Pay off student loans or invest?
You've got extra money each month. Here's what each choice leaves you with, in dollars, after the years you pick.
| Pay loan first | Invest the extra | |
|---|---|---|
| Net worth at the end | – | – |
| Interest paid | – | – |
| Loan paid off in | – | – |
How the comparison works
Both paths spend the same money every month: your required payment plus the extra. Pay loan first sends all of it to the loan until it's gone, then invests the whole amount. Invest the extra pays only the minimum and invests the rest from day one. Net worth is investments minus whatever loan is left.
Rule of thumb: above about 7%, pay the loan. Below about 4%, investing usually wins over long periods. In between, it's close, and the guaranteed option is worth something.
Before you do either
- Get your full employer 401(k) match.
- Build an emergency fund of at least one month of expenses.
- Pay off anything above 10%, like credit cards, first.
Questions
Should I pay off student loans or invest?
Compare your loan's interest rate with the return you can reasonably expect. Paying off a 7% loan is a guaranteed 7% return. Investing might beat it over long periods, but it isn't guaranteed. Always take a full employer 401(k) match first; that's an instant return no loan can beat.
What return should I assume for investing?
Broad U.S. stock indexes have historically averaged around 10% a year before inflation over long periods, with big swings along the way. Many planners use 6-7% to be conservative. Try a few numbers and see if the answer changes.
Does this apply to federal loans on income-driven repayment?
Not cleanly. If you expect forgiveness through Public Service Loan Forgiveness or an income-driven plan, extra payments may never pay off. Run that case with your servicer before sending extra money.
What about refinancing?
Refinancing private loans to a lower rate can beat both options. Refinancing federal loans gives up federal protections like income-driven repayment and forgiveness, so it's a bigger decision.