Student loans can be crippling, and undergraduates often don’t realize how neck-deep they are in debt until they graduate and have to start paying back. After graduation, the pressure to stop the loan from compounding starts to bear down on them. This pressure has forced many American students to wonder if they should pay off their loans, or invest. Either way, it’ll require jumping at any job opportunity that pays well, even if it isn’t fulfilling, just so that they can start paying off the debts.
But for such students, paying off debts with their first incomes can negatively affect their quality of life. For instance, if a newly employed young man has an emergency requiring a lot of money, he will have little to spare because of the difficulty in building good saving habits while repaying student loans.
For these reasons, many students think about investing their earnings instead. They can use the profits to repay their student loans while still having some money left for the rainy days. The math adds up, but is it that straightforward? This article will analyze the underlying factors in clearing student debts and investing so that undergraduates and young professionals can make better-informed decisions.
Offsetting student debts early
Paying off student loans as someone who just started a new job means that every earning that does not go into essentials will go into debt-repayment. When students consider the cons of student loans, they realize that there may be better ways to use their money. And that is where the investment frenzy comes in, which seems like a better idea because no one wants to wake up at 60 and realize that they have no sizable retirement sum.
The way student loans work seems pretty straightforward until one is in the repayment process and realizes that they may not have known what they got into at the time. Many students think that loans are as simple as the government lending students money to go to school and repay upon graduation. It all seems simple because few people fully grasp the loan process and what to expect during repayment.
The reality today
The average student borrows $37,000, and the average interest rate placed on these loans is 4.5%. And going by the earning power of Americans after graduation, it will take the average person about ten years to repay this loan. This scenario depicts that they would have to pay around $384 per month.
Some may try to one-up the system by paying more at the end of each month. If a fresh graduate throws in an extra $200 at the end of each month, it means that they can pay off their loans in record time, right? It sounds like a great plan — except it’s not very feasible.
How many jobs will pay a fresh graduate enough to fork out $584 monthly while taking care of their living expenses? Besides, some companies are averse to hiring people with student loans, further narrowing the options for students looking to land their dream jobs that pay enough to offset their loans.
Sometimes, fresh graduates start side hustles or other odd jobs to make cash. Even then, it is often not enough to make up the money needed to pay off a student loan in record time. In the end, students find themselves back to where they started, with a debt that keeps growing.
13 factors to consider when choosing between paying student loans or investing
Now that readers have a better idea of the choice they have to make, they need to weigh their options. Depending on a student’s risk aversion, is paying back the loan immediately a better option, or should they invest in their retirement, since many rich people got their wealth through investments? The answer depends on how the following 13 factors apply to whoever is making the decision.
1. The interest rates on student loans
The interest rates on student loans influence the choice to either pay up or choose investments. If the rate on a student’s loan is higher than the average of 4.5%, it may be a bad idea to wait for a long time before paying off the loan. The due amount will keep increasing, while students wait to earn more to pay the loan.
Considering the $37,000 loan and the 4.5% average, the loan and interest accrued after ten years would be $53650. If the interest rate is lower than the average percentage, it might be easier to pay off, but it worsens if the interest is higher. When the individuals multiply the loan interest by the waiting time and add to the initial loan, delaying becomes a bad idea.
If anyone is looking at investing instead of paying the loans later, they should consider their interest rate. In many cases, this accruing interest compounds the initial loan. If there were a way to stop interest from accruing on student loans, it would help, but there isn’t.
2. Age factor
Many people ignore their age and limitations when stuck in this financial dilemma. The average age of an American college graduate is 23. But if a person went to college later than expected and got a student loan, they would have less time to pay the loan off or invest before retirement.
Now, if for some reason someone waits till they are 25 before they get into college, it means they would be done by 30. At 30, they will have 35 more years before retirement, which means that they should be preparing for retirement by 50. Going by the number of years it takes to pay off student loans on average, this individual would have missed saving for retirement for the first ten years after school. Ten years out of 35 means they have 25 years to sort their 401k plan.
A younger person who finishes college at 23 has a better chance at investing in retirement than someone who graduated at 30. Besides, investing in stocks and mutual funds yields better returns when started early, thanks to compounding interest. So, when considering these choices, one should consider how long they have to work and earn.
3. Employer’s contribution to retirement plans
Some employees’ benefits come with employer contribution packages, whereby employers contribute a percentage to their retirement. The average rate an employer should contribute to an employee’s retirement savings is 7.5% of their monthly earnings. If an employer contributes to a person’s retirement at that rate, they can forego the 10 to 15% average percentage required to invest and start paying off their student loans.
Unfortunately, the employer contribution is not automatic and not everyone will enjoy that privilege. But if a person is lucky to work with an employer who contributes to their 401k, they can take advantage of it. The primary borrower can leverage their employer’s contribution to clear their student debt early. Since the employer has the retirement end covered, the person can set more aside for monthly loan repayment. The goal is to finish early enough to start putting the rest of their money into investments for further years.
4. Personal financial goals
Everyone has financial goals: buying a house, a new car, or paying for a vacation somewhere. However, financial goals take the backseat when paying off student loans comes into the space. If a person wants to have a house after retirement, student loans can take a considerable chunk off the savings for that goal. So for anybody planning to retire early, investing for retirement should take precedence over paying off the student debt.
The result of putting student loan repayment over personal financial goals is that it may take longer to get to those goals. On the other hand, if one prioritizes saving for these goals, they will offset the debt slower. The loan’s interest will keep accruing, as the loan will not disappear just because the primary borrower ignores them. And if a person dies without clearing their debt, it can affect their families, especially if it is a private loan that doesn’t offer discharge due to death.
5. The kind of student loan taken
There are two types of student loans: federal student loans and private student loans. The former often come with lower interest rates, benefits, and options that people can use to their advantage. Some benefits of federal student loans include providing alternative repayment plans and loan forgiveness programs in exceptional cases.
However, private student loans come with higher interest rates and stringent payment options that the borrowers must follow. There are also fewer protection plans when anyone takes private student loans. If students took a federal loan, they could chase financial goals and get into investments that could later help them pay off the loan. However, with private loans, the earlier a person pays them off, the better it is for them.
So before opting to invest or repay student loans, primary borrowers should consider the kind of loan they took. They should also check their lender’s policy to clarify the loan terms and decide how liberal they can be with their repayment strategy.
6. The interest rates (variable or fixed)
Fixed interest rates usually come with federal student loans, and this means that if the interest on the loan is at 4.5% percent, it stays that way. It does not matter how long the primary borrower goes without repaying the loan; the interest does not change. So if one has a favorable fixed interest rate, they can decide to start investing their earnings.
However, with private loans, the interest rates are usually variable, which means they change and often not in a way that favors the borrower. In such situations, delaying repayment isn’t wise as it would only mean that the borrower will pay more. And when factors like inflation start to affect the payable amount, they may not even have enough to save at the end of the month, let alone invest. So for those whose loans have variable interest rates, clearing the debt is a smarter option.
7. Earning power
Before anyone starts repaying a student loan, they should first look at how much they are earning. The average starting salary for a college graduate is $55,000, and this is only if the going is good. Notwithstanding this average annual income, some college graduates don’t get jobs that pay as much due to factors that include their areas of specialization, states of residence, ethnicity, etc. So what are the choices for these people who don’t earn enough?
A great option would be to get an extra job to pay off student loans. It isn’t uncommon to see Americans working multiple jobs; but the downside is its toll on the individual’s social life, physical and mental health. Yet, if the borrower has federal loans with low or fixed interest rates, they can decide to shelve the loan payment, pending when they can afford to repay and still have a decent savings plan.
8. The emotional and mental effect of the loan on the person
To make the right investment choices, one needs to be in top shape and have the right advisers. So whether they decide to pay off their principal or invest, they will make financial mistakes if their mental health and emotions are compromised. And having to pay off a student loan without a feasible payment plan can mess with a person’s emotional and mental health.
When a person gets out of college and starts earning, many bills and responsibilities come with that independence. They have to sort rent, feeding, tax, utility bills, insurance, and savings. And when you throw the student loan into the mix, the individual can start to overanalyze and worry, which will compromise their financial decisions.
So if one tends to worry about their unpaid student loans excessively, they shouldn’t dabble into investments. There is a good chance they won’t make the right investment choices in that state of mind, as they will let fear and crippling urgency guide their financial decisions.
9. Refinancing the loan
Refinancing student loans refers to a situation whereby borrowers have a private lender pay off their federal loan and then pay back the lender. People don’t like the idea of refinancing student loans because of the benefits they will lose from the federal government. The letter often provides favorable interest rates as well as loan discharge options. Still, some private lenders offer lower rates suitable for people who intend to do other things with their money.
So if a person is on a federal student loan and intends to invest, they should consider refinancing. Depending on their lender’s policy, they may strike a more flexible bargain to save money over the loan and reduce their monthly payments. However, the borrower should remember that their credit scores will help determine their new interest rate, which means that not everyone will get a good deal, and refinancing may become costlier in the long run.
10. Availability of viable investments
Some people prefer using investments to pay off debts, and that is fine. In this approach, borrowers invest the amount they would have used to pay back their principal. At the end of the investment tenure, they take out the amount needed from the investments to pay off the loan and the accrued interest. If they get into a profitable investment, they will have some extra money to save, spend, or reinvest at the end of the day.
While this idea sounds exciting, the trick is in finding viable investments that can support it. As a fresh graduate, investing may be tricky, especially without a solid financial background or professional adviser (since affording one at that stage is difficult). So invested student loans can bring great returns, enough to pay off student debts and reach financial goals. But one can quickly lose their money in ill-advised investments or fraudulent ideas like Ponzi schemes.
Buying company shares used to be something the younger generation avoided because they assumed it was dull, didn’t pay quickly and was for Wall Street professionals. But with finance education becoming accessible, buying blue-chip stocks now appeals to Gen-Zs and Millennials. Many of them consider buying shares with the money set aside for loan repayment.
But the market fluctuates, and the COVID-19 pandemic didn’t do the economy any favors. So before anyone invests in stocks, they should research and speak to a trusted financial adviser or stockbroker. They can buy student loan stocks from private companies that service student loans, especially if the federal policies favor the industry.
For example, with President Biden canceling 11.5 billion dollars in student loan debts, the shares of private loan companies may take a hit. So anyone looking to invest should follow the market, understand and predict trends and evaluate the risks. More importantly, they should have a contingency plan that isn’t hoping for student loan forgiveness or other factors beyond their control.
12. The presence of a cosigner
Private loan recipients can have an adult with a good credit score to cosign. In this case, the cosigner will step in if the primary borrower cannot pay their debt after a stipulated time. Most students use their parents as cosigners because of the convenience.
When choosing whether to pay off debt or invest, calculator websites can come in handy with financial assumptions. But with all these factors watering the ground, many student debtors don’t understand the burden of their debt. Many parents have found themselves in tough spots with private financiers because their children thought they didn’t have to worry about repaying their student debt.
So while having a cosigner can incentivize a borrower to invest instead of paying off their student loans, they should know that they are passing the burden to the cosigner. But depending on the relationship between the borrower, the cosigner can pay off the loan and have the debtor pay them back later. This deal will allow the borrower to use their extra earnings for investments and other financial projects.
13. Eligibility for student loan forgiveness
While the student loan forgiveness program is an option, it should be the last thing on anyone’s mind. With a 98% rejection rate, this factor isn’t in the borrower’s control, so it isn’t an advisable backup plan. The idea of applying for loan forgiveness should only come in if an investment plan supposed to pay off the loan failed. Besides, skipping loan repayments in hopes of seeking loan forgiveness later is irresponsible.
But emergencies occur and people can get the short end of the stick no matter how well they plan. So for those choosing between paying off student loans and investing, having their student debt erased is the best outcome, as it will allow them to start on a clean slate. But loan waivers are not available for people using private lenders. And even for federal loans, though the process is rigorous and a favorable outcome is improbable, it isn’t impossible.
The Bottom Line
Student loans weigh on many Americans today because of how difficult they are to pay off, not to mention when there’s little left to invest. And with external factors like inflation and pandemic, more students are looking for profitable things to do with their income instead of debt repayment. Investing seems like the best alternative because there are many investment options today, but it is equally risky.
Following the market trends and listening to financial experts will help anyone make better investment decisions. And by comparing the underlying factors in this article to their personal cases, students and recent graduates can decide whether to invest or repay their student loans.
Paying off student loans as early as possible has its pros and cons. While it is a great idea to get the loan off the table early, this strategy may affect the borrower’s ability to save and or invest and thus reduce their quality of life.
If one does not pay back their student loan after 90 days, their credit score will nosedive, which will affect other financial steps they may want to take. If they got the loan from a private lender, the latter could sue them. So it is always a good idea to pay back the loan.
If one can afford it, offsetting their student debt at once is a brilliant idea. This step will prevent the person from paying extra due to the interest accruing on the principal loan. It will also give them the freedom to use their earnings for investments and other profitable projects.
The choice to either pay the loan or invest depends on several factors. The biggest deciders are the person’s financial state, earning power, and interest rates on loans. The repayment plan can also influence the decision, but paying down debt is usually better if you can afford it.