Should I Pay Off My Student Loans or Invest?

Should I Pay Off My Student Loans or Invest - picture of concerned piggy bank with diploma and graduation hat

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Editor’s Note: In response to the coronavirus pandemic, as of March 13, 2020, the Trump Administration has halted interest payments on federal student loans. Please note that this applies to federally held student loans only and may not apply to your private student loans. Also note that student loan payments are still required, however your entire payment will now be made toward the principal of the loan. Check with your student loan provider for more information.

We all have limited funds at our disposal. So, using our money efficiently means making sound financial choices. Whether we’re shopping for groceries or buying a car, every dollar spent means we have less to spend in other areas.

The same goes for student loans and investing. Sarah from Colorado recently asked us this:

Hi Holly and Greg,

I started a budget a few months ago and have cut my expenses. It’s wonderful, and I’m saving more money than ever! Now, I’m trying to decide what to do next. I’m considering using the extra money to payoff [sic] my student loans early, but I’m also thinking about investing more money in retirement or mutual funds. Do you have any suggestions?

First of all, bless you Sarah! We’re freakin’ ecstatic to hear that you’re taking charge of your money. Better yet, you’re going to use that money to get even further ahead. You deserve two snaps in “Z” formation!

Seriously, good work.

Should You Pay Off Student Loans or Invest?

Now, about your question. The thing is…it depends. I’d love to offer a quick and clean answer, but there are a gazillion different factors that could influence your decision. So, before you choose whether to pay off student loans or invest that money, let’s take a look at some of the things that should drive your decision.

Get Rates from Multiple Lenders – Whether you decide to pay off your loans or invest first, refinancing your student loans could be a great option. If you’re considering refinancing, Credible can help you compare rates from multiple lenders here.

Why It Makes Sense to Pay Off Your Loans First

Generally speaking, I’m of the opinion that debt blows. It crushes you emotionally and financially. When you’re in debt, part of every dollar you earn is spoken for. It destroys your ability to save and it limits your options – both with your money and your career. So, yeah, I’m typically firmly in the “pay off your debt now” camp.

Shameless Plug: Holly and I just finished writing a book on this very subject. It’s called Zero Down Your Debt, and you can find it in stores now!

Beyond that, debt is dangerous. When you owe money, you put yourself in a precarious financial position. If you lose your job or aren’t able to work, there’s a good chance you won’t be able to make your payments. Student loans can be even riskier. In almost all cases, even bankruptcy won’t make them go away. That means you’ll be paying on those puppies for-ev-ah!

Additionally, paying off your student loans (and any other debt) could be considered one of the safest investments you can make. By paying off your loans early, you’ll be saving on interest. So, if you’re loan is at a 4% interest rate, you’ll effectively be keeping an extra 4% of your money by paying it off early. (Make sense?)

Finally, being in debt tends to perpetuate accumulating more debt. The fact that we already owe dulls our senses to the harm that debt causes. But when you’re out of debt, the last thing in the world you want is to rack up a new payment. Paying off your student loans quickly helps you enter that state of mind in a jiff!

See Also: Compare the Best Student Loan Refinancing Rates Here!

Why It Makes Sense to Invest First

Although I abhor debt, there is an argument to be made for investing the extra money you’re saving. Depending on the type of loans you have and their interest rates, keeping your loans and investing your money may be the correct mathematical solution. By paying your loans off early, you could be losing money to opportunity cost.

So what is opportunity cost? Let’s look at an example to understand the concept. Suppose you keep $10,000 in a savings account. That’s fine and dandy, but you could be missing the chance to make additional money by investing it in the stock market instead. The loss of potential gain is called opportunity cost.

By paying off your loans instead of investing, you could be missing out on the chance to make more in investment returns than you save in interest payments. The basic rule is this: If your interest rate is lower than your potential market gains, you should keep the loan and invest the rest. Mathematically, you’ll come out ahead…provided you actually invest your savings.

Digging Into the Numbers

So, let’s get a little more specific. We’re going to create a few examples which make some assumptions. Then, we’ll use LendEdu’s nifty new student loan calculators to run the numbers. Because “average market returns” are a bit misleading, we’ll use the Compound Annual Growth Rate (CAGR) over the last 60 years – which is roughly 6% – to calculate our expected investment gains.

Example 1

Assumptions: Federal Direct Subsidized Loan: 3.4% Interest Rate, Loan Amount: $35,000, Loan Term: 10 years, Extra Payment: $200/month, Market CAGR: 6%, Investments are tax deferred

Paying Off Student Loan Early: According to the student loan prepayment calendar, our monthly payment on this loan would be about $345 per month. By paying an additional $200 a month, we would save $2,700 in interest over the life of the loan. We’d also pay the loan off 5 years and 11 months early. Not bad, right?

Investing the Extra Money: Using the “Student Loan Payoff vs. Invest” calculator, we find that paying off our loan early isn’t the correct mathematical choice. By investing that extra payment at a 6% return over the same time frame, we’d come out an additional $1,612 ahead. In this case, it is mathematically correct to invest the extra money rather than pay off our student loans early.

Example 2

Assumptions: Federal Direct PLUS Loan: 7.9% Interest Rate, Loan Amount: $35,000, Loan Term: 10 years, Extra Payment: $200/month, Market CAGR: 6%, Investments are tax deferred

Pay Off Student Loan Early: In this case, the calculator figures our monthly payment to be $423 per month. If we use the same $550 payment, we’ll still save $3,685 over the life of the loan and knock 2 years off of our term. However, if we keep our extra payment at $200/month, we’ll save a whopping $6,941, paying it off in just under 6 years. That’s a big chunk of change!

Invest the Extra Money: By investing the extra $200 instead of paying off our student loans early, we’ll actually lose out on $3,604. Even if we use the same $550 payment, we still save $1,971 by paying the loan off early. In this case, since the interest rate on the loan is higher than our expected return, we’ll save a lot more by paying off the loan early.

The Verdict

As you can see, when the interest rate on your loan is lower than your expected investment returns, the math dictates that investing supersedes any gains you’d get by paying your loan off early. If your interest rate is higher than any investment returns you can reasonably expect, paying your loans off early is the correct mathematical choice.

However, there’s more to it than just the numbers because numbers can be tricky. Basing investment return assumptions over a long period of time may not accurately predict what the market will do in the short-term. Yes, the average return may be 6% over the last 60 years, but student loan terms generally last only 5 to 10 years. That’s a very short investment window to play with. The market can swing wildly over such a short period, which could be good or bad for you. Often, the market falls short of the average annual mark, while other times it goes far above. Over the course of decades, those swings even out. Over a shorter period, they may not.

Benefits available on certain federal loans, investment advisor fees, and your emotional attitude toward debt also must be considered. Plus, you actually need to use that extra money for investing – which is something many people actually fail to do. Spending the extra money on consumer goods doesn’t help you save on either front.

In my opinion, it’s never a bad idea to pay off debt. Although you might miss some investment gains, there is no doubt that you’ll save money. Better yet, you don’t have to guess how much you’ll save. Just use a student loan prepayment calculator and you’ll be able to see the concrete, real results that paying early will have.

Of course, there’s no reason you can’t do both. Pay some toward your loans and invest the rest. Doing both is just another way to diversify your financial plan.

What do you think? Do you prefer to play the numbers or would you rather go for the sure win? Let us know in the comments below.

(Disclosure: Some of the offers seen here are from companies from whom Club Thrifty receives compensation. This may affect the order and manner in which they appear. Rates are subject to change. Club Thrifty does not include or review all companies or available offers.)

*Credible rates and terms


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  1. I’m a big believer in paying off the debt first, although I would save heavily for an emergency fund while paying down debt–I’d shoot for an initial savings goal of at least 6 months income to cover difference between unemployment (~$1,600/month last time my husband needed it in NY state) and your current salary–if you reach that goal, I’d try saving for 6 months without unemployment if you feel necessary . While you could theoretically lose out major investment gains (who knew Nintendo stock would double in price, etc) at the same time, no job is guaranteed. Plus, a stock can falter, like how Chipotle stock came crumbling down the past 6 months. Having the debt paid off is akin to having FU money–it gives you the ability to take any job you want with little concern for the shackles of a monthly debt payment holding you back. Plus if you’re OK for relocation, after the debt is gone, you can look for a low cost of area place to find a job and move to so you can them sock away more of that extra, post-debt income.

    1. I’m inclined to agree with you. As you said, when you’re in debt, your debt controls many of your decisions. It limits your options. If you knock it out fast, you’re free from that weight the rest of your life.

  2. In a choice between all investing or all early debt pay off, I’d choose the early debt pay off, but as you say at the end of the article it isn’t an either/or prospect.

    If I was young with student debt I’d probably prioritize:
    1) make debt payments
    2) build emergency fund of at least one month’s expenses
    3) participate in 401K to maximize any employer match
    4) accelerate loan payments by a set amount per month
    5) open Roth IRA by a set amount per month of half the extra going to loans
    6) build e-fund to 3 months expenses.
    7) increase loan payments/ 401K contributions proportionately. Maybe increase Roth at a lesser rate.

    1. I usually land in the payoff debt camp as well because debt is so restrictive. It really ties you down and eliminates a lot of options. However, if you are going to pay it off, you need to do it fast. Otherwise, you’re valuable time slip away.

  3. In situations like these I think it’s best to do the math, but also take into account how comfortable you will be with the volatility of the market. As always, very well summed up Greg!

  4. I feel its always the debt first to finish. When you are paying a high interest in loan, there is no point to invest money to earn penny return.Thanks for this great share and eye opener article.

  5. I’m so glad you answered this for someone because I have had the same question. I am going to run the numbers with the calculators you provided. I don’t have enough to pay it all off but I have thought about doing some.

  6. Thanks for providing the example #1 and #2 analysis. It’s interesting but when I finished college (my husband and I), I was so fed up with my student loans that I wanted them gone. Our combined student loan debt was $120k at 5.5% and they were all federally issued loans so no getting out of that one. It is not until now that we are debt free with savings and investments that I wonder if I had made the right decision. 5.5% was pretty steep and I don’t think the markets could exceed that consistently year after year. The good thing about it is that we took a very aggressive approach to paying it off and managed to pay it off in 2.5 years covering our needs and forgoing all of our wants (we did not live with parents or get any subsidies). Its possible but painful. No regrets however. Its is just interesting how I thought about after the fact and not before. All the best to those struggling with the same decision, it is not an easy one to make

    1. Congrats on being debt free!!! Eliminating your debt is never a bad decision. Now, you have all that money you can use to grow wealth and enjoy what you love!

  7. Also worth pointing out that if you set up direct deposit to pay your federal loans, they reduce your interest rate. In my case, I received an additional 0.5 percentage point reduction off my already low rate.

    Given the low rate I have to pay, I\’d take my extra money and invest it in an IRA with Lending Club or Prosper and get tax sheltered 6-8% returns.

  8. I\’m a fan of splitting the decision. Half towards paying down the debt faster, and half towards investing. Investing small amounts gets you in the habit of investing. It also gets you some idea of what volatility feels like in your small portfolio. You can grow into the habit and not panic during a downturn once you\’ve built up this investing muscle.

  9. This is tough question to answer, as everyone’s situation and variables are different. A one-size-fits-all approach rarely works in personal finance, and this case is no exception.

    Starting with a budget is the key, IMO, because it reveals how much discretionary income you have to throw at your student loans. Some quick basic math can be quite revealing in this regard.

    A few months ago, my wife and I were staring at just over $17,000 in student loan debt from my MA studies. We had just finished paying off my undergraduate student loans a month earlier. When I looked at our available liquid cash in savings and determined how much we could throw at the debt on a monthly basis, we realized we could be done with the debt in two months with a bit of sacrifice. 54 days later we had paid off the entire debt.

    On the other hand, those who are facing extreme debt figures might be wise to take the opposite approach, as you suggested. At any rate, it is a big decision that should not be entered into lightly, IMHO.

    Congrats on the book, by the way! That’s very exciting.

    1. Thanks so much! We’re really excited. And you’re right, this is a complex personal issue that is different for everybody!

  10. I don’t like stress, so I’d go for paying off my debt in the soonest time possible by getting more side hustles to pay more. When I am finished with it, I can focus on investment. But I know time is important in investment, which is why if I focus on paying debt, I have to make sure that it doesn’t take me too long to pay it.

    1. Exactly. You need to pay off that debt super fast. Otherwise, you’ll lose some valuable time.

  11. Great post! We did both at once–obviously not as quickly as focusing on one or the other. But we started investing sooner than we would have, giving that a chance to grow, and we still paid off our loans long before they were due. It’s definitely a complicated a personal issue, and we could have invested a lot more by now if we had kept our debt around longer, but it feels great to not have our paychecks already spoken for!

    1. Shedding that debt is a really liberating feeling. Plus, I think it helps build a “debt free” mindset that you carry with you the rest of your life.

  12. I’m a big advocate of maxing out 401k’s for the tax benefits before paying extra into student loans. If you can’t max out, then at least put in enough to see your employer’s match. The end result is that our budget has very little room for any crazy luxuries, but we still find places where we can travel or afford something nice.

    This strategy helped me save a little over $7,000 in 2015 alone (compared to using that same money to pay down student loans).

    Outside of the tax savings, I believe the biggest benefit is developing a strong habit of paying ourselves first. That alone is worth it in my opinion. I’m at the age now (27) where I’ve seen friends of my mine rapidly pay off debt over the course of 4-5 years. They don’t develop a savings habit and they wind up in credit card debt. I might have a bad example of friends, but I hope people consider this when they decide to accelerate the rate of their loan payments instead of investing.

  13. We paid off my student loans, as we don’t like debt hanging over our heads. We also made sure to max out my employer’s 6% match and fill a Roth at the same time however. That is money you can’t retroactively go back and get. We would have paid off the loans at a slower pace if we were unable to do both at the same time.

  14. I really appreciate what you two share about the emotional baggage of debt. My husband and I started marriage with $23,500 in school loans. Although it was “good debt” by the standards of some, we felt like it was a weight on us. People kept telling us to take our time and eventually pay it off. We didn’t take that advice. We booked it and we’re $1,500 away from being debt-free, 14 months into marriage. It hasn’t been easy, but it feels so freeing to be almost done!

    Your advice about knowing how much you’ll be saving by paying off debt early makes sense to me as well. Sometimes it’s not so much the math as the heart of the matter. Once we’re debt-free, every dollar we earn is completely ours. We have been saving for retirement as we paid off debt, but we’re excited to increase our savings afterward and hopefully save for a house!

    Thank you for helping your readers weigh the emotional/psychological factors of debt along with the mathematical factors.

    1. Thanks for the kind comment! IMO, the math is always important and should play a role in the decision. However, getting out of debt is more complex than just the math. Its not ony emotional baggage, but it holds you back. It forces you to do things you wouldn’t otherwise choose to do. Plus, it’s a mindset. Once you break free of the debt mentality, you’ll stop using debt, stop buying things you can’t afford, and save more money over the long-run.

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