Should You Pay Off Your Student Loans or Invest?
My last post was on whether or not you should pay off / pay down your mortgage or invest, so I thought it would be fitting to tackle a similar situation that many of you might find yourselves in.
Should you pay off your student loans or invest?
Student debt is a big deal. Here in the US, we owe $1.5 trillion in student loans.
That’s, on average, close to $40,000 borrowed per student.
No one-size-fits-all answer, because everyone’s situation is so different
There are a ton of variables here to consider.
Without going into crazy details that would make most of you close out of this page, I’ll try to quickly name a few things that you’ll need to take into consideration:
- your current income and future income projections
- what tax bracket are you in (this is important because it’ll show what the actual effective rate you will pay after tax deductions is)?
- are you a single income household or dual income (spouse)?
- where do you live (high cost of living area or low cost of living)?
- do you have an emergency fund?
- do you have other loans such as credit card debt or a mortgage?
- do you work for an employer (for example federal or state government) that will forgive the loan (i.e. public service loan forgiveness program)?
- your comfort level with risk and stability of your income going forward
- are you maxing out your tax advantaged space?
- does your employer offer 401K matching?
See how much there is to consider? I point all of this out to show you that it’s not a one-size-fits-all type of situation.
Non-mathematical considerations you should keep in mind
Mathematical considerations aren’t the only things you should be thinking about. I’m big on both practicality and what’s realistic.
And being realistic, I always try to think about the “human” component because let’s face it, we’re not robots so we can’t be 100% optimized in our lives. It wouldn’t make sense to.
- mental and emotional peace of mind of not having student loans anymore on your plate. That’s huge. Even if mathematically, in your situation, it might be optimal to keep your loans, I would say that for most people, the mental and emotional benefit of paying off your loans by itself is worth it. Life is too short to be 100% optimized, and stress will shorten your life span anyways. And to be honest, my personal opinion is that nothing is worth sacrificing your peace of mind.
- maneuverability and flexibility in your life from liquidity. What does that mean in plain English? What that means is that, if you use all your money to throw it towards your loan, whether it be your mortgage or your student loans, you have to understand that you lose a ton of flexibility because you don’t have the quick access to that money anymore. And if you needed the money again, you’d have to re-borrow at higher interest rates (for example like a HELOC – I won’t get into this because I don’t want to go down a rabbit trail). So it might sound a bit contradictory to what I said above in my first point, but, if you have zero cash on hand, that will introduce a lot of stress in your life too. So I’m big on not going with an all or nothing type solution. So, just because you can put extra money towards your loans, doesn’t necessarily mean you should. For example, would you feel better having a $100,000 emergency fund that you can tap at any time ready-to-go in your bank? Or would you rather throw that $100,000 into paying back your student loans so you end up having a $200,000 loan balance vs. a $300,000 loan balance. I know this is a pretty one-sided example, but you get my point. Sometimes, having the flexibility is what eases stress.
- let’s continue to be “real.” If you were to invest the extra money you have left over from your income into investments rather than paying down your student loans…are you really going to do it? I guess my question is, how disciplined are you really? A lot of people say that they can beat the interest on their loans by investing the money, but often times they end up not staying disciplined, and so they spend the extra money on other things that don’t provide a return.
Conclusion and take-aways
As I’ve mentioned earlier, there are a ton of variables to this formula. Both mathematical and non-mathematical.
So because of this reason, there is no one-size-fits-all solution; having said that, I’m big on being realistic.
You can have the best plan, but let’s face it, we’re all human. And because we’re human, we need to take into consideration our mental and emotional health and not only consider the 100% optimal path. So if you’re the type to be overwhelmed and anxious, I would highly recommend paying off your student loans first just so that you can have a breather and have a far more simpler life. Same goes for all other types of loans. Debt can be a huge burden for most people, so really think about your own sanity and get on the same page with your significant other.
Keep this in mind: nothing is worth sacrificing your peace of mind.
But having said all of that, if you’re the type of person who wants to be 100% optimal with your finances without any emotional or mental considerations, I would do the following (listed in order of priority):
- Save up between 3 and 6 months in an emergency fund that you can access anytime, right away (this is to prevent yourself from financially collapsing in a worst case scenario – don’t get cocky with this because anything can happen in life; so you don’t want to be dead in the water with bills to pay but no money to pay the bills with)
- Max out your employer 401K matching (this one’s a no-brainer because it’s free money you’d be leaving on the table – dude…free money)
- Pay off/down your credit cards because credit cards usually have way higher interest rates (20 – 30% +) compared to student loans
- Pay off/down your car loans if rates are higher than your student loans
- Pay off/down your student loans
- Max out your Roth or Traditional IRA
- Max out your 401K
- Pay off/down your mortgage
- Invest in a taxable account (most people won’t ever get this far since you’ll run out of extra left-over money, but basically this is just standard non-retirement investments)
- Keep or pay down your subsidized student loans as long as the subsidies last (this is your lowest interest student loans that don’t go above 3% – not talking about your usual 4-8% loans)
I hope this post helped some of you!
Business Insider – I Have the Money to Pay Off My Student Loans – But I’m Choosing Not To