Let’s say that you have some money saved every month. It can be challenging to decide whether to invest or pay off your student loans. At first, the best advice and the most advocated option would be to invest whenever you get the chance.
More on that, it is easier today to invest more than ever due to new technologies. Even better, numerous digital wealth managers have paved the way for lower-risk investments. However, student loan interest rates tend to change often.
Federal loans can rise to 7%, private student loans, 14%. So investing may not be the best choice. This guide will show you what you need to consider before you make your final decision.
What To Consider Before Deciding To Pay Off Your Loans Or Invest
Check The Interest Rates On Your Student Loans
Many financial experts advise young borrowers with extra money to invest instead of paying off their student debts. They have a convincing argument to back these claims: you are young, time is on your side, and you can gain more by investing in the stock market.
However, that advice was entirely based on student loans with low interest rates, which made a lot of sense. For example, when your student loans have an interest rate of four percent, it is logical to invest your money. That is because the outcome of the investment might be more than four percent.
So if you have student loans with low-interest rates, it might be logical enough to pause on repaying your student debts. You can get some free money to invest. But of course, you have to understand that investments are mostly not guaranteed to have a particular return rate.
However, student loan interest rates can fall or rise. If it increases, it cannot be easy to find investment opportunities that offer a higher return rate than the cost of your student loan interest rate. In such situations, it may be better to clear off your student loan debts.
Are Your Student Loans Private Or Federal?
Generally, federal student loans have lower interest rates compared to private student loans. And they mostly come with more benefits such as income-driven repayment options. So if you have federal student loans, it would make more sense to invest instead of paying off your student loans.
On the other hand, if you have private student loans, you may want to prioritize your repayment. You have less to lose that way, and you potentially have more to gain if you refinance.
Refinancing your student loans can decrease your interest rates, allowing you to pay off your debts quicker. You can even have extra money for other financial goals such as investing or saving.
You can save a lot more if you have a credit score of at least 600 and above, including a stable income. However, keep in mind that refinancing your student loans can be risky. That is because you will lose any repayment options and other protections.
So be sure that you will not need those benefits before you proceed.
5 Reasons You Should Pay Off Your Loans First
Are you not sure whether to pay off your student loans or invest your money? These five reasons or signs indicate your student loans should be your priority.
1. Do You Want A Faster Higher Rate Of Returns?
A report from Vanguard shows that the average rate of return over the previous year on the stock market was only 3.04%. With the student loan rates over 5%, you could earn a higher rate than the 3.04% when you invest for the year.
So if you want to pay off your debt as quickly as possible, it is more logical to pay off your debt when expected stock market returns are lower. However, the average return rate on the stock market for the past ten years has been around 10.49%.
If you are aiming for a long-term rate of return, it would be wise to invest. You will have to decide the one which works best for you.
2. Do You Want To Lower Your Debt-to-Income Ratio?
When you manage to clear off your student debts, you will also lower your debt-to-income ratio. That is the amount of loan debt you have relative to your monthly income. When it comes to your debt-to-income ratio, it is a big deal.
It plays a massive role in determining your credit score. And it is what loan lenders use to decide whether or not you can manage other forms of debt, such as a mortgage. It is better to keep your debt-to-income ratio low.
If you plan to purchase a house or buy something significant in the future, it would be best to pay off your debt. That will increase your chances of getting approved by your creditors to get a loan.
3. Do You Want To Decrease Your Student Loan Interest Rates?
If you can put extra money into your high-interest loans, you can manage to get out of debt faster. For example, assuming you make a monthly payment of $400 towards your student loan repayment, you can add an extra $50.
Even though it is relatively small, you can finish paying your loans ahead of schedule. So let’s say you had $35,000 in student loans at a 7% interest rate. You can get rid of your loans 19 months before the deadline. You can even save $2,340 in interest.
However, you can even save more if you refinance your student loans. Refinancing helps you to decrease your interest rate. That means most of your payments go toward your principal. Just remember that your monthly payment will increase, even though you will save more over the loan life.
It means that you may not begin your investing until you finish paying off your loan. That is unless you have more disposable income.
What To Prioritize Before You Pay Off Your Loans Or Invest
Before you even consider paying off your student loans or investing, you need to prioritize the following at all costs:
1. Start Your Emergency Fund
It is crucial to have funds set aside for emergencies. You can set from $500 t0 $1,000 in a savings account before you invest or pay off your loans. The emergency fund should be able to cater to your expenses for at least from three to six months.
2. Contribute To Your Retirement Fund
If your employer provides a company match on 401(k) contributions, contribute more to get the entire match. If not, you are leaving free money to go to waste.
3. Focus on High-Interest Debt
If you have other massive interest debts, such as credit card debt, you should prioritize them. You will acquire a higher return on investment, taking out the high-interest debt.
4. Decrease Your Interest Rates
Try to decrease your interest rates on your student loan debts through refinancing. Refinancing can help you save money and get rid of your debt before the deadline.
After ticking all these boxes, you can then put extra funds toward your next goal.
When it comes to choosing whether to invest or paying off your student loans, it is essential to consider numerous factors of your financial circumstance. You have to consider your financial goals, interest rates, and potential returns.
After considering all these options, including your finances, you can make an informed decision. Sometimes, that can mean paying off your student loans while investing.