Should You Pay Off Student Loans Or Invest?

Pay off student loans or invest

When you finally finish college, it’s exciting to get out in the real world! You’ll finally be able to get a real job and have some income. Now the question is — what should you do with it? You may be caught deciding if you should pay off student loans or invest?

It can be confusing to decide, but don’t let this choice get you down. We see no reason why you have to choose between the two!

Investing with student loans is possible

We'll cut straight to the chase. You don’t need to decide if you should pay off student loans or invest, because you can do both. That said, it will take some careful planning.

You’ll need to create a budget that will maximize your savings while also still allowing you to make your student loan payments. This may take some calculating to nail down just right, but once you do, stick to it. This way, you’ll have a solid financial base and be well on your way to monetary freedom in a few years.

How to decide if you should pay off student loans or invest

Ok, we’ve established you should definitely try to invest while paying off your student loans. But should you put more of your money toward your loans or your investments? Let’s take a look and see what makes the most sense for you.

Think about your interest rates

First and foremost, consider your student loan interest rates. Are they higher than the return you’d get on investing? If so, make paying them off a priority.

The average investment return from the stock market has been about 10% over the last 50 years. Meanwhile, federal loan rates are fixed at 5% for Perkins Loans and 2.75% for Direct Subsidized and Unsubsidized Loans.

This means that for many graduates, putting more into investing is a better idea. However, if you have private student loans with a higher interest rate, consider paying them off faster.

Consider the tax perks

Did you know that paying student loans means you can take up to a $2,500 deduction on your taxes? That’s a great way to owe less come Tax Day!

But is that enough to offset your investment earnings? We recommend doing a quick calculation to see how much the tax credit would lower your student loan interest rate. Just take your student loan interest rate and multiply it by 1 minus the marginal tax rate.

Let’s do a quick example so you can see what we mean. The marginal tax rate as of 2021 is 22% for income over $40,525 and below $86,375, which is probably the tax bracket most graduates fall into. So you’d subtract 0.22 from 1, which is 0.78.

Then, multiply 0.78 times your student loan rate — let’s use the current rate for a Perkins Loan, 5%. Your result is 3.9%, meaning that’s your new estimated student loan interest rate when you account for the tax credit.

Is your estimated investment return rate still higher? In most cases, it should be, so stick with putting more money into that! Also, keep in mind you may also get investment tax savings — like a special tax credit for contributing to retirement accounts.

Look into student loan forgiveness

Federal student loans can sometimes offer income-driven repayment or even forgiveness depending on your job. There are programs for teachers and public service workers to get a portion of their loan forgiven. You may also be able to qualify if your school closed or lost its accreditation. If you qualify for such a program, you can definitely put more toward investing.

While private loans can’t be forgiven, but you might be able to refinance to potentially lower your interest rate. There are pros and cons to this though, so take some time to consider before pulling the trigger.

Tips for investing with student loans

Now that you’ve decided whether you should pay off student loans or invest, we’ll provide some tips to help you make it work.

Always pay your minimum balance

Even if you decide to go heavy on investing, never skip on a student loan payment. Even missing one payment could lower your credit score, and your loan might eventually go into default.

Still keep up with an emergency fund

An emergency fund is imperative to have in case you have unexpected bills. We recommend having at least three to six months of essential living expenses saved up.

Think about refinancing to lower your monthly payments

If you have a high-interest rate on your student loans, you might be able to lower that rate by refinancing. This would lower your monthly payments so you could put more toward investing.

Take advantage of your employer’s plan

Does your employer offer a 401k? If so, you need to be contributing to that! That’s especially true if they provide 401k matching. This means they’ll double a specified percentage of what you contribute — more free money!

Open an IRA

One easy way to invest without too much stress is opening an IRA. You can contribute to this whenever you have extra cash on hand, up to a total of $6,000 a year.

Investing outcome examples

You might not be able to invest a ton at first, especially if you have larger loan payments. But that’s ok, because every little bit counts when you give it time to compound!

Let’s say you have a job that pays $50,000 a year — about $44,000 after federal taxes — so you’ll have a salary of roughly $3,400 a month.

The average student loan payment is between $200 to $299 a month, so let’s use $250 for that. Then let’s assume you have $2,500 in living expenses, put $200 toward your emergency fund, and spend $200 on entertainment. That leaves $250 a month for investments.

It might not sound like much, but it adds up. The average large-cap index is estimated to deliver a 6% average annualized return rate over the next 10 years. While conservative, let’s use that number for our calculations.

With that return rate, you’ll have $39,359 saved after 10 years with $1,275 of that coming from compounded interest. After 25 years, that’s $150,013 with $26,491 of compounded interest – in other words, free money!

Find the right balance

Investing with student loans is not only possible, but a great life choice. You’ll be paving the way to financial success with every dollar!

Be smart with your money, and make responsible choices when it comes to paying off loans, investing, or both. Need more help? Check out our financial roadmap to get a better idea of how to budget and prioritize debt.

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