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Getting rid of debt: Pay off student loans fast.
Saving money: Lower your interest rate on student loans.
Shrinking payments: Reduce your monthly student loan bill.
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If you're wondering whether to pay off student loans or invest, first look at your current financial situation.
How is your monthly cash flow? Do you have money left over after covering your necessities — also called discretionary income — or do you feel like you're living paycheck-to-paycheck?
What about an emergency fund? Is there a safety net in case unexpected expenses pop up?
In an ideal financial situation — high disposable income, no high-interest debt — here's what your money landscape should look like:
If you've hit these goals or you're well on your way, here’s how you can decide whether to use any leftover money to pay off student loans or invest.
» MORE: New law makes it easier to pay student loans and invest
If you have high-interest student loans
A general rule of thumb is to invest instead of aggressively pay off your student loans if the average return on investment is higher than your student loan interest rates.
A conservative but plausible return on investments is 6% per year. If your student loan interest rates are higher than that, you’d save more money by paying them off — and avoiding interest charges — than by investing.
If your student loan interest rates are less than 6%, consider putting extra money toward retirement or a brokerage account for non-retirement investing. Over the long term, your investments could potentially earn more compared to the savings from paying off those loans.
Remember, the more time you allow your money to sit in an investment, the more compound interest can work in your favor. By investing when you’re younger, you give your money more time to grow. See how much you could gain by using a retirement calculator.
If you have federal student loans
Federal loans generally have lower interest rates than private loans and come with more benefits, like Public Service Loan Forgiveness, where your remaining balance is discharged after 10 years of monthly payments. If you only have federal loans and you qualify for a forgiveness program, investing rather than paying them off could make more sense.
If you have private student loans, there is less to lose by prioritizing repayment — and potentially more to gain by refinancing. Student loan refinancing can decrease your interest rates, letting you pay loans off faster and free up money for other financial goals, like saving or investing.
Refinancing will save you the most money if you have a credit score at least in the high 600s and stable income. Refinancing federal student loans can be risky because you’ll lose federal benefits and other protections. Be sure you won’t need those benefits before going this route.
» CALCULATE: Should you refinance student loans?
What is your personal money goal?
For some, being debt-free is a top priority. If paying off student loans early is a major personal goal — and doing so would relieve a burden and bring more joy than having a hefty investment account — go for it.
To aggressively pay down your debt, you’ll have to pay more than the minimum payment. Opting for biweekly payments rather than monthly could make this a bit easier. Some lenders will even let you make multiple payments a month automatically.
Other ways to prioritize repayment could include using tax refunds and extra income from side jobs to make lump-sum loan payments on your balance. You can also look to your employer for benefits, like an employer student loan repayment program, to help you pay off your balance quicker.
And beginning in 2024, employers will be able to count qualified student loan payments as elective deferrals toward a retirement savings account. That means your employer would be able to match your student loan payment and deposit that amount into your 401(k) — a great way to grow your retirement savings without shelling out the additional dollars.
FAQs
A general rule of thumb is to invest instead of aggressively pay off your student loans if the average return on investment is higher than your student loan interest rates. A conservative but plausible return on investments is 6% per year.
Is it better to invest or pay off student loans first? ›
Neither option is inherently better than the other, as the "right" one to prioritize will depend on your goals and how comfortable you are having debt. Before you decide between using extra cash to either pay down student loans or invest, you'll want to ensure you fully understand your financial situation.
Is it more important to invest or pay off debt? ›
A less aggressive investment mix, meaning one with a lower allocation to stocks, may be expected to result in slightly lower returns (on average) over the long run. And with slightly lower expected returns on investing, paying down debt comes out ahead even at slightly lower interest rates.
Is it more important to save or pay off student loans? ›
If your loan interest rates are low and fixed, you may want to prioritize saving over paying off your loans. On the other hand if your loans are high-interest, or you don't have a plan to get a good return on your savings, paying off your loans may make more sense.
Is it better to have an emergency fund or pay off debt? ›
On one hand, paying off debt could save you thousands in interest. On the other hand, failing to build your savings could force you into further debt if you encounter unexpected expenses. Generally, building an emergency fund should be your priority.
Is it smart to aggressively pay off student loans? ›
Paying off student loans early can benefit you financially, but it should typically come second to building your emergency fund and retirement savings. People with private student loans or without other debt tend to benefit more from paying off student loans early.
Should I pay my loan off early or invest? ›
Investing and paying down debt are both good uses for any spare cash you might have. Investing makes sense if you can earn more on your investments than your debts are costing you in terms of interest. Paying off high-interest debt is likely to provide a better return on your money than almost any investment.
What is the 50 30 20 rule? ›
Do not subtract other amounts that may be withheld or automatically deducted, like health insurance or retirement contributions. Those will become part of your budget. The 50-30-20 rule recommends putting 50% of your money toward needs, 30% toward wants, and 20% toward savings.
Why you shouldn't rush to pay off student loans? ›
Despite what you may think, paying off your loans as soon as possible isn't always the best thing to do. Getting ahead of your debt is, in general, a smart move; however, if it comes at the cost of avoiding other debt, or overshadowing other benefits you may be receiving, it could set you back in the long run.
Why is student debt not worth it? ›
Key Takeaways. Carrying student debt can affect your ability to buy a home if your debt-to-income ratio is too high. If you have too much student loan debt, you won't be able to save as much for retirement. Student loan debt can lower your credit score, especially if you fail to make on-time payments.
Wiping out high-interest debt on a timely basis will reduce the amount of total interest you'll end up paying, and it'll free up money in your budget for other purposes.
How much savings should I have at 40? ›
By the time you reach your 40s, you'll want to have around three times your annual salary saved for retirement. By age 50, you'll want to have around six times your salary saved. If you're behind on saving in your 40s and 50s, aim to pay down your debt to free up funds each month.
Is saving more important than paying off debt? ›
Though you may want to pay off your debts as soon as possible, it's also important to create an emergency savings fund in case an unexpected expense arises. With no emergency savings to draw on during a crisis, you may have to rely on a high-interest credit card or a personal loan to cover the costs.
Is there a downside to paying off student loans early? ›
Con: You May Be Short On Cash
Allocating all of your extra cash toward your debt can cause you to fall behind in saving for retirement or building an emergency fund, so it's important to find a balance between paying off student loans early and pursuing other financial goals.
Should I pay off 6% loan or invest? ›
Pay off high-interest debt before investing.
There's a big difference between your 5.05% federal student loan and 16.99% to 23.91% credit card debt. High-interest credit card debt costs more over time making it much more difficult to pay off.
Is it a good idea to invest student loans? ›
If you have high-interest student loans
A conservative but plausible return on investments is 6% per year. If your student loan interest rates are higher than that, you'd save more money by paying them off — and avoiding interest charges — than by investing.
Should you pay off student loan interest or principal first? ›
Initially, most of each loan payment will be applied to interest charges, not the principal, so the loan balance will decrease slowly. There may also be interest that accrued during a deferment or forbearance. This interest must be paid off before the principal balance will decrease.
