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When to prioritize student loan repayments
When trying to decide on priorities, there are a few things to consider:
- Your overall financial health, including any other types of debt you have (credit card, car loan, personal loan, etc.)
- The total amount of your student debt and your interest rate
- Your monthly student loan payment and its impact on your monthly budget
- All the consumer protections you could enjoy, including federal student loan forbearance, income-based repayment plans, and the possibility of a federal student loan forgiveness
Next, you’ll want to do a little math to see how much interest you’re paying over the life of your student loan. As an example, let’s look at the average student loan balance for a 4-year public college (you can enter your own data into the FSA loan calculator to see what your monthly payments might be).
- Student loan debt amount: $ 26,946
- Interest rate: 3.9%
- Monthly payment: $ 272
- Term of the loan : 10 years
If you don’t consolidate your loans for a lower interest rate, it will take you 10 years to pay off your debt, and you will pay a total of $ 32,585 (including $ 5,639 in interest). If you can’t afford to pay $ 272 per month, you might consider an income-based repayment plan, which will increase the amount you pay in interest, but make your monthly payments more manageable.
But for this exercise, let’s say you can afford to pay the $ 272 each month, already have a fully funded emergency fund, and have some cash left over. The question becomes, should we give priority to repaying our loans or investing in the market?
Next, you need to think about how much you are paying in interest. When Select spoke to Rachel Sanborn Lawrence, director of advisory services and certified financial planner at Ellevest, she said borrowers should feel okay with taking intentional debt below 10% APR, and even better if it is less than 5% APR.
If you’re paying more than 10% interest on your student loans, you should definitely make repayment a priority (and consider refinancing). But in the case of the example above, the borrower should feel good about focusing on other priorities.
Then take the time to do the math to see how much you can earn by investing your money versus paying off your student debt faster. Here is an example.
Say you have $ 50 more a month to spend on your loans instead of investing in the market. There are many calculators you can play around with to see how much you could earn or save. In this case, we used the compound interest calculator from Investor.gov.
- Initial investment: $ 50
- Recurring monthly investment: $ 50
- Chronology: 10 years
- Return rate: ten%*
- Total gained over 10 years: $ 9,692
Now let’s see how much you will save in interest if you were to invest an additional $ 50 per month in your student loans. For this purpose, we have used the Student Loan Hero Prepayment Calculator.
- Student loan balance: $ 26,946
- Interest rate: 3.9%
- Monthly payment: $ 322 ($ 272 + $ 50)
According to this calculator, you could save $ 1,072 in interest and pay off your loans 22 months faster.
While there are savings to be made by putting extra money on your student loan debt, you would earn a lot more by putting that extra money on the stock market. Plus, that money would continue to grow over time and grow faster over time due to compound interest, if you left it in the market.
Things to keep in mind
It is quite easy to look at the math to make a decision. However, not all decisions need to be made by looking at the numbers on a spreadsheet. Here are some other things to consider when making decisions about your student loans:
- A fully funded emergency fund is the top priority: Whichever side of the argument you choose, you need to make sure you have a fully funded emergency fund with 3-6 months of spending before you start investing or spending more than the minimum on your loans. Before making the decision between student loans or investing, make sure you have money in your emergency fund in a high yield savings account. Select chose the Marcus by Goldman Sachs high-yield online savings product as the best for its highest interest rates in the industry and easily accessible customer service.
- Refinancing of public loans to private loans: If you have federal student loans and are considering refinancing, you should be wary of compromises. You may be able to earn a lower interest rate, but you’ll be sacrificing any chances of federal student loan cancellation through programs like Public Student Loan Cancellation (PSLF), as well as safety nets like than income-based or forbearance repayment plans.
- Having debts hanging over you can be a burden: Taking the priority off your debt to start investing for the future may be the best decision on paper, but there is something to be said about the pressure of having a lot of debt. Capital One has found that 73% of Americans rank their finances as their first point of stress.
- If you choose the path of investing, invest smartly: Warren Buffett, one of the most successful investors and business leaders of our time, has been repeatedly quoted as saying that an S&P 500 index fund is a great way for any investor to make money.. This index is a group of the 500 largest companies in the United States. While there is always some risk when you invest in the market, this index has gained in value over 40 of the past 50 years, with an annualized return of 10%. However, it is recommended that you contact a financial advisor to choose the portfolio that suits your financial goals. Also consider a robo-advisor like Wealthfront or Betterment.
At the end of the line
Student loans are a drag on the financial growth of millions of Americans, and paying off that debt should always be a goal. At the same time, there will be a day when your loan amount reaches zero, and there will be new financial goals to be achieved. And with the power of compound interest, the only integral factor you need on your end is time.
* S&P has an annualized rate of return of 10%.
Editorial note: Any opinions, analysis, criticism or recommendations expressed in this article are the sole responsibility of the editorial staff of Select and have not been reviewed, endorsed or otherwise approved by any third party.