Pay Off Student Loans or Invest? These 7 Questions Will Help You Decide

Have a little wiggle room in your budget but not sure where you’ll get the most bang for your financial goal-achieving buck? Investing enough to take advantage of your employer’s match can make your retirement savings go further, but throwing extra cash at your student loan debt may decrease the overall interest you’ll pay.

There are math-based rules on whether you should pay off your student loan balance or max out your 401(k) but when it comes down to it, there are psychological reasons for each choice too. Either choice can boost your net worth — you’ll just take a different path to get there.

Not sure how to decide? Let’s walk through the top decision-making factors you’re likely to face.

7 questions to help you decide: invest or pay off student loans?

Before you allocate any excess cash flow, make sure you've covered the basics. Your first priority should be to build an emergency fund and pay off high-interest credit cards or other high-interest debt. Once you’ve met those must-do money milestones, you’re ready to start funneling funds toward your next goal. Here’s how to decide which to tackle.

Does your employer offer a 401(k) match?

When it comes to employer perks, you often have to grab them when you can. “You can’t go backward a year or two to get a company match,” says Katie Brewer, a Texas-based fee-only planner and owner of virtual planning firm Your Richest Life, who suggests at least the minimum 401(k) contribution that will allow you to capture that employer-gifted cash. That assumes, of course, that “you’re not struggling with credit card debt or emergency savings,” she adds.

Even so, stashing away enough cash to take advantage of your employer’s match isn’t always an easy decision. Some debt-averse borrowers might rather forego that free money in exchange for a faster path to debt freedom. In the end, only you can decide whether it's the financial or psychological benefits that hold greater weight for you.

Do you qualify for student loan forgiveness?

The average recent college graduate left school with a staggering $30,000 in student loans. However, some students, particularly those with freshly-minted advanced professional degrees, may carry six-figure debts as they launch new careers. That’s a burden that could be eased by one of many available student loan forgiveness programs, so long as you qualify.

If you qualify for loan forgiveness under a program like the federally funded Public Service Loan Forgiveness (PSLF) program, it may make sense to stick to the minimum-required payment while funneling excess cash toward saving for retirement.

There are many options for student loan forgiveness, based on when you borrowed your loans, where you work, and how much you’re paid. In general, forgiveness programs apply to qualifying federal student loans only (which loans qualify differs by the program) and cap your loan payments (by how much also differs by program, but typically by either 10%, 15%, or 20% of discretionary income) for a specific period of time (again, the period of time varies by program but can be between 10 and 25 years of on-time monthly payments). Experts often warn student loan forgiveness program participants to carefully track their steps so they don’t slip up and unintentionally void years of hard-earned program progress. If you need help, a financial advisor can help you untangle the details and develop a repayment plan that works for your financial situation.

Could you benefit from a student loan refinance?

A student loan refinance could reduce your interest rate, shorten your term, or simplify your repayment options by rolling several student loans into one. “A lower rate will typically reduce your interest expense, which can allow you to pay off your principal more quickly,” says Jamie Ebersole, Massachusetts-based chartered financial analyst and founder of Ebersole Financial.

If you go this route, look for a refinance loan that’s offered at a fixed rate so it remains the same through the life of your loan. An adjustable rate may fluctuate over time, which could cause your payment to increase.

The benefits of refinancing to a loan with a lower interest rate are twofold: you’ll most likely knock out your loan balance faster and pay less overall interest too. Once you pay back your student loan, you can funnel those payments toward your investment portfolio — and potentially grow your net worth even more.

Not sure whether student loan refinancing would be best for you? Plug your info into a fast, easy online loan marketplace like Credible to get personalized rates¹ and refinance options from lenders. Credible makes it easy to compare loans and find the best option for you. (Hint: the best student loan interest rates are often awarded to borrowers with the most attractive credit score. Here’s how you can improve yours in just 30 days.)

What’s the interest rate on your student loans?

Some investors choose to use excess cash to tap into the markets, particularly if they expect their rate of return to outpace the interest they pay on their debt. For example, say your student loans are fixed at an interest rate of 3% and you expect the market to increase 8% in coming years. You may decide to start investing money in mutual funds or exchange-traded funds (ETFs) — either through your 401(k) or in a taxable account — to take advantage of that potential 5% spread.

Still, markets are impossible to predict; investments can and do lose value. One effective strategy may be to split the difference — consider using half your excess cash to pay down debt and the other to take advantage of any potential stock market gains.

When markets are on the rise, Ebersole suggests clients tap their taxable account earnings to pay down debt. It’s best to avoid tapping into your retirement account, which is subject to income tax and a 10% penalty for early withdrawal.

Want to make even bigger strides? The same strategy could be used with any unexpected windfall like the proceeds from a tax refund, a bonus from work, or an inheritance.

What about the student loan tax deduction?

Student loan borrowers can deduct up to $2,500 per year on qualified student loan payments, so long as their income falls below a certain threshold. That can be a substantial financial benefit for some borrowers, particularly those with higher-balance loans. “If a borrower calculates the deduction, and it’s significant, they may decide to pay less toward their loans each year so they can let student loans stretch out longer,” Brewer says.

Even so, it’s a rare client who creates a student loan repayment strategy based on a tax deduction alone. Instead, it's their long-term goals that usually drive just how aggressively a borrower targets the repayment of those loans.

It’s also worth noting that the interest on federally-funded student loans has been suspended until December 31, 2020, due to the coronavirus crisis (a better financial perk than a tax deduction, for sure!) That means this deduction will apply only for private student loan borrowers — for now, anyway.

How much are you saving for retirement?

If you’re already maxing out your 401(k) — employee contributions top out at $19,500 for those under 50 in 2020 — it often makes sense to start thinking about your next level financial goals.

“Paying down student loans is a great idea” in this situation, Ebersole says, who adds that a reduced debt load can create greater future financial flexibility, particularly when you’re ready to buy a first home or purchase another big-ticket item.

What are your financial goals?

In the end, there isn’t a one-size-fits-all solution for competing personal finance goals — these goals are personal, for a reason. It’s often effective to rank credit card debt, emergency savings, and first-level retirement savings (get that employer match!) as top-level goals.

After those, it’s time to reassess the importance of your next tier goals like buying a home, having a baby, or saving for a child’s education. Prioritizing each can help you decide how to allocate your funds.

The bottom line

When it comes to investing and putting extra money toward your student loans, you don’t have to choose just one or the other. Take some time to think about what’s most important to you — the potential for investment gain or the emotional security that can come with a clean-slate balance sheet. Then, develop a plan to help you prioritize your most meaningful money ambitions.

Still not sure where to start? Reach out to a financial planner who can help you understand which money moves make the most sense for you.