The average student loan in America is $40,000, making it hard to decide whether you want to pay down your student loans or invest. Let’s face the facts: Saving for retirement and getting out of debt are equally important.
Do you want to pay down your debts or do you prefer investing? Consider these factors
Three elements will determine which route is best for you. These are:
Mathematical approach: You can use math to determine which option is more advantageous – investing extra cash or paying off debt. You might choose to pay down the debt first if your interest rate is higher than the amount you are earning on your investment. Math isn’t all that important.
The emotional approach: Student loans can be a burden on your head and you want to get rid. You might feel better if you make an emotional decision, even though it may not be financially sound.
The hybrid approach: This allows you to do both, paying down your debt and saving for retirement. This approach is worth investigating to ensure the best split possible – we’ll go into all of those details in this article.
Before you jump in, understand how external factors can affect your decision.
Your financial position
The effect of the move on your finances is a critical consideration when deciding whether you want to reduce your debt or increase your retirement savings. Consider these things:
You should have emergency savings. These funds must be immediately accessible and can be used in case of a financial emergency. Although financial experts may recommend three to six months of emergency savings, Ramit Sethi believes that 12 months is a better option. Before you can begin investing or paying down debt, your emergency savings must be maintained.
Make sure you are paying on time: It is better to pay your bills on time if you fall behind in any debts. These arrears could cause havoc with your bank account and other service providers. This can also affect your credit score.
You have enough to live on: Although long-term plans like debt repayments or retirement planning can benefit from additional payments, you must meet your immediate needs. This includes housing, food, and transport as well as utilities.
It’s still fun to have money. When you can’t do the things you love, financial freedom becomes a difficult journey. You can save money on something you love and are happy with. As you begin to tick off financial goals, this amount may increase.
The amount of your outstanding debt
Even if you have a decent income, a $40,000 average student loan debt might seem manageable. Let’s not forget about the specialist degrees that can make your student loans reach hundreds of thousands of dollars. This amount suddenly seems overwhelming and you might be tempted to spend your money elsewhere until you have it under control.
You could also have saved for retirement by putting all your effort into paying off student loans. It may be a good idea to set a goal to give yourself some flexibility to invest. You might decide to start contributing to retirement funds once you have paid off half of your debt.
Rest of the years
You might have different priorities if you are right at the start of the loan period.
Your finance costs
The interest rates on debt are rarely lower than those you would earn from an investment. You want to ensure that you are getting the most value for your money when it happens. If you don’t have enough money in your 401(k), a student loan with a low-interest rate might be a better option than the minimum payment.
If the interest rate you are paying is higher than the rest, you may want to pay your debt first, before you increase your investment contributions.
Which student loan option is right for you?
You can save a lot of money by paying your student loans quickly.
An extra $100 can help you clear the interest faster.
Here’s an example. Let’s suppose you have a $10,000 student loan at a 6.8% rate and a 10-year repayment term. You’ll be paying around $115 per month if you choose the standard monthly payment. Consider how much interest you can save if you only pay $100 each month.
Monthly payments Total interest paid Save!
$115 $3,810 $0
$215 $1,640 $2,169
$315 $1,056 $2,754
$415 $728 $3,027
It is worth noting that there are many options available to students who want to repay their student loan debt.
Knowing the type of loan you have (or plan to take on)
There are three types of student loans to choose from: refinance, private, and federal. Each type of student loan has its own rules and comes with some pros and cons.
The fact that you can make extra payments or prepayments to an education loan without any penalty charges is a big plus. What’s not to like?
Federal student loans
To help students access higher education, the government provides loans. These loans can be taken out by the federal government, and students won’t have to borrow from banks or other financial institutions.
There are three types of them:
Direct Subsidized – This is for students who require financial aid.
Direct unsubsidized – applicants do not need to prove financial need.
PLUS loans – These loans are available to professionals and graduates to help cover tuition costs not covered by other programs. These loans require good credit scores and a higher interest rate than other federal student loans.
There are positives, such as the ease of applying for federal loans and the availability of deferral or forbearance options in cases where there is a hardship. Because the government controls the interest rates, they tend to have lower rates.
It is important to remember that these loans have costs and require an initiation fee of 1.057% – 1.059% for regular student loans and 4.228% – 4.236% for PLUS loans.
Private student loans
Banks and other institutions offer a variety of private student loans. These loans are great because they can be tailored to your needs. For example, you could get a loan for bar exams or medical school.
These loans are more expensive and there are no initiation fees. However, the interest rate cannot be fixed by the government. This means that these rates can be significantly higher than federal loans.
A good credit score is also required for applicants. These loans are not eligible for any government forgiveness programs. Why would you want to get it? These loans are excellent for students with high tuition costs.
Refinance student loans
A student loan with high-interest rates is a real pain in the stomach. You can get your money back by choosing a product that has a lower interest rate. Students with a good credit rating can get student loans to refinance products that will lower their interest rates. Refinance is not an option for federal loan holders. However, you will lose federal benefits and protections.
Building wealth is only possible if you save for your retirement. You also get tax benefits and other benefits from saving for retirement. How do you decide how to pay off your debts in the future? Understanding retirement investment options will make it easier to answer that question.
Roth and Traditional IRA
These retirement plans allow you contribute to your retirement savings up until a specified threshold per year. This annual threshold was $6,000. In 2020 and 2021. This means that if your concern is about saving for retirement or paying down debt, you should first make sure that you aren’t already maxed on these contributions.
Individual Roth IRA earnings limits are also $140,000.
A matched 401k is the best way to save money for retirement. Let’s reread that. You’re losing money if you don’t have enough cash. Let’s explain.
Your employer may match your contributions to your 401k either partially or fully up to a specified percentage. Keep in mind that the limit is just below $20,000 per annum or 100% of your annual salary.
How to reduce your debt while still investing
Find out your financial situation
We’ll be honest, there will be some work. It’s worth the effort to save money now and in the long term. Before you decide on whether you want to invest or pay off student loans, there are some things you should know.
How much is my outstanding debt? Check the installments and the due dates. Also, find out the settlement amount. Although this may seem obvious, many people prefer to ignore their debt. Either they are afraid that their debt will grow beyond their capabilities, or they are embarrassed to admit they may be a net negative. This means that their debt is greater than their assets. The truth is, nobody cares. It won’t go away because you don’t want it to.
Which item has the highest rate of interest? You never know, student loans may be your least concern. To ensure you are focusing on the right debt, make sure to check your credit card and personal loan details. These numbers could indicate that you are a candidate for debt consolidating.
What do I pay each month? You should be aware of your spending habits. It’s essential to understand your fixed expenses, your savings, and your investments.
Use the envelope system
An envelope system allows you to budget all of your money for savings and payments. The idea behind it is that if you had money, you would put your dollar bills in different envelopes and mail them to cover the bills.
Because you choose the categories, an envelope system is very useful. You can have an envelope for entertainment and lattes. Housing is a given. You can choose to give Target the largest chunk of your salary, but the goal is to pay your bills and have fun while also saving money and investing.
Once you have spent all of your entertainment money, it is considered done. You should stop when the envelope is empty. This will allow you to spend more efficiently and will stop frustrating overspending.
Here’s the best part. An envelope can be used to make additional payments on student loans, or it can be used for investment purposes.
Select investment options that fit your budget
If you ask the question “Should my student loans be paid off or should I invest?” it is likely that you aren’t interested in spending large sums of money on expensive investment products and fees.
Two huge financial goals are yours. The faster you can achieve them, the better. You’ll need options to help you achieve both of these goals.
Ramit Sethi’s ladder or Personal Finance is now available. This is a game-changer in terms of building wealth and eliminating debt. Here’s how it works.
You’ll be glad you got your 401(k).
Reduce high-interest debt. High-interest debt is too stubborn. This can be done by increasing your repayments.
Contribute to a Roth IRA. Retirement is cheap investing. It’s true, but it’s still true.
Maximize your 401(k). You want to get maximum value from this product!
Diversify your portfolio by looking into other investment options such as bonds, CDs, or stocks.
To learn more, you can watch this video:
The bottom line
Student loans can be a real pain. It is only natural to want them to be repaid as soon as possible. The problem is that we are getting older. Investing should not be put off until things are perfect and debts are paid.