Many students take out a loan to help pay college expenses — often, even more than one. For graduates who secure jobs with healthy salaries, paying those loans off early becomes a distinct possibility. If you are fortunate enough to be in this situation, you may wonder if paying off your student loans is a smart financial move, or if you should be investing the money elsewhere. Here are three questions to ask in making the right decision for your financial circumstances.
Find out now: Can I afford my student loan payments?
What Else Could You Be Doing with the Money?
Look at your other debts, such as credit cards and other types of loans, and take note of the interest rate you pay each month. Think about the impact of spending the money to pay off your student loans could have on your debt and your current lifestyle.
Should you not have any outstanding debts, you might want to consider your investment options and goals. If you didn’t pay off your loans right now, would you use that money as a down payment on a house? Or would you invest additional money in your 401(k)? Determine the average annual return on any potential investments and how that income would affect your quality of life down the road.
What Is the Interest Rate on Your Loan?
Next, examine your loan paperwork and determine the interest rate you are paying on each loan. Paul Gabrail, with The Capitalist Manifesto, recommends that if the interest rate is less than what you would earn on other investments, then you should not pay off the loan, and should put your money elsewhere instead. “For example,” he notes, “if they [graduates] have a credit card with a $10K balance with a 15% interest rate and $50K of student loans, then they should put as much as they can, especially extra cash, towards the $10K debt. Always pay your highest interest loans first, no matter the size.” If the student loan rate is below 7%, however, then you should continue paying on the loan each month and invest the money in accounts or mutual funds that typically earn more than 7%.
When you have more than one student loan, it often makes sense to pay off the ones with higher interest rates and continue paying monthly on lower-interest loans. “Graduates should focus on paying off … student loans by order of interest rate from highest to lowest, one at a time. Typically private loans have the highest interest rates, so pay those loans off first,” says Elle Kaplan, CEO and founding partner of Lexion Capital Management.
Does the Loan Cause an Emotional Burden?
For some people, having any kind of debt weighs them down and keeps them up at night. If that’s the case, and if you can afford it, you may want to pay off the loan early regardless of other financial considerations. “If they can’t sleep because of the burden of this loan,” Gabrail says, “and it is hurting their quality of life, that’s a totally different story, but that’s an emotional decision, not a financial one.”