rates, interest can add up quickly and add to your loan balance. In this case, it may make more sense to pay off the debt to reduce your interest costs, and that frees up more money later.
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 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 benefits. If your employer offers its workers a retirement plan, such as a 401(k), and offers matching contributions, this is an important benefit that you may not be enjoying right now.
4. Financial goals
Think about your goals. If you want to become a homeowner or start a business, you may find that your loans get in the way of you achieving those goals. On the other hand, you may want to focus on investing if your goal is to retire early.
Your age can affect what you should prioritize. If you’re fresh out of college and in your 20s, you have more time to save for 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 saved in a retirement fund.
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When to Prioritize Student Loan Repayment
A common question people ask is, “Should I pay off my student loans or invest?” While there’s no one right answer for everyone, here are three scenarios where it might make sense 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 and 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 may exceed what you would earn in stock market 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 period. This is not always the case for private student loans. Some private loans have variable interest rates which may change over time.
Although variable rates may start low, they can increase significantly. If you have a variable rate loan, paying it off as soon as possible can save you from having to deal with market fluctuations later, and you could save money.
3. Your loans cause you stress
Personal finance isn’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, it may be worth paying off your loans first just to have peace of mind.
When to Prioritize Investment
If you’re unsure about investing or repaying student loans, here are some situations where it might be a good idea to prioritize your investments.
1. Your employer offers matching contributions
If your employer offers a pension plan with matching contributions, this is an important advantage.
According to Vanguard 2021 How America Saves study, 59% of employers offered matching contributions in 2019. Unfortunately, nearly 40% of employees miss out on full matching by not participating. And not making enough contributions to qualify for the full match means you lose money that is part of your compensation package.
Under the most typical 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), or 6% of your salary, your employer will contribute $1,500 to your retirement.
If your employer offers matching contributions, you should prioritize the benefit of full company matching over debt repayment.
2. Your behind on retirement savings
About a quarter of non-retired adults have no retirement savings, according to the Federal Reserve. If you haven’t started saving for retirement yet, it probably makes sense to delay prepaying your loans to focus on building your retirement fund.
The earlier you start saving for retirement, the less you will have to spend of your own money on post-retirement living expenses. 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, such as when your loans are paid off, you’ll have to work a lot harder and save a lot more to reach 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 the interest rate on your loan to the expected returns on your investments. Conservatively, the annual rate of return you can expect from your retirement investments is typically 4% to 7%. If the expected return exceeds the interest rate on your loan, prioritizing your investments may be a better choice.
Hybrid approach: Repaying student loans and investing at the same time
Although many people choose one goal or the other, 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 each month to reach your financial goals. Divide this amount in half and contribute to each goal. For example, if you have $200 left over after paying all your bills, invest $100 for your retirement and use the remaining $100 to make additional student loan payments.
Even though you will progress more slowly than if you focused on one goal at a time, you will still progress and improve your overall financial situation.
Choose a debt repayment strategy
If you want to start reducing your student loan balance, you can speed up your repayment by using repayment strategies like the Methods of Debt Avalanche or Debt Snowball.
Depending on your mindset, focusing on the debt with the lowest interest rate may be the best option. Or, you can stay more motivated if you prioritize paying off debt with the lowest balance first. Whichever repayment strategy you use, you’ll repay your loans faster and reach your goals faster.