Should you pay off student loans or invest?

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After paying your bills and covering necessary expenses each month, you may have money left over. While it’s tempting to splurge, it’s usually better to use that extra money to make extra payments on outstanding debt or invest. If you have a large student loan balance, you may want to put all extra funds into paying off those loans. However, generally, investing is a better option to explore when you can reasonably expect a return that’s higher than your student loan interest rate.

Paying off student loans early vs. investing: Key takeaways

  • It’s important to make the minimum required payments on your student loans.
  • Paying off student loans early could be a good idea if you have a high interest rate.
  • Consider investing if you have a potentially high rate of return or are in a loan forgiveness program.

Factors to consider when deciding whether to pay off student loans or invest

If you have extra cash at the end of the month, should you pay off student loans or invest? In short, there’s no right answer. A lot goes into this decision — like your expected return and your personal priorities. Here’s what to think about when considering if you should pay off student loans or invest.

Personal priorities

Start by thinking about your overall financial picture. You need to consider your other debts, savings goals and personal priorities. Here are some other goals you might decide to prioritize:

  • Save for emergencies: Building your savings – particularly your emergency fund – should be your first priority, because it can help you stay afloat during financial emergencies. So before you pay off student loans or invest, save at least one month’s worth of expenses. Over time, try to build up to six months’ worth of expenses.
  • Save for retirement: It’s always a good idea to start your nest egg early and give it plenty of time to grow. If your employer offers a 401(k) match, take advantage of it. Explore other opportunities outside of a 401(k) to start contributing to retirement accounts and saving for your retirement.
  • Pay off high-interest debt: Credit card balances, personal loans and other types of debt might have higher interest rates than your student loans or your return on investments. Paying these off first can give you a higher return than investments or student loan debt.
  • Tackle big life goals: If you’re looking to have kids or save for a house down payment, you might decide to make minimum payments on your debt and hold off on investing for now. This gives you space in your budget to save for those bigger financial milestones.

A final personal priority to think about is whether becoming debt-free is a top goal for you. If so, you may want to hold off on investing and put all your excess funds toward paying off your student loans early.

Interest rates

Depending on when you borrowed the money, interest rates on federal loans range from about 3 percent to 7 percent. Private student loan interest rates are usually higher. Paying down your debt is like a guaranteed return on the money, so if your student loan interest rate is 5 percent, then you’re getting a 5 percent return.

Compare this rate of return to your expected investing return. Money market accounts and certificates of deposit generally get a low return, around 0.5 to 2 percent. Stocks can offer a much higher return, around 10 percent annually in a strong economy, but they’re more volatile. A conservative but realistic return on investments is around 6 to 7 percent a year.

If your student loan interest rate is lower than what you can realistically expect to earn investing, then it could make sense to prioritize investing over paying down student loans early. It’s worth noting that until Sept. 30, 2021, all federal student loans have a 0 percent interest rate and payments are not required, so now could be a great time to start investing.

Tax deductions

When you’re paying off student loans, you might be able to deduct interest payments you make on that debt. Eligible borrowers can lower their taxable income by up to $2,500, which helps offset the cost of student loans over time.

Forgiveness programs

If you have federal student loans, you might be able to get student loan forgiveness, which eventually cancels all or some of your student loan debt. If you plan to take advantage of student loan forgiveness, then it might not make sense to put extra payments toward the debt, since making extra payments won’t get you to loan forgiveness any faster. You could instead put the extra money toward investing and grow your money over time.

But look closely at the loan forgiveness details. When you enroll in income-driven repayment plans, such as Pay As You Earn (PAYE), you might pay more in interest, because the loan terms are stretched over more years. This may affect your decision to enroll in one of these programs or to start investing now.

Paying off student loans vs. investing

There’s no definitive answer for when it’s best to pay off student loans early or invest. However, consider a few scenarios when one option might be better than the other.

When to pay off student loans

  • Your top goal is to be debt-free: If being debt-free is a high priority for you, it makes sense to put all your extra money toward paying off your loans. Sometimes, knowing that the burden of your loans will be gone is enough to make it worth it.
  • Your loans have a high interest rate: A higher interest rate (closer to 7 percent or above) on your student loans means that you will likely get just as good a return on your investment for paying off your loans as you would with investing.
  • You don’t have extra funds after setting your financial goals and budget: If your cash flow is unpredictable and you typically have only enough for your minimum student loan payments, it’s best to hold off on investing.

When to invest

  • The rate of return for investing is higher than the interest rate on your loans: While investing never offers a guaranteed return, if your research shows that the rate of return for your investments will likely be higher than the interest rate for your loans, it could be a good idea to start investing.
  • You are enrolled in a student loan forgiveness plan: When your loans will be forgiven after a certain period of time, it may not make sense to pay off as much as you can. Make the minimum required payments and use your leftover money to start investing.

How to invest when you have student loan debt

If you’ve decided to start investing, start by figuring out how much you can put toward this goal every month while still making student loan payments. Add up your monthly expenses (including a little bit of spending money) and subtract this amount from your monthly post-tax income. What’s left is fair game for investing. Here are a few ways to try investing:

  • Use an investing app: Some apps, such as Stash or Acorns, let you start investing with as little as $5. These are great for people who are new to investing or who need a little help managing their investments.
  • Hire a broker: A stock broker is a person or company that buys and sells shares on your behalf. You may decide to look for low-cost online brokers, like Fidelity, or go for a free service like Robinhood.
  • Buy an S&P 500 index fund: An S&P index fund has shares of all the stocks in the index, which helps you diversify your investment and get a less volatile return.

The bottom line

Deciding whether to pay off student loans or invest depends on your financial priorities and which option gives you a better return. If the rate of return in investing is higher than your student loan interest, then you might decide to invest – but keep making minimum payments toward your student loans in the meantime.

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Written by
Kim Porter
Contributing writer
Kim Porter is a personal finance expert who loves talking budgets, credit cards and student loans. In addition to serving as a contributing writer for Bankrate, Porter also writes for publications such as U.S. News & World Report, Credit Karma and Reviewed.com. When she's not writing or reading, you can usually find her planning a trip or training for her next race.
Edited by
Student loans editor