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Updated on Thursday, January 31, 2019
With millions of Americans dealing with more than $1.5 trillion in outstanding student loan debt, it’s no surprise that many young workers are stressed about their debt and hope to pay it off ASAP.
No matter what, it’s vital to keep up with your minimum payments on your student loan debt. But if you can comfortably afford your loan payments along with the rest of your regular budget, what should you do with the spare cash left over at the end of each month? Does it always make sense to pay off your student loan debt immediately, or could you put some of that money to better use by investing?
The decision isn’t always an easy one, but we’re here to help. Here’s what you need to know as you weigh the options.
Pay off student loans or invest: 6 questions to help you decide
Once you have a handle on your monthly expenses and you’re making minimum payments on all your student loans, it’s time to step back and evaluate your situation. If you answer the following questions honestly, you might come to a conclusion about which path — paying off your student loans or investing — is best for you.
1. What are your loans’ interest rates?
Start with your interest rates. How much do your student loans cost, and could you potentially earn more by investing your extra cash?
The common view of paying down debt is that it amounts to a “guaranteed return.” For example, if your student loans have an average interest rate of 4.45%, it’s like earning a 4.45% return on your money since you’re getting rid of something that’s costing you.
However, the average annualized return on the S&P 500 is close to 10%. On top of that, you end up with compound returns from investing, so the earlier you start, the more wealth you can build. By investing today, you could see higher overall returns that beat what you’d save in interest by paying off your student loans faster.
And don’t forget that if you’re eligible for refinancing, you might be able to reduce your student loan interest rates further, see lower payments and put more toward investing, boosting your long-term returns even more.
2. Do you have an emergency fund?
Deciding whether to pay off student loans or invest might not matter if you wind up in an emergency situation and turn to credit cards. Credit card interest rates cost more than you’re likely to earn by investing, and credit card interest isn’t tax-deductible like student loan interest is.
One way to avoid tapping credit cards is to have an emergency fund. You still need to make minimum payments on your student loan debt, of course, but you could divert extra cash toward an emergency fund — building up to at least one to three months’ worth of expenses — before turning your attention to paying off your student loans or investing.
Consider other financial moves that should come before paying down student loans faster too. Paying off higher-interest debt, getting proper insurance and other money priorities might need to be tackled first.
3. Do you earn benefits from your student loans?
Don’t forget that there are some benefits that reduce the overall cost of student loans. Your student loan interest is tax-deductible up to $2,500 if you meet certain income requirements. Plus, because this is an above-the-line deduction, you don’t need to itemize to claim it.
While the deduction isn’t as valuable as a dollar-for-dollar reduction in taxes, it still makes your debt less expensive. That fact, combined with the benefits of investing, means you could see a bigger net gain by investing instead of paying off the debt early.
If you have federal student loans, you may be eligible for student loan forgiveness. If you have a qualifying job and plan to make qualifying payments for Public Service Loan Forgiveness, accelerating your payoff doesn’t help. Additionally, if you qualify for certain forgiveness programs for teachers or health care professionals, diverting spare cash toward investing and taking full advantage of forgiveness may make more sense.
4. Do you have an employer-sponsored retirement plan or employer match?
An employer match is one of the easiest ways to build wealth for the future. It’s money your company invests for your retirement. Even if you decide that it makes sense to tackle your student loan debt faster, consider investing enough in your 401(k) that you get the full employer match before you divert extra money toward your loans.
There is no substitute for time in the market, and investing while you’re young will benefit you when you’re older. That’s why it typically makes sense to do all you can to earn your employer’s full 401(k) match; otherwise, you’re leaving cash on the table.
5. Does your employer offer student loan repayment assistance?
Find out if your employer offers a student loan repayment benefit, a perk that’s becoming increasingly common. Employers may give you extra cash for your student loans if you can show you’ve been making regular payments.
Make sure you carefully weigh competing benefits, though. If you have to choose between a 401(k) match and student loan repayment assistance, the 401(k) match might be the more valuable option over time.
Some companies, however, help you make the most of both. Pharmaceutical company Abbott, for example, offers a 5% 401(k) match for employees who put at least 2% of their pay toward their student loan debt. It’s a way for you to work toward both goals without sacrificing your future.
6. Does your debt stress you out?
Realistically, the math might not matter as much if your student loan debt stresses you out. High levels of debt can lead to serious mental and physical health consequences. Sometimes, it’s less about the financial aspect and more about the psychological realities of having student loan debt hanging over your head.
Consider your financial and emotional risk tolerance. If you lost your job, would you feel comfortable using an option like deferment or income-driven repayment for your federal student loans? Can you handle your student loan payments with ease while meeting other financial goals? Or does the thought of your debt keep up you at night and tie your stomach in knots?
If your health and well-being are better served by getting rid of the debt, that might be the path to take.
Only you can decide what makes the most sense for your situation. Run the numbers and consider the implications as you decide whether to pay off student loans or invest.