When recent college graduates work on creating a first budget, one issue that may come up is choosing between paying off principle on student loans or putting that money into investment or savings. The problem is that there is no simple answer, and even after all of the known variables are considered, one still has to guess or approximate the expected return on their investments and their personal willingness to take financial risks.

First of all, its a good thing to have some cash in the bank for emergency situations like injury or losing a job. A common rule of thumb is to have enough money to make it through about two months worth of fixed costs (rent/mortgage, food, utilities, and monthly credit payments).

  • The problem with non-cash savings is that they can be difficult to convert into money instantly – bonds have to mature, real estate can sit on the market unsold, and stocks could be at a temporary low and selling at a forced time could cause a substantial loss
  • The benefit is that these are the true vehicles to building wealth since cash is a constantly depreciating asset. Every day it seems, the dollar loses just a little bit of value and prices creep up.

Once you have some cash saved up to cover emergency and unexpected situations, its time to consider the non-liquid investments listed above versus student loan balances and interest.

  • If the student loan is subsidized, chances are that your best bet is to just make the monthly minimum payments and forget about it. Most investments, even safe ones like government bonds, can get a better interest rate than what you’re paying to the student loan. It might just be 1 or 2% difference, but over the life of the payments you could earn thousands more from investing than you saved by avoiding the almost non-existent interest fees.
  • If the student loan is private, the interest rate of the loan and your willingness to take investment risks determine your best outcome.
    • Private loans to low income students or students in a family with a low credit rating can be at 10% or higher. If this is the case, you would almost certainly want to pay that principle off before investing. It is not impossible to get a 10% return in our modern bubble-oriented economy, but it is extremely risky. Unless the loan has pre-payment penalties, its a much safer decision to pay the debt as soon as possible. Even if it does, it may be worth it to pay the penalty to avoid the even higher interest bill.
    • Private loans to students with high family incomes and/or good credit ratings are the ultimate gray area. The 5-7% interest rates are right in line with returns you could expect from fairly safe investments like certificates of deposit or moderate-risk mutual funds so you’ll have to base the decision on things like tax credits, and whether or not your employer matches any of your contributions to a 401k or similar investment plan.

Compounding interest is a powerful financial force, and based on your own personal situation it may be better to approach the debt side or the investment side as a top priority. All of these variables have to be considered, and even then there are risks that an investment in a particular company, fund, or any asset could lose its value due to some unforeseen change in the economy. Then again, if the dollar devalues too much, there is a risk that paying off your college debt could also backfire, financially.

22 Responses to “Pay off student loans, or invest?”

  1. With 2 starting colledge this year a lot of good info-thanks.

  2. Thanks for the great advice. Now I have something to consider when beginning college this fall.

  3. I had a big interest student loan, so I preferred to pay it off first, then think about investments. Besides, you never know when you need another loan and not get it due to a poor credit score.

  4. Definitely good to pay it off ASAP when its a high interest rate, its almost impossible to re-capture those rates unless you’re in speculative investments and chasing bubbles. On the other hand, if you have wealth saved up that could help with your credit rating for the purposes of extending your debt limit.

  5. I went to grad school. Even my subsidized stafford loans are at 6.8% (and most of my loans are higher than this). So I guess I’ll max out my 401K (for the tax purposes even though my employer unfortunately doesn’t match) and then vigorously pay off the debt.

  6. College kids with low-rate loans often don’t realize how good they have it. If you can get money at 2% a year, you should get as much as you can and hang onto it for as long as you can. Too many kids don’t realize that money that cheap is pretty hard to come by.

  7. I have always believed that using your money to investing is much better than paying off your loans.
    http://www.stocks-simplified.com

  8. Some students say you have to do both things at the same time. That to me is the best way to deal with it. And pay the minimum and invest the rest. And make sure you have at least 3 to 5 months of liquid cash for fodd and other supplies should something happen. Such as losing your job. It would be very nice to try and pay off as soon as possible but sometimes that is very hard to accomplish so I would rather pay minimum first and if things or my job pay increases, i will increase the loan payments.

    Thanks
    Studen Loans

  9. When stuck with a student loan, it is better to at least try to pay it off rather then to neglect it.. Interest rate goes up and bad credit start to take into affect…
    My best suggestion is to try by paying the loan some amount than nothing.. At least you tried….

    To make things better … Think of it as if everyone paying of a NEW Car you just bought… Never Give Up.. Keep Trying.. and Keep saving…
    Limit your spending…

  10. R/sir.my name is Blal Hussain s/o IKhtiar Ali.I belong to Parachinar Kurram Agency NWFP Pakistan. I am the student of BBA(hons)from Agricultural University NWFP Peshawar Pakistan.MY father is a farmer and he is the only one who lookafter our family.My home has destroyed by the “TALIBAN ” i-e “AL-QAIDA” during crises in our area.so nowaday i have no source to continue my study and pay my university fees i-e 40000/- rupees.I am a brallient student of my class and i have done the “IELTS TEST (4.5 bands)”but due to financial problem i will not continue my study .so i will be wery thankful if you give me a chance and minimum help to continue my study.sir if there is a chance to go fareign i will be ready. i will be waiting for ur reply. thanks yours truely, BILAL HUSSAIN . E-mail. b4y_sawan@yahoo.com

  11. Well you have to be sure that those investments will pay back on time so you don’t lose your credit score. Also it is a good idea to use that money for something that you know will work. Overall good tips. Thank you.

  12. Auto Marketing Group
    December 17th, 2009 at 12:36 am

    Thank you for this post, I so totally agree! And it’s very inspiring for me. Auto Marketing Group is selling cars and financing loans for buying a new car.

  13. Well it all depends on the rate of interest. When you take on a mortgage you are getting the lowest rate of interest possible and hence why some people use that money to invest in property. It really is cheap finance. However, student rates are not always such a ‘banker’ so tread carefully, otherwise that loan will never get paid off.

  14. I have seen some of my best friends slip back to abject poverty after inadvertently taking loans without having a concrete plan for spending the money. Some of them who had big houses are on the streets begging for money.

  15. It is true, you definitely need to have a plan when you take out any sort of debt, especially student loans, as these are loans that can’t be discharged via bankruptcy.

  16. Whilst you check out the various loan options, have a go at talking with your own bank. If you’ve established a good relationship, you may be a viable candidate for a cheap loan approval since credit scores are derived from patterns of usage.

  17. A refreshing point of view written in a compelling and interesting way. Nice.

  18. Its best to pay it off ASAP when its a high interest rate.

  19. I think that the best way for freedom is to be out of debt. So you should focus of paying the loans. After this you can invest in what you want.

  20. I had also taken Student Loans Without Cosigner from Sallie Mae of $50,000 to complete my post graduate studies. After the completion, I was indeed facing a lot of problems in making the payments on time. Any how I completed my studies and my advice to everyone would be to take only that much loan amount which you are capable of repaying.

Trackbacks/Pingbacks

  1. Don’t Worry About the Money: Why Stressing About Student Loans is Unnecessary | AcceptedToCollege.com
  2. How to Save Money for College the Free and Easy Way

Leave a Reply

You can use these tags: <a href="" title=""> <abbr title=""> <acronym title=""> <b> <blockquote cite=""> <cite> <code> <del datetime=""> <em> <i> <q cite=""> <strike> <strong>