There’s no one-size-fits-all answer to the question of whether to pay off student loans or invest. In fact, there are many factors to consider when making this decision, including your student loan interest rates, predicted returns on investment, and other financial priorities.
By taking all of your goals into account, however, you can strike a balance between paying off student loans and investing for your future.
- Pay off loans or invest: 5 factors to consider
- When to pay off student loans
- When to focus on investing
- Is it possible to do both?
5 factors to review before you pay off student loans or invest
Before deciding whether to pay off student loans or invest, take a look at your current financial situation. Here are a few things to consider:
1. Monthly cash flow
If you’re living paycheck to paycheck or struggling to make your student loan payments, investing likely won’t be your first priority. Instead, consider ways to improve your finances first.
You could lower your loan payments by enrolling in income-driven repayment, for example, or work on increasing your income through a promotion, new job, or side hustle.
2. Available emergency fund
In an ideal world, you’d have an emergency fund that could cover three to six months’ worth of expenses if you lose your job or become seriously ill. Before putting extra cash toward paying down student loans or investing, shore up your emergency savings so a pricey car repair or medical bill won’t derail your budget.
3. Financial goals
Consider any other financial priorities that might take precedence over paying down student loans or investing right now. Along with building an emergency fund, for instance, it’s often a smart idea to save for retirement, especially if you can max out an employer’s 401(k) matching benefit. You may also have short-term savings goals, such as saving for a house or wedding.
“It’s certainly possible to work toward multiple financial goals at the same time,” says Justin Draeger, president and CEO of the National Association of Student Financial Aid Administrators. “Doing so is a personal decision that will vary for each borrower.”
Put some thought into what you want the next few years to look like financially, and rank your priorities from highest to lowest.
4. Interest rates and investment returns
If you have extra money to put toward extra student loan payments or investing, it’s worth comparing your student loan interest rates to your potential investment returns.
“When making this decision, borrowers should make a budget and look not just at how monthly [student loan] payments factor in, but also what they will be paying over the life of a loan after accounting for interest accrual,” says Draeger.
Let’s say, for example, that you estimate a return on investment (ROI) of 6%. If your student loan interest rates are higher than 6%, you might benefit more from paying down that debt ahead of schedule. But if your rates are lower, you could potentially make more money from investing than you’d save by paying off your student loans faster.
5. Tax advantages of student loans vs. investing
It’s also worth considering the tax implications that come with student loan repayment and investing. Student loan borrowers may be eligible for the student loan interest tax deduction of up to $2,500 per year (this deduction is phased out at higher incomes).
Retirement savings accounts, such as 401(k)s and IRAs, also offer tax advantages to savers. Independent brokerage accounts, however, are taxable accounts that don’t share the same benefits as retirement accounts.
Considering all these factors, it may be worth striking a balance between paying off student loans and investing. For instance, you likely don’t want to wait until you’re debt-free to start saving for retirement, since you could miss out on years of compound interest earnings.
But if you have extra money after setting some aside for retirement, you may choose to accelerate student loan repayment to get out of debt faster and save money on interest.
When to pay off student loans
For some borrowers, prioritizing student loan repayment may be a smart option. Here are some scenarios when you might pay off student loans before investing:
Your student loans have a high-interest rate.
If your loans have a high-interest rate, the cost of your debt can add up over the years. For example, a $20,000 student loan with 8% interest will cost you over $9,000 in fees over 10 years. But if you can pay it off in five years instead, you’d pay just $4,300 in interest.
“If borrowers have the flexibility in their budget, paying down student loan debt more quickly is a smart way to make a dent in their principal balance and avoid accruing more interest over time,” says Draeger.
You have a variable rate that’s increasing.
You may also be eager to pay off your student loans if you have a variable rate that’s been rising. This may be especially important in a high-rate environment, which the U.S. has been experiencing since 2022.
Alternatively, refinancing your student loans may be a useful strategy if you can switch to a fixed-rate loan.
Your loans are a financial burden.
If your student loans are eating up a big portion of your cash flow each month, you may want to say goodbye to that bill as soon as possible.
A high debt-to-income ratio is holding you back.
Your debt-to-income ratio (DTI) compares your monthly debt payments with your income. Lenders like to see a lower DTI, since it indicates that you likely have more cash on hand to put toward your debt. Your credit score is also indirectly affected, and a high level of debt could bring your score down.
For these reasons, a high DTI can make it difficult to secure additional loans or access low-interest rates. If your DTI is preventing you from taking out an affordable mortgage or car loan, for example, you might focus on paying down your student loans to improve your chances of qualifying.
Being debt-free is a priority.
Maybe you want to be debt-free so you can afford to quit your job and travel. Or perhaps you’re ready to start a family, but want to pay off your loans before doing so.
Whatever your reasons, you might focus on paying off your student loans simply because you no longer want the burden of debt hanging over your head.
When to invest
On the flip side, here are some scenarios when investing may be the answer:
You have low-interest loans.
If your loan rates are below 5% or 6%, you might get a better ROI from investing than from accelerating loan repayment. Review the past performance of potential investments and see what you can reasonably estimate for the future.
You’re comfortable with the risks of investing.
Remember that investing has no guarantee of returns, so you’ll have to be comfortable with the inherent risks that come with it.
You qualify for loan forgiveness or other repayment assistance.
There may be no need to make extra payments on your student debt if you’re on track to receive loan forgiveness or are eligible for other repayment assistance programs.
You want to reap the benefits of compounding interest.
With investing, you can typically earn more the earlier you start. If you wait to invest until you’ve paid off your student loans, you could miss out on the effects of compound interest. When interest compounds, you begin earning interest on interest — and the results can be significant.
Check out this example comparing your earnings if you start investing at age 25 versus age 35:
| Age 25 | Age 35 | |
|---|---|---|
| Monthly contribution | $200 | $200 |
| Annual return | 6% | 6% |
| Total contributions | $96,000 | $72,000 |
| Total balance at age 65 | $371,429 | $189,739 |
You can experiment with potential compound interest earnings using the Investor.gov calculator.
Your employer offers a 401(k) match.
Many employers offer a 401(k) match in their benefits packages. For example, your company may contribute 3% to 6% of your salary to your 401(k) — as long as you contribute a minimum amount.
If you don’t contribute enough to receive your full match, you’re leaving free money on the table. If you can afford to, it’s likely worth maxing out that benefit if your employer offers it.
Is it possible to pay off loans and invest?
Deciding whether to pay off student loans or invest doesn’t have to be an either/or decision. If you have enough room in your budget, you can work toward both goals at the same time. For instance, you could invest enough of your paycheck to max out an employer’s 401(k) match while using any extra cash to make extra student loan payments.
You might also consider ways to make your debt more affordable — leaving you with spare cash to invest. If you refinance your student loans for better interest rates or a new repayment term, for example, you could free up cash in your monthly budget.
| Note: Refinancing federal student loans turns them into a form of private debt and thus makes you ineligible for federal forgiveness programs, income-driven repayment plans, and other federal protections. Make sure you won’t need these perks before refinancing, as the process is permanent and irreversible. |
Finally, it may be worth consulting a financial adviser to discuss your individual situation and goals. A financial adviser can guide you in the right direction and help you determine your priorities, including student loan repayment, investing, and everything else that goes into managing your money.