Should You Save Your Money Or Pay Off Your Student Loans?
6 September 2006Millionaire Artist has a post ruminating on a personal dilemma at the moment: whether she should pay off her student loans or invest that money in a 401(k) to have a cushion available if there are any problems in the future. I think this is an easy call myself - saving money is virtually always better with student loans, because with the low interest rate you can make so much more by investing.
Let’s assume you have $50,000 in student loans. You’ve got another $50,000 - you could either pay off your student loans, or invest it in stocks and make 9% per year. We’ll assume you pay $450 a month in interest and principle to pay off your student loans in 15 years. I think that’s probably erring in favor of the loans as an option, because my guess is most people are paying less than that with a pretty low interest rate. That’s $5,400 a year you could save over the next 15 years. What would you end up with if you invested it instead?
If you save the $5,400 a year, you end up saving $81,000 in payments over the 15 years - a savings of $31,000 net in exchange for the $50,000 you paid. But if you’d invested it, you’d have $182,124 - a gain of $132,124. Pretty big difference.
What if you’d taken that $5,400 a year in savings and invested it each year? That’s the smarter thing to do, and closer to what your real choice likely is. But you’d still end up with $160,173 at the end of 15 years - about $20,000 less than what you’d have if you’d invested it. So even assuming pretty high student loan payments, you’re going to be better off having invested the money.
Is it ever a good idea to pick student loans first? There are a couple reasons outside this basic Excel-spreadsheet calculation to think about, however. For example, I paid off a smaller student loan I had because it was higher interest (7%) and I could eliminate a monthly payment pretty easily. The reduced stress on my monthly budget was worth it to me to get rid of that portion of my student loans. Another reason might be because you’re planning on borrowing a lot more money to buy a house and you don’t want to be carrying as much debt when you go into it. It can look bad on the credit report to be overextended. Then again, if you’ve got huge student loans, you’re probably not getting rid of enough of them to change a bank’s loan decision on your interest rate or whether to lend to you. And increasing your down payment by $5,000 is probably more likely to affect that decision that $5,000 less in student loans. In most situations, you’re better off saving that money and letting your student loans sit there at 3% interest until they’re naturally paid off.
Discuss this in the Free the Drones Forums.
One Response to “Should You Save Your Money Or Pay Off Your Student Loans?”
September 11th, 2006 at 10:27 am
[...] Free the Drones ponders if you Should Save Your Money or Pay Off Your Student Loans. [...]