The Student Debt Dilemma: Invest Or Repay?

Deciding whether to pay off student loans or invest depends on your financial priorities and which option gives you a better return. If you have a high-interest rate on your student loans, you should probably pay those first. If you are in a loan forgiveness program or have a low-interest rate, you may want to consider investing.

If you have high-interest student loans, particularly private loans, and are not eligible for any income-driven repayment (IDR) plans or student loan forgiveness programs, you should prioritise paying them off. This will save you money in interest and help you become debt-free sooner, improving your debt-to-income ratio (DTI) and making it easier to qualify for a mortgage.

However, paying off student loans before investing can be time-consuming and may cause you to miss out on potentially greater returns than your interest rate. Investing sooner will help you avoid working longer in your older years and, with certain investment accounts, you can withdraw if you need the money in the future.

A conservative but plausible return on investments is 6% per year. If your student loan interest rates are higher than that, you’d save more money by paying them off. If your student loan interest rates are less than 6%, consider putting extra money toward retirement or a brokerage account for non-retirement investing. Over time, your investments could earn more than the savings from paying off those loans.

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. In this case, it doesn't make sense to put extra payments toward the debt; instead, you could put that money toward investing and grow it over time.

It's important to note that you may not have to choose between investing and repaying student loans faster. If you need help deciding what to do, contact a financial advisor.

Investing in stocks vs. paying off student loans

Weighing Your Options

Deciding whether to pay off student loans or invest in stocks depends on your financial priorities and goals. Paying off student loans early can save you money on interest, but it won't necessarily increase your future savings. On the other hand, investing can position you for a more secure future but comes with risks, and you'll still have loan debt.

Factors to Consider

• Interest rates: Compare the interest rates on your student loans with the potential returns on investments. If your student loan interest rate is higher than the expected return on investments, you may save more money by paying off the loans first.
• Financial goals: Consider your financial priorities. If becoming debt-free is your top goal, focus on paying off your student loans. If you want to work on your financial security, investing may be a better option.
• Tax deductions: You may be able to deduct interest payments on student loans from your taxable income. Weigh this against tax deductions for contributions to retirement accounts.
• Loan forgiveness: If you have federal student loans and are eligible for loan forgiveness, it may not make sense to pay off the loans early. Instead, you could invest the money and grow your wealth over time.

A Balanced Approach

It's not necessary to choose exclusively between investing and repaying student loans. You can do both by contributing to your financial goals and investing any remaining funds. Additionally, investing in your 401(k) up to your employer's match, if offered, is often a good idea as it provides tax benefits and essentially gives you free money.

Pros and cons of paying off student loans

Pros of paying off student loans early:

• You can save a lot of money by becoming debt-free sooner.
• You can pursue other financial goals, such as buying a house or saving for retirement.
• You can lower your financial stress and improve your mental well-being.
• You can improve your debt-to-income ratio, making it easier to qualify for a mortgage or other types of credit.

Cons of paying off student loans early:

• You may rack up debt with higher interest rates if you only pay the minimums on other forms of debt.
• You will lose out on the student loan interest tax deduction, which can lower your taxable income by up to $2,500 per year.
• You may be short on cash and fall behind in saving for retirement or building an emergency fund.
• You may not be able to benefit from student loan forgiveness programs or income-driven repayment plans.
• You may overlook saving for unexpected expenses or other financial goals.

Pros and cons of investing

Investing while paying off student debt is a complex decision that depends on your financial goals and priorities. Here are some pros and cons of investing to help you make an informed choice:

Pros of Investing:

• Potential for Higher Returns: Investing in the stock market or other financial instruments can offer the potential for higher returns over time compared to the interest paid on student loans. The long-term average annual return of the S&P 500, for example, is about 10%, which is more than twice the interest rate of some student loans.
• Building Wealth Early: Investing allows you to start building wealth immediately, and the power of compound interest can lead to significant growth over time. The earlier you start, the more time your investments have to grow.
• Employer Matching: If your employer offers a 401(k) plan with matching contributions, investing in your retirement account can provide you with "free money" from your employer, boosting your retirement savings.
• Tax Benefits: Investing in retirement accounts like 401(k)s and IRAs can offer tax advantages, such as tax-deferred growth or tax deductions for contributions, which can reduce your taxable income.

Cons of Investing:

• Risk of Loss: All investments carry the risk of losing money. There are no guaranteed returns, and the stock market can be volatile, especially in the short term.
• Opportunity Cost: Investing instead of paying off student loans faster means you may pay more in total interest on your loans over time.
• Impact on Debt Repayment: Investing while paying off student loans may slow down your progress in becoming debt-free, especially if you have high-interest student loans or a large loan balance.

When deciding whether to invest or focus on repaying student loans, it's important to consider factors such as your interest rates, expected returns, financial goals, and emotional comfort with debt. Additionally, keep in mind that you don't have to choose exclusively one option; you can always invest a portion of your discretionary income while still making progress on repaying your student loans.

Weighing interest rates vs. investment returns

Weighing interest rates against investment returns is a tricky business, and there is no one-size-fits-all answer. However, there are some general rules of thumb that can help you decide.

Interest Rates vs Investment Returns

Firstly, it is important to understand the interest rate on your student loans. The higher the interest rate, the more you will pay over the long term. Federal student loans tend to have lower interest rates than private loans and often have more benefits and repayment options. Private student loans are riskier, with fewer protections and often higher interest rates.

If you have high-interest student loans, it is generally better to pay these off before investing. A good rule of thumb is to compare the average return on investment to your student loan interest rate. If your interest rate is higher, you will save more by paying off your loans and avoiding interest charges than by investing.

For example, if you have a student loan with a 9% interest rate, you will be charged 9% on your balance each year. A conservative but plausible return on investment is 6% per year. In this case, you would save more money by paying off your loans than by investing.

On the other hand, if your student loan interest rate is less than 6%, you may be better off putting extra money towards retirement or a brokerage account for non-retirement investing. Over time, your investments are likely to earn more than you would save by paying off the loans.

Other Factors to Consider

There are also other factors to consider when deciding whether to pay off student loans or invest.

• Emergency fund: It is generally recommended to have at least three months' worth of expenses saved for emergencies before deciding to pay off student loans or invest.
• Retirement savings: If your employer offers a 401(k) match, it is a good idea to take advantage of this and contribute to your retirement savings.
• High-interest debt: If you have other high-interest debt, such as credit card balances or personal loans, it may be better to pay these off first, as they can offer a higher return than investments or student loan debt.
• Financial goals: Consider your financial goals and priorities. If becoming debt-free is your top priority, you may want to put all your extra funds towards paying off your student loans. On the other hand, if you want to retire early, investing may be a better option.
• Tax benefits: When paying off student loans, you may be able to deduct interest payments from your taxable income. With investments, you can deduct contributions made to a 401(k) or traditional individual retirement account. Consider which tax break is more beneficial for you.
• Loan forgiveness: If you have federal student loans, you may be eligible for loan forgiveness, which cancels all or part of your debt after a certain period. In this case, it may not make sense to make extra payments towards your loans, and you may be better off investing your money instead.

Hybrid Approach

Remember, you don't have to choose one or the other. It is possible to take a hybrid approach and work towards both goals simultaneously. You can split any extra money you have each month between investing and making extra payments on your student loans. While progress may be slower, you will still be improving your overall financial picture.

Student loan forgiveness

Public Service Loan Forgiveness (PSLF)

The Public Service Loan Forgiveness programme offers student loan forgiveness to borrowers after 120 qualifying monthly payments. Borrowers must work as full-time employees for certain non-profit or government organisations for at least 10 years while meeting other program requirements to be eligible for this relief.

Biden Administration's Efforts

Since the start of the Biden-Harris Administration, over 942,000 public service workers have received student loan forgiveness totalling $68 billion under the PSLF programme. The Biden Administration has also implemented a new and improved student loan forgiveness tracking system, allowing borrowers to monitor their progress on a new dashboard at StudentAid.gov.

Criticism of Student Loan Forgiveness

Some critics, including Republican presidential nominee Donald Trump and his vice-presidential nominee, J.D. Vance, argue that student loan forgiveness is unfair and should be fought "with every ounce of [their] energy and power". They believe that it is a "massive windfall to the rich" and benefits those who have already gained from a "corrupt system".

Others, like Jane Fox, chapter chair of the Legal Aid Society Attorneys union, counter this view by stating that "student debt forgiveness is a working-class issue". She highlights that those in the 1% who attended elite institutions rarely need debt relief, and that the focus should be on helping those who have been failed by the loan system.

Moving Forward

The debate around student loan forgiveness is complex and multifaceted, with valid arguments on both sides. While some see it as a necessary measure to alleviate the financial burden on students, others view it as an unfair advantage for the privileged. Ultimately, the decision to invest or pay off student loans depends on individual financial circumstances and goals.

Frequently asked questions