Home > Students & Debt > Millennial Dilemma: Pay off Student Loans or Invest and Save
After earning a pricey new degree from college, your natural tendency is to seize the first respectable job offer that comes your way and work to reduce your student loan debt as much as you can.
But what about putting those hard-earned money into the stock market? The more you invest, and the earlier you invest, the more you may be able to withdraw for retirement, home ownership, or other major financial objectives.
After thinking about it for a while, you can’t help but wonder: Is there another way I could use my extra money?
In other words, is it better to pay down student loan debt or invest in retirement?
Riley Adams, the founder of the personal finance blog Young and the Invested and a licensed CPA, stated that pursuing one at the expense of the other is not a good idea. According to Adams, “the individual should contribute to the allocation which makes them feel best. ”.
Although it’s not an easy choice, you could find the answer a little bit more easily if you enter some numbers into a fictitious scenario.
Student loan debt weighs heavily on the minds of millions of Americans With an average student loan balance exceeding $30,000, many borrowers grapple with the question of whether to aggressively pay off their loans or pursue other financial goals.
This comprehensive guide will delve into the pros and cons of aggressive student loan repayment, helping you determine the best strategy for your unique financial situation. We’ll explore the potential benefits and drawbacks, analyze various repayment options, and provide valuable insights to guide your decision-making process.
Understanding Aggressive Student Loan Repayment
Aggressive student loan repayment refers to prioritizing debt reduction by making larger-than-minimum payments, often with the goal of becoming debt-free as quickly as possible. This approach can offer significant financial advantages, but it also comes with certain trade-offs.
Pros of Aggressive Student Loan Repayment
- Reduced Interest Payments: By paying off your loans faster, you’ll accrue less interest over time, potentially saving thousands of dollars.
- Improved Credit Score: Aggressive repayment demonstrates responsible financial management and can boost your credit score, leading to better interest rates on future loans and credit cards.
- Financial Freedom: Eliminating debt can free up your income for other financial goals, such as saving for a down payment on a house, investing for retirement, or starting a business.
- Reduced Stress: The burden of student loan debt can be a significant source of stress. Aggressive repayment can alleviate this stress and provide peace of mind.
Cons of Aggressive Student Loan Repayment
- Reduced Liquidity: Aggressive repayment may limit your available cash flow, making it difficult to cover unexpected expenses or invest in other areas.
- Sacrifices in Other Areas: Paying off loans faster may require sacrifices in other areas, such as reducing spending on entertainment, travel, or other discretionary expenses.
- Potential Tax Implications: Depending on your income and the type of loans you have, aggressive repayment could lead to higher taxes.
Factors to Consider When Deciding
Several factors should be considered when deciding whether to aggressively pay off your student loans:
- Interest Rates: The higher your interest rates, the more sense it makes to prioritize repayment to minimize interest charges.
- Income and Expenses: Your income and expenses will determine how much you can afford to put towards debt repayment without compromising your lifestyle.
- Other Financial Goals: Consider your other financial goals, such as saving for retirement, buying a home, or investing.
- Risk Tolerance: Are you comfortable with the potential sacrifices involved in aggressive repayment?
Analyzing Repayment Options
- Standard Repayment Plan: This is the default repayment option, typically with a 10-year repayment term.
- Graduated Repayment Plan: Payments start low and gradually increase over time.
- Extended Repayment Plan: This plan extends the repayment term to 25 years, reducing monthly payments but increasing the total interest paid.
- Income-Driven Repayment Plans: These plans base your monthly payments on your income, making them more affordable for borrowers with lower incomes.
Seeking Professional Guidance
Consult a credit counselor or financial advisor for advice if you’re unclear of the best course of action. They can assist you in assessing your financial status, creating a customized repayment strategy, and making defensible choices regarding your student loan debt.
The decision of whether to aggressively pay off your student loans is a personal one. There’s no right or wrong answer, as the best approach depends on your individual circumstances and financial goals. By carefully considering the pros and cons, analyzing your repayment options, and seeking professional guidance if needed, you can make an informed decision that aligns with your financial priorities.
Remember, there’s no one-size-fits-all approach to student loan repayment. The best strategy is the one that works best for you.
Paying off Student Loans Early
This can work, but you need a high enough and steady enough income from your first job. If you’re already having trouble making ends meet with rent and utilities, you will find it extremely difficult to pay off your student loans early. If you want a simple method to reduce spending and use the money to pay off your student loans, get a roommate or stay at home for a year or two.
Prior to paying off your student loans, you should also have an emergency fund saved up that is equivalent to three to six months’ worth of income. If you haven’t saved up any money to fix your car and it breaks down, it can be difficult to get to work.
With that all settled, it’s time to whip out the budget. The more you can bolster your required payment the better. The secret is to allocate as much as you can while still finding joy and purpose in your life. Eating out is acceptable occasionally, but paying for meals five or six times a week is a bad financial decision. And that two-month-long African safari? Put that one on hold. If you’re struggling to create a balanced budget, you might want to give a nonprofit credit counseling organization a call for some free guidance on how to get by.
Reaching out to a lender to find out if you qualify to refinance that student loan is an additional option. Car loans, mortgages and credit cards can all be refinanced. Student loans are no different.
Be careful: refinancing can help you get rid of your student loan debt, but it also removes your access to the federal loan lifelines. This implies that in the event of calamity, you forfeit your eligibility for any kind of deferment or forbearance if you refinance with a private lender.
Lenders that refinance student loans want to know about your income stability and credit score. The lender believes that the best applicant is one who earns a consistent salary and has a good credit score (680 or above). You could get rates anywhere from 2. 4%-8% in the summer of 2019.
This is only a good idea if your lender is reducing your interest rate. Consider improving your credit score for a few months and then getting in touch with lenders again if you’re not getting a good offer.
The average student graduates with around $37,000 in student loan debt with an average interest rate of 4. 5%. That means payments of $384 a month for the next 10 years. If you’re wise, you’ll make more than the standard payment to avoid racking up interest.
Let’s say you find a lender offering you a rate of 3. 5%. After crunching some numbers, you figure you can throw an extra $200 a month toward your payment.
In this instance, the $200 monthly payment will be added to the $384 monthly minimum that you would have paid otherwise you hadn’t refinanced. After all, if you could make it work then, you can make it work now. This means you will pay $584 a month on your new loan.
Compared to a typical 10-year plan, this approach will pay off the debt in less than six years and save you $3,968 in interest. That is a total of $40,968 for an undergraduate diploma.
Unfortunately, college is still pretty expensive. Positively, by paying an extra $200 a month and lowering your interest rate by one percentage point, you save $5,048.
Clearly, paying off your student debt quickly can save you a lot of money, but what about the stock market? Compound interest, that thing your economics professor used to lecture you about all the time, can actually make you a lot of money if you play your cards right.
401K or Student Loans?
What happens when we add a 401k into the mix? For one, you can earn even more money. The 401k programs are popular because your employer is essentially, handing you free money.
The median employer match for a 401k is 3% of your salary. This means if you invest 3% of your salary into your 401k, your employer will invest another 3%. The money is tax-free, at least until you pull it out in retirement.
Let’s say you decide to take full advantage of your 401k. You and your employer both contribute 3% of your salary. Upon reaching the average entry-level salary of $50,000 per year for a recent college graduate, your 401(k) balance will have increased by $3,000 by the end of the year. That is $1,500 from you and $1,500 from your employer.
This is an even better option than investing on your own. You only risk $125 per month as opposed to $200 of your own money, and you end up with even more money saved for retirement.
Am I Doing the Right Thing By Paying Down My Student Loans Aggressively?
FAQ
Is it smart to aggressively pay off student loans?
Should I pay off a chunk of my student loans?
Is there a downside to paying off student loans early?
Is it better to save money or pay off student loans?
Should I pay off my student loans aggressively?
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.
Should you pay off student loans fast?
Paying off any debt — usually credit cards — that has a higher interest rate than your student loans. If you’re anxious to pay off student loans fast, pay a little extra while working toward your savings and investment goals.
Should you pay down a student loan if you have high interest rates?
If you have high interest rates, interest can accrue rapidly, adding to your loan’s balance. In this case, it might be smarter to pay down the debt in order to lower your interest rate costs, and it frees up more cash down the road. 2. Loan Type There are two main types of student loans: federal and private.
Should you invest or pay off student loans?
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. 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.