Which Should I do First, Pay Off Student Loans or Invest?

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One of the many debates personal finance nerds love to talk about is whether to pay off student loans or invest? We go back and forth. Invest or pay off debt? Pay off debt or invest? Do both maybe? IDK.

I used to have a hard stance on this one but I’ve loosened it in resent years. But I will tell you my personal opinion:

I think you should pay off your student loans before you get a big head about investing for retirement.

There, I said it. It’s how I feel, it’s the truth I lived, and here’s why:

The Math That Matters

When I took out student loans the federal rate for graduate student loans was 6.8%. I signed up for auto-pay (something everyone should do) and got a .25% decrease in rate. That is still applicable today so my math is going to account for someone taking advantage of that deal.

I got through undergrad with no loans so I never experienced these low-interest rates the government says they give on student loans. 6.55% seems pretty high to me. It’s no credit card but it’s more than my mortgage and what my car loan was.

The average undergraduate debt for grads in 2015 was $29,200 with an interest rate of 4.53%. With auto-pay, grads will pay 4.28% on their loans.

Average master’s degree debt is $66,000 for undergrad and graduate degrees so about $36,800 in just graduate loan debt. The interest rate for those loans is now 6.08%, or 5.83% with auto-pay.

Assuming our theoretical student is on a 10-year repayment plan the math looks like this:

Undergrad: $29,200 at 4.28% for 10 years= $300 monthly payment & $6,731 paid in interest over 10 years.

Graduate: $36,800 at 5.83% for 10 years= $405 monthly payment & $11,869 paid in interest over 10 years.

Total: $705 monthly payment for 10 years with $18,600 paid in interest

Hold up.

I’m doing Income-Based Repayment or Public Service Student Loan Forgiveness so I don’t need to pay my loans off. The gov will “forgive me.”

Why Income-Based Repayment & Public Service Studen Loan Forgiveness Can Suck

If you ever plan on being married, getting a better job, or just getting a raise, you’re going to want to rethink IBR and PSLF.

Other than the fact that 99% of applicants are denied for forgiveness, when I calculated our eligibility we’d definitely pay more over 20 years doing IBR. Then at the end, we’d be taxed on the forgiveness (basically the equivalent of a third income that’s higher than what both of us make.)

And if you don’t pay your taxes in one payment then you’re charged interest on the payments until you pay it off! It’s a vicious and stupid cycle!

These programs are designed for people who’ve fallen on hard times. Not the millennial who regrets taking out $60,000 for a teaching degree. Participating in these programs willingly severely chains you to mediocrity and makes sure you won’t excel for the next 10-25 years. It is a bad idea to stake your financial future on government programs.

Now, with that off my chest.

What if our theoretical grad made a budget, got a side job, (got sober) and paid off their student loans in four years? Seem impossible? He or she would only need to come up with an extra $189 per week to do it.

And she’d save $11,428 in interest.

You could literally pay for your next in cash with the money you save by not giving it to the bank. Or you could invest it.

$11,428 invested over 30 years with a 6% return will make you an extra $65,636.

All Interest Compounds

It’s either working for you or against you. If you pay off your student loans you can always put investing on hold if times get tough and it won’t affect your credit score at all.

You can’t dodge student loans.

You can defer them, where interest accrues while you’re neither investing nor paying your debt. Or with private loans, that give much fewer leniencies when times get hard, stop paying them and watch your credit score plunge.

Why The Math Doesn’t Matter

The truth is, most of us aren’t making anywhere near the income it would take to make investing a higher priority than paying off your loans. I make less than $50K per year. If I should be putting away 10%-15% of my income to retire “on time” I’m left with about $35,000 to live on after taxes. Not much more there than rent, food, and a pedicure for the year.

So while interest accrues on the loan at an average of 5.05% and interest builds on your investment at 6% you’re netting a whopping .95% return. 

Six years ago I didn’t care about my financial future. I was in my early twenties and I cared more about living my best life now than buying a house or retiring. It wasn’t until I made paying off my loans a priority that I started seeing the big picture.

I started caring about interest, credit, and not having to work until I die. I did the math and saw that freedom from student loans was possible and how much better off I’d be if I did it.

The real reason to pay off student loan before you invest is because the math doesn’t matter. The only thing that matters is where you put your money.

Pay them off so you actually care, because that’s the only way you’re going to invest enough to retire well.

And this advice is all worthless if you take 10,15, or 20 years to pay off your student loans. You have to pay them off fast; you have to quit spending on “I want it now” stuff and learn frugality; you have to quit saying you don’t have time to work extra hours so you don’t have to work until you’re 80.

Do Something That Holds You Accountable

I highly suggest refinancing your student loans not just to get a lower rate but to hold you accountable for paying them off and guaranteeing you save that money on interest. People have the best of intentions when they say they’ll make extra payments on their loans but I know from experience those good intentions are bogus.

Try plugging your info into a program like ElFi to see what rates you qualify for  and take the plunge before you think too hard. Heck, take the five-year term if you can! Whatever gives you a friggin sense of urgency to HUSTLE.

The only way you learn this is by diving deep into the practice. It takes years to develop bad personal finance habits so you have to be intentional about breaking them.

We’ve been debt free for two years and five months. We went from $0 invested on that day to over $80,000 in our Roth IRAs and 401(k)s. I don’t feel like we missed out on anything by not investing.

In fact, we wouldn’t have realized how important investing is if we hadn’t gone full force with paying off our loans. I think we’d still be in debt and not even have $80K invested.

Maybe you lose about $2,000 by not investing right away, I don’t know, I’m bad at math. But I’m good at developing habits. And you will make it back tenfold in the habits, skills, and grit you learn by having to hustle.