Pay Off Student Loans or Invest: What You Should Do

The average borrower takes 20 years to repay their student loan debt, costing them around $26,000 in interest alone. While it may be tempting to throw all your extra cash toward your student debt to relieve that burden faster, sacrificing investing for retirement to do so may not be the best approach. That said, the decision to pay off student loans or invest isn’t that simple.

If you’re frozen with indecision, here are a few things to consider.

Should I Pay Off Student Loans or Invest?

As with any personal finance decision, deciding whether to pay off student loans or invest is personal. Which route is more advantageous for you will depend on your unique situation.

Generally speaking, however, there are a few main factors to consider:

What Interest Rates Your Student Loans Have

It’s important to consider the interest rate on your student loan(s) in comparison to what you believe the stock market will return. For example, the average student loan interest rate, across all types of student loans, is 5.8%. However, the average return of the S&P 500 is around 10%.

Most investing experts agree that the earlier you invest, the better. This is because of the power of compounding interest: the longer you allow your investments to grow, the greater return you will receive. But by the same token, the longer you take to pay off your student loan debt, the more interest will accrue.

If you have a low-interest student loan, investing may generate a greater return than the amount of interest that accrues on your student loan. However, if you have a high-interest student loan, the interest costs may far outweigh the 10% return from investing.

>> MORE: What is the average student loan interest rate?

What Type of Student Loans You Have

Federal student loans have the potential to be forgiven. Each student loan forgiveness program will have its own unique set of requirements. Nonetheless, many will require you to make a specific number of minimum monthly payments to qualify. After making the required payments, your remaining student loan balance will be forgiven.

Given that your debt will be forgiven upon making just the minimum payments, there is little benefit to making surplus payments. In this case, investing would make more sense than directing a surplus payment toward your student debt.

Private student loans, on the other hand, don’t have the potential to be forgiven. So, depending on your interest rate and loan balance, surplus payments may make more sense in comparison to investing.

>> MORE: Compare private student loan rates

Your Debt’s Impact on Your Mental Health

If your student loan debt is causing you an unmanageable amount of angst, it may make more sense to focus your attention on throwing all your spare cash toward it. Even if you recognize that the returns from investing will far outweigh the cost of your student loan interest, it’s okay to prioritize your mental health and pay off your student loan debt first.

When to Prioritize Paying Off Student Loans Over Investing

As a guideline, there are a few circumstances in which paying off your student loans before investing makes more sense:

1. If your student loan interest rate is over 6-7% and you have a high loan balance. The larger your loan balance, the more interest you’re likely to accrue. For example, if you owe $10,000 at a 6% interest rate, you would pay $17,194 total over the course of a 20-year repayment term. However, if you owe $100,000 at a 6% interest rate, you would pay $171,943 total over the course of a 20-year repayment term. Notice how the higher outstanding loan balance results in significantly higher interest costs.
2. If you are concerned about being unable to pay your student loan payments in the future. If you opt to prioritize investing, but later experience an inability to make your student loan payments, it may be a scramble to come up with the cash. While you can withdraw money from your investment account, you will likely face a penalty to do so.
   
   If you predict a circumstance that will impact your ability to make your student loan payments in the future, it may make more sense to prioritize paying them off before investing. Directing surplus payments toward your student debt will lower your minimum monthly payment, which may make your future payments more manageable.
3. If your student loan debt is negatively impacting your mental health. If paying off your student loans will provide you with an immense amount of peace, paying them off before investing may make the most sense.
4. If you simply don’t want to have any outstanding debt on your record. Paying off your student loans would not only remove the outstanding debt from your record, but it could improve your credit score as your debt-to-income ratio shifts. 

When to Prioritize Investing Over Paying Off Student Loans

Here are a few instances in which investing before paying off your student loans makes more sense:

1. If your student loan interest rate is less than 5% and you expect to return the average 10% on your investments. Even with interest costs, the average rate of return on investments will likely outperform most low-interest student loans.
2. If your employer offers a 401k match and you are fully vested, meaning you are entitled to the full amount in your 401k including your employer’s match. If you currently contribute to a 401k with an employer match, you may be required to work for the company for a specific amount of time to be entitled to 100% of that employer match. If you decide to leave the company prior to being fully vested, you may only be entitled to a portion of your employer’s contributions.
3. If you believe the return on your investments will far outweigh the cost of the student loan. In some instances, investing will far outperform the interest costs associated with making minimum monthly payments on your student loans. In those instances, it may make more sense to focus on investing over paying off your student loans.

Do the Math to See Which Option is Better

If you still aren’t leaning towards one option over the other, do the math to give yourself a concrete answer. Mathematically, one option will outperform the other, which can give you a clearer picture of what to do.

Let’s say you’re in an “either/or” situation — you either want to put an extra $500 on your student loan each month or invest it. Here’s how this would play out based on the average student loan debt and investing data.

Pay Off Student Loans	$37,693 balance	5.8% interest rate	20 year repayment term	Total paid before $500/mo surplus payment: $63,771	Total paid with $500/mo surplus payment: $43,360	By adding a $500/mo surplus payment, you save $20,411 and pay off your student loans in 5 years instead of 20.
Invest	You invest $500/mo.	Average rate of return: 10%	Balance after 20 years: $361,993.36	After 20 years, you contribute $120,000 but earn $241,993.36 in interest.	Balance after 15 years: $200,810.61.	After 15 years, you contribute $90,000, but earn $110,810.61 in interest.

If you opted to direct the $500 a month toward your student debt, you could pay off your loan in 5 years instead of the full repayment term of 20 years. This would save you $20,411 over the life of the loan. Then, let’s say that after paying off your student loans, you began investing that $500 a month. After 15 years, you would have earned $110,810.61 in interest. In total, you “earn” $131,221.61 between both the savings on interest and the interest that accrued on your investments.

Now, if you chose to pay only the minimum monthly payment on your student loans and invest that $500 a month instead, it would take you the entire 20-year repayment term to pay back your student loans. However, you would have earned $241,993.36 in interest on your investments. Even after considering the additional $20,411 cost of making only the minimum monthly payments on your student loans, you still score a net earning of $220,933.36.

In this case, prioritizing investing over paying off your student loans makes mathematical sense. To calculate whether it makes sense for your specific situation, utilize investment calculators and student loan repayment calculators.

Create a Balanced Approach Between Debt Payoff and Investing

The examples we’ve discussed illustrate an “either/or” approach. However, it isn’t necessary to be successful in paying off your student loans OR investing. In fact, creating a balanced approach may work best for you.

If focusing solely on one leaves you anxious about your progress in regards to the other, find a middle ground. For example, in the case of having an extra $500 each month, it’s okay to split up your payments. Directing half towards your debt and half towards your investments isn’t a bad idea if it gives you peace of mind.

FAQs About Paying Off Student Loans vs Investing

The decision of whether to pay off student loans or invest may feel difficult. It’s normal to still have questions. Here are a few of the most common ones:

Is there a downside to paying off student loans early?

When borrowers ask this question, they’re often concerned about facing a prepayment penalty. A prepayment penalty is a fee charged when a borrower pays off their entire loan balance earlier than scheduled. While some lenders may charge a prepayment penalty, student loan lenders cannot.

With that said, the only notable downside to paying off your student loans early is that you may experience a temporary drop in your credit score. By paying off your student loans, you are closing an active line of credit. By doing so, the positive repayment history associated with the account will no longer be factored into your credit score.

Should I use all my savings to pay off my student loans?

While it may be tempting to use your entire life’s savings to wipe out your student loan debt, it isn’t the best approach. Before even considering investing or putting a surplus payment on your student loans, make sure you have a fully funded emergency savings of at least 3 to 6 months of expenses.

However, if you have a fully funded emergency savings, it may make sense to use the remaining balance to pay off your student loans.

What else can I do to pay off my student loans faster?

If it’s not feasible to make a surplus payment on your student loans, here are some ways to pay off your student loans faster:

Consider refinancing. In a simple sense, refinancing your student loan allows you to swap your current student loan(s) for one with a lower interest rate or more favorable terms. Then, you can save money over the life of the loan and expedite the process of getting your balance to zero.

>> MORE: Compare the best student loan refinance rates:

Opt into automatic payments. Many private student loan lenders offer a 0.25% interest rate discount to borrowers who opt in to automatic payments. While a small deduction, it can make a significant difference depending on your current interest rate and outstanding loan balance.

Cut back on expenses. If you don’t already track your spending, consider doing so. By understanding where your money goes, you may find that you’re able to cut back expenses in certain areas. Then, you can re-direct that money toward loan payments.

Pick up a side hustle. The average side hustle generates between $507 and $746 per month, according to USA Today. If you have the capacity to take on a side gig, the additional income could cut down your repayment period.

Final Thoughts from the Nest

When it comes to the decision of whether to pay off student loans or invest, there is no one-size-fits-all solution. Before making a decision, take the time to understand what makes most sense for your unique financial situation. If you still feel unsure, consider consulting a financial or investment advisor for personalized advice.

The content of this article is not, nor should it be, taken as financial advice. The content of this article is for educational purposes only. For personalized financial advice, please consult a financial or investment advisor.