In this day and age, nearly everyone is saddled with student loan debt, no matter if you went to med school or majored in English Literature. So, if you have suddenly found yourself with a larger-than-usual sum of money, you’re probably wondering— “Should I invest this money or pay off my student loans?” It’s a good question but the answer is a little more complicated than you think.
Before deciding whether to invest or pay off your student loans, first consider how much money you have at hand, as well as the current terms of your loan. If your loan is quite large or set with high compounding interest rates, you will do better to pay it off. However, if the loan is small and you can manage the interest, investing could be the right choice.
If you are uncertain whether to invest your money or pay off a student loan, continue reading to learn the pros and cons of both options. We’ll explain a few of the nuances that can affect your decision and clarify when it’s better to invest or pay.
First, Check the Terms of Your Student Loan
Student loans can be a tricky thing to advise on because there’s no telling how much money you borrowed. Unlike a mortgage, student loans vary in size from just a few thousand dollars up to a hundred thousand dollars or more. This can greatly affect whether it’s better to invest or just pay off the debt.
What we can speak definitively about, though, are interest rates. If your student loans were processed through the United States Federal Student Aid program (FAFSA), there won’t be much variation in your annual compounded interest. For both subsidized and unsubsidized undergraduate student loans, you’ll pay a fixed rate of 3.73%. For a subsidized graduate loan, you’ll pay 5.28% or 6.28% for an unsubsidized loan.
How Interest Rates Can Affect Your Decision
A 3.73% interest rate is generally manageable as long as your loans are small and you’re earning a decent living. In this case, it may be better to invest since you’re already paying your debt back and have extra income to spend. However, if you’re struggling to make payments or feel suffocated by high interest rates, you’d do better to pay it off.
The sooner you pay off a large debt, the less you’ll pay in interest. After all, interest compounds from year to year, slowly adding thousands of dollars to the amount you already owe. By significantly dropping the total debt, you’ll slice the interest in half and free yourself from its burden.
What is a Manageable Amount of Debt?
No one enjoys paying off student loans, but debt is a healthy and normal part of the modern financial system. As long as your debt is within your means, it’s probably best to invest a sudden large sum of money to reap the benefits of the returns. This begs the question, though, what is a manageable amount of debt?
As a general rule, most advisers recommend keeping your total debt below 30% of your total annual income. For example, if you earn $50,000 a year, all of your debt—including rent/mortgages, credit card payments, and student loans—shouldn’t account for more than $15,000 worth of outgoing payments. If they do, your debt burden will become unmanageable.
Anything less than that, and you should have a wide enough range to make payments, invest, save, and still have enough money left over for leisure and emergencies. So, if your student loan debt is manageable and you have extra money to invest, it may be better to invest the money.
What are the Benefits of Investing?
Investing has many benefits over just paying off debt. First, it offers the potential to make a lot more money. A well-chosen stock or mutual fund has the potential to double or triple in value over just a few years. Second, it diversifies your holdings and can protect you in case of an economic downturn.
Of course, there are also risks involved with investing. The most obvious is that you could lose money. This is especially true if you don’t diversify your portfolio or choose high-risk investments. However, even a conservative portfolio has the potential to make you a lot of money over the long term.
Another risk to consider is that your investments may not mature for years or even decades. This means you may not have access to the money when you need it. However, this is also true of student loans, which can take 10 years or more to pay off.
The Bottom Line
Whether you should invest or pay off your student loans depends on the interest rate and total amount of your loan. If you’re struggling to make ends meet, it’s probably best to pay off your debt. However, if you have extra money and are comfortable with your debt payments, investing may be the right choice.