There are two types of people in this world: those who scramble to pay off their student debt early, and those who don’t.
It’s no secret that millennials are coming out of post-secondary education facing student loans that need to be paid off. Tuition is constantly rising and more people are graduating with overwhelming debt forcing them to rely on credit cards, put off buying a home and resorting to moving back in with their parents to save money. What’s less obvious is the destructive impact high debt repayments early on can have on the retirement security of today’s younger generation.
Maybe you’re thinking, “Investing? Retirement? But I’m broke. And, like, twenty-something.” While putting your money towards a retirement account now is a great way to build yourself a nest that will eventually lead to financial independence, wouldn’t you be better off paying down your student debts first?
Here’s how to decide the best next step towards your financial freedom:
When not to pay off your student loan early:
Interest rates are low and you have other debt to tackle first: Federal student loans typically have lower, manageable interest rates that other forms of debt such as, credit-card debt, while higher-interest loans, don’t. Pay these and any loans with comparable interest rates off first since they’re unlikely to offer the same tax benefits as your student loans.
Also, consider that your money may be put to better work elsewhere, like stocks. If, for example, you’re paying 3.5 per cent in interest on a student loan and looking at an investment that could provide you with a 6 per cent return, it makes sense to invest that money. As long as you’re comfortable with the risk involved.
You don’t have an emergency stash: Without proper savings, you’re inviting more debt in. An emergency fund saves you from relying on that credit card or additional loan when surprise expenses, like a car accident or medical/dental crisis, threaten to set you back.
Putting away the recommended amount for that fund – typically three to nine months worth of expenses – can feel as intimidating as paying off your student loans. Instead, aim for an amount that makes you feel comfortable, but not so much that it kicks your other goals out of reach. Maybe that’s $2,000 or maybe it’s only $200. You can always go back and add more.
You aren’t already saving for retirement: If you want to make it rain in your golden years, invest now. You may not grasp the importance of saving for something that isn’t going to happen for a few decades yet, but investing in your retirement today means compound interest that can work longer in your favour. Don’t shortchange yourself trying to pay off debt ahead of schedule with funds that could otherwise lead to a higher net wealth at retirement.
When you should demolish your student debt quickly:
You don’t have other financial obligations: If you’re already saving for retirement and are otherwise debt-free, paying your student loans off early could save you thousands in interest – and make it easier to save for other goals such as travel or a new car. Being debt free will also increase your credit score and make it easier to apply for a mortgage, business loan or rewards credit card. All things you might want in the near future. If you’re living back at home, best choice you can make is putting more than 50% of your income onto your loan. I’m sure your parents would spare you $20 if you needed it.
You have a high interest rate and don’t qualify for any loan forgiveness plans: It may be the case that you don’t qualify for one of the several student debt forgiveness plans in place, and your loans come with a high interest rate of 7 per cent or more (comparable to what you could’ve earned if you invested your money in the stock market). In this instance, paying down your student debt quickly makes the most mathematical sense.
Debt makes you anxious: If you can’t sleep at night because of financial stress hanging over your head, do yourself a favour and get rid of it. A study published in the European Journal of Public Health found that adults with debt suffered from significantly more mental health issues than those without. Paying off your student loans earlier can relieve anxiety, stress, and depression, plus stifle that subconscious negativity.
So, where do you stand on the spectrum?
It’s important to consider what paying down student debt early might do to your quality of life. If being totally debt-free is your financial priority because the principal of debt leaves more than a sour taste in your mouth, eliminate it. On the other hand, if you’re struggling to pay bills and eat or foregoing basic necessities like health insurance, it’s probably a good indicator to wait off on making aggressive payments. Maybe consider the best of both worlds: Save a little, pay off other ‘bad debt’ first, and shop around for retirement and investments while making the minimum payments on your student loans before diving into them wallet first!