The question to ask isn’t whether to pay off student loans or invest. It’s actually how much you have saved for emergencies. That should be your top priority.
While it feels good to pay off student loans fast, other priorities should come first.
- Save for emergencies. Nothing will affect your financial future as much as avoiding debt in the first place.
- Get a start on retirement savings. Time and compound interest are on your side. You won’t have this chance again.
- Knock off debt, but start with toxic debt first.
Here’s how to know whether you should pay off student loans, save or invest.
A little money in the bank goes a long way
First, save at least $500 in a bank account, and make a plan to eventually have three to six months of expenses set aside.
Aim to save enough to feel comfortable, but not so much that it derails other goals.
An emergency fund is critical when you need to replace your tires or get unexpected dental work. If you’ve sent all available cash to your student loans, you may have to put those expenses on a credit card — costing you more money over time.
Ideally, your emergency fund should include three to six months’ worth of expenses. But that can feel about as intimidating as paying off student loan debt. Instead, aim to save enough money to feel comfortable, but not so much that it kicks your other goals down the road.
If all you can afford to put aside right now is $500, that will get you out of many common jams; add more once you’re in a better financial position.
Investing for retirement comes next
Get the company match on a 401(k) if you have one. If not, save as close to 10% of your income as possible in an individual retirement account.
If you’re knee-deep in student loans, you’re likely also knee-deep in the middle of the most important time to invest for retirement. When you’re young, your money might have 40 years to grow.
You’ll probably come out on top by investing rather than paying down student loans, especially those with low interest rates.
History says a long-term investment portfolio can earn you 6% to 7% per year in returns. Over the long term, you’ll probably come out on top by investing rather than paying down student loans, especially those with low interest rates.
This is especially true if you have a 401(k) with matching dollars, which amount to a guaranteed return on your own contributions. Even if your federal loans are at 6.8% — the highest rate for undergrads in recent years — or you have private loans that are even higher, get that match before you pay more than the minimum toward your loans.
Once you’re on track for retirement, you’re free to whale on those student loans all you want. Check your progress with a retirement calculator.
Then pay off student loans — the smart way
Get rid of credit card and personal loan debt before turning your attention to student loans. These types of debt generally charge more in interest.
When it’s time to focus on college debt, student loan refinancing can bring your interest rates down, freeing up more money for savings if you’re not in the position to pay off your loans now. You’ll save the most money if you have a credit score at least in the high 600s and stable income.
» CALCULATE: Should you refinance student loans?
Combine refinancing with other strategies to pay off student loans early. You’ll have to pay more than the minimum to get rid of your loans fast, so make it easier by opting for biweekly payments, rather than monthly. Some lenders will let you make multiple payments a month automatically.
Apply tax refunds and extra income from side jobs to your balance, and take advantage of an employer student loan payoff program if one is offered where you work.