Paying Student Loans vs. Investing: Where to Put Your Money First
When you graduate from college you can expect to leave with two things: a diploma and an average of $37,172 in debt. That’s before interest. While student loan debt averages vary based on a number of factors, about one in four Americans has some form of student loans.
If you have student loans, you know chipping away at the interest is frustrating. It’s tempting to invest your money so it can grow versus throwing all your extra income toward your loans. A LendEDU study examined the expected debt-to-income (DTI) ratios of nearly 10,000 student loan borrowers at time of graduation, concluding that 16 percent of those borrowers will have a DTI over 20 percent solely from student loans.
To pay down loans and build wealth in a way that makes sense for your financial situation, take these factors into consideration.
Time for Math
When paying off debt, including student loans, you need to put all your debts on the table. Some may make financial sense to pay off as quickly as possible. Other debts may not be as pressing.
To figure out how to prioritize which loans to pay off as well as where investing fits in, you need to compare your after-tax cost of debts (based on any tax breaks you may get from debts) against your after-tax expected return on investments. Remember, your expected returns will vary greatly depend on where you’re investing money and your investment strategy.
Use the Student Loan Hero Student Loan Payoff vs. Invest Calculator to make the math a little easier.
When to Pay Your Loans First
If interest from any one of your loans or other debts is higher than the amount you expect to earn from an investment, it makes sense to pay that debt first. But there are also other factors you’ll want to take into consideration beyond the math.
If the mere existence of your loans stresses you out, it’s worth working toward becoming debt-free before investing. It’s also worth reducing debt if you like a guaranteed ROI. As The Motley Fool explains, paying off your loan sooner saves you on interest. You know exactly how much money you’re saving in interest whereas investing comes with no guarantee.
When to Put Your Money Elsewhere
If you have credit card debt with high interest rates, you’ll want to focus on paying that off first. Most credit cards have higher interest rates than student loans. If you still have extra money after paying credit cards, consider investing if you expect to earn more than the amount of your student loan interest. This will also help you diversify your wealth and ensure you’re planning for your future, not just trying to keep up with your past.
MarketWatch points out that the problem with paying student loan debt is you may keep interest from piling up but you’re not building any equity. This significantly impacts your ability to grow wealth as you’re missing out on time you can’t get back. Lifehack created a chart that shows how you can earn significantly more money by starting early, even if you invest less money than someone who starts investing later in life.
For loans that are particularly large, Money Under 30 urges you to “get on with the rest of your financial life.” The same applies if you’re early in your career. You may find paying down debt and investing, especially to receive an employer 401(k) match, makes the most sense.
Funding Your Needs
Revisit your strategy often as your circumstances change, you pay off loans, and take on new debt—or your rate of return isn’t as high as you anticipated. You can always change your mix of where you’re putting your money. Of course, you always want to make the minimum payments so you don’t get whacked with fees (aka even more debt) or hurt your credit score.
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The opinions expressed in this post are for informational purposes only. To determine the best financing for your personal circumstances and goals, consult with a licensed advisor.