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Should You Invest or Pay Off Student Loans?

By manybanking.com Staff
Graduating from college is an exciting time, but if you’re like many recent grads, you probably have thousands of dollars in student loans.

Category Product: 
Savings
Category Finance: 
Personal Finance
Keywords: 
Student Loans, Education, Higher Learning, School, NelNet, Loan Consolidation, Savings, Interest, Yield, University, Stafford Loan
Introduction: 

By manybanking.com Staff
Graduating from college is an exciting time, but if you’re like many recent grads, you probably have thousands of dollars in student loans.

According to the National Postsecondary Student Aid Study (NPSAS), undergraduate seniors at 4-year institutions on average have more than $20,000 in debt. Graduate and professional students typically have even more with debt ranging from $27,000 to $114,000.

The good news is that unlike credit card debt, student loan debt typically has relatively low fixed interest rates. That means you can probably afford to carry a student loan longer than higher-interest debt.

So why would you want to do that? By holding off on paying down your student loans, you could free up some extra money to invest.

Getting started investing early pays huge dividends in the future. Because of compounding interest, waiting even just five years after you graduate to start building your nest egg could cost you hundreds of thousands of dollars when it’s time to retire. Consequently, it may be more profitable in the long-term to funnel money into your 401(k) or Roth IRA now instead of into your student loan. Of course, you always have to pay at least the minimum monthly payment on your student loan or it will negatively impact your credit.

Deciding if it is better to start investing or to pay off your student loans depends partially on interest rates. The interest rate on a Stafford Loan that is first disbursed after July 1, 2006 is fixed at 6.8%. (Lower interest rates apply to loans disbursed after July 1, 2008 through June 30, 2012.) So, let’s use that interest rate as an example. In the long run, investing in the low cost funds historically pays around 8%. Using simple math, it’s easy to see that you will make more by investing than by paying off your student loans. Because most credit card debt has interest rates higher than 8%, it’s probably wiser to pay off that debt before investing.

The current economic situation has made this particular investment decision more salient. Low prices in the market provide even more opportunity for young investors to capitalize. By getting into the market now, young investors will likely see even bigger gains if and when the market rebounds.

Additionally, if you are investing in a 401(k), you may be eligible for employer match funds. When your employer matches your 401(k) contributions, your employer is effectively giving you a 100% return on your investment. Because of compounding interest, however, that ROI is actually even higher than 100%. That doesn’t even take into consideration the tax advantages of retirement accounts.

This decision, however, is not entirely cut and dry. You also have to consider your level of tolerance for debt. If you are someone who can’t sleep at night knowing that you owe money, it may be prudent for you to try to pay off your student loans as soon as possible.

One way to reap some of the benefits of early investing and get out of debt more quickly is to do a hybrid split. Take the money you have budgeted for debt repayment and put a portion (higher than the minimum) towards the student loan. Invest the remainder, and once your debt is repaid, you can invest more.

—For more ways to save, spend, invest and borrow, visit MainStreet.com.

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According to the National Postsecondary Student Aid Study (NPSAS), undergraduate seniors at 4-year institutions on average have more than $20,000 in debt. Graduate and professional students typically have even more with debt ranging from $27,000 to $114,000.

The good news is that unlike credit card debt, student loan debt typically has relatively low fixed interest rates. That means you can probably afford to carry a student loan longer than higher-interest debt.

So why would you want to do that? By holding off on paying down your student loans, you could free up some extra money to invest.

Getting started investing early pays huge dividends in the future. Because of compounding interest, waiting even just five years after you graduate to start building your nest egg could cost you hundreds of thousands of dollars when it’s time to retire. Consequently, it may be more profitable in the long-term to funnel money into your 401(k) or Roth IRA now instead of into your student loan. Of course, you always have to pay at least the minimum monthly payment on your student loan or it will negatively impact your credit.

Deciding if it is better to start investing or to pay off your student loans depends partially on interest rates. The interest rate on a Stafford Loan that is first disbursed after July 1, 2006 is fixed at 6.8%. (Lower interest rates apply to loans disbursed after July 1, 2008 through June 30, 2012.) So, let’s use that interest rate as an example. In the long run, investing in the low cost funds historically pays around 8%. Using simple math, it’s easy to see that you will make more by investing than by paying off your student loans. Because most credit card debt has interest rates higher than 8%, it’s probably wiser to pay off that debt before investing.

The current economic situation has made this particular investment decision more salient. Low prices in the market provide even more opportunity for young investors to capitalize. By getting into the market now, young investors will likely see even bigger gains if and when the market rebounds.

Additionally, if you are investing in a 401(k), you may be eligible for employer match funds. When your employer matches your 401(k) contributions, your employer is effectively giving you a 100% return on your investment. Because of compounding interest, however, that ROI is actually even higher than 100%. That doesn’t even take into consideration the tax advantages of retirement accounts.

This decision, however, is not entirely cut and dry. You also have to consider your level of tolerance for debt. If you are someone who can’t sleep at night knowing that you owe money, it may be prudent for you to try to pay off your student loans as soon as possible.

One way to reap some of the benefits of early investing and get out of debt more quickly is to do a hybrid split. Take the money you have budgeted for debt repayment and put a portion (higher than the minimum) towards the student loan. Invest the remainder, and once your debt is repaid, you can invest more.

—For more ways to save, spend, invest and borrow, visit MainStreet.com.

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