Should I pay off my student loans or invest?

Student loan debt is a burden for many Americans. In 2020, 30% of all adults reported that they had student debt, according to Federal Reserve data. Student loans can cause financial strain and make it hard to save for retirement or other goals.

If you’re in this boat, you may be eager to pay off those student loans as quickly as possible. But in some cases, that might not be the right move.

If you’re wondering whether to pay off your student loans or start investing now, this guide will help you weigh the pros and cons of each.

• Pay off student loans or invest? What to consider.
• Option 1: Pay off student loans first
• Option 2: Invest first
• Option 3: Pay off student loans and invest at the same time
• How to invest when you have student loans

Pay off student loans or invest? What to consider.

There’s a lot to think about when deciding whether to invest your extra cash or put it toward your student loans.

Here are a few things you’ll want to keep in mind as you make your decision:

• Your emergency fund — Ideally, you should have three to six months’ worth of living expenses in an emergency fund, just in case something unexpected happens. If you don’t already have savings stowed away, building up this fund should be your top financial priority.
• Interest rates — How do your student loan interest rates compare to the returns from the stock market or other investment vehicles? If your student loan rates are lower, then investing could earn you more money in the long term. But if your rates are higher, you may be better off prioritizing your student loans so you can save money on interest.
• Type of student loans — If you have federal student loans, you have many repayment options at your disposal, including income-based repayment plans. These can help you lower your monthly payment while investing your cash elsewhere. Private student loans don’t have perks like this, and they may have higher interest rates than federal loans — so it may make more sense to pay these off faster.
• Financial priorities — How important is it that you’re debt-free, and how much risk can you afford to take? Investing is always riskier than paying down a debt and getting rid of the interest costs that come with it.
• Retirement fund — Consider how long you have until retirement, the amount currently in your retirement accounts, and how much you’d like to have saved when you retire. You may choose to prioritize investing in your retirement account if your savings are lacking. Additionally, if your employer offers 401(k) matching, you may want to take advantage of this rather than invest that money.

When it comes to choosing between investing and paying off student loan debt, there’s no right or wrong answer. It depends on your unique situation and your goals.

Option 1: first

Here are some scenarios in which you might want to prioritize paying down your student loan debt before investing your money:

• Your interest rates are particularly high. If your student loan rates are particularly high, paying them down quickly is typically the best way to utilize your money. Generally speaking, if your loans have a higher interest rate than what you could earn on the stock market or from another investment, paying them off first is probably a better choice than investing.
• You have a variable interest rate. With a variable interest rate, both your rate and payment can increase regularly. In this situation, it may make more sense to pay off the loans quickly or refinance into a fixed-rate loan instead.
• Your debt is creating stress (financial or otherwise). If your student loan debt is making it hard to get by or just causing mental stress, paying it off is probably the best path forward.

If you think paying off your loans first is the right move, you have several ways to go about it. In some cases, refinancing may be the best route.

Should I refinance my student loans?

Refinancing can give you a lower interest rate (and, potentially, a lower monthly payment), making it easier to pay your loans off quicker.

Keep in mind that if you refinance federal student loans into a private student loan, you’ll lose all the benefits of federal loans, including income-driven repayment plans, loan forgiveness, and forbearance.

Also, consider your credit score, which plays a big role in your ability to refinance. Lenders generally require a score of at least 670 to qualify. And the lower your score, the higher your interest rate is likely to be. You may want to add a cosigner with good credit to help you qualify for refinancing with a better rate and terms.

Debt payoff strategies

Several debt payoff methods can help you handle your student loans efficiently. The most common are the debt snowball method and the debt avalanche method.

With the debt snowball method, you make the minimum payments on all your loans and then put any extra cash toward the smallest student loan balance, aiming to pay that one off first. Once that’s paid off, you move on to the next-lowest balance, and so on.

The debt avalanche method prioritizes the debts with the highest interest rates. You focus on paying off the loan with the highest interest first, and then continue to tackle the rest of the loans. Ultimately, this method saves you the most money in the long term, since you’re reducing the amount of total interest you pay.

Option 2: Invest first

In some cases, investing before paying off your student loan debt may be the smarter move.

You may want to consider investing before paying off your student loans in the following situations:

• The rate of return is higher than your student loan interest rates. The estimated return on the stock market is about 6.6% through 2030, according to Charles Schwab Investment Advisory, Inc. If your student loan interest rates are below this, investing could earn more than you’d save by paying off your student loans faster. But remember, there’s no guarantee of returns in the stock market.
• You’re behind on saving for retirement. If you’re nearing retirement or are just behind on your savings goals, investing in your retirement now with a 401(k) or other retirement plan can help you build up those savings more efficiently. Compound interest is on your side, and the earlier you start, the better.
• You qualify for loan forgiveness or other assistance. If you know you’ll qualify for student loan forgiveness or some sort of loan assistance (even a few years down the line), paying off your loans sooner may not be the best use of your funds.

Keep in mind that investing also comes with risks. While returns might be estimated at higher rates than your student loan rates, those returns are never guaranteed.

Option 3: Pay off student loans and invest at the same time

You don’t have to choose just one or the other. A hybrid approach can also work, allowing you to both pay down your debt and invest simultaneously.

To do this, take any discretionary funds and split them between your loans and your investments. (You can still use the debt snowball or avalanche methods when paying down your loans.)

The upside to this approach is that you’ll make progress toward both goals. You’ll also minimize risk, since you’re not putting all your funds toward investing.

The drawback is that you'll stretch out your loan repayment timeline, which will cost more in interest. You also won’t see the full potential of your investments, since you’ll be limiting the funding you put toward them.

How to invest when you have student loans

If you have extra cash after making your student loan payments, or you decide to take the hybrid approach, you’ll need to follow a few steps to start investing:

1. Calculate how much you have to invest. Sit down and crunch the numbers. After paying the bills, how much can you comfortably put toward your investments?
2. Decide between self-managing and working with a professional. You can pick your own investments or enlist the help of a fund manager. With a fund manager, you entrust your investment portfolio to an expert, but you’ll typically pay a fee for this service.
3. Research your options. You have many options for investing, including investing in your 401(k), buying an S&P 500 index fund, and using an investing app.
4. Open your accounts. Once you’ve chosen your investment path, you’ll need to establish your investment accounts. From here, you’ll choose your investments or they’ll be managed by a fund manager.

If you’re unsure whether to invest or pay off your student debt, consider speaking to a financial advisor. They can offer personalized advice to guide you down the best path for your situation.