Should You Prioritize Paying Off Student Loans or Investing?

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Choosing between paying off student loans and investing can be difficult because there’s no universally correct decision. Instead, the right choice can vary from person to person, and even when certain factors point to one being logically better than the other, sometimes the best option can come down to personal preference.

To figure out whether you’re better off repaying your student debt or investing, you’ll want to take your interest rates, taxes, and overall financial situation into account. The choice also depends on factors like your interest rate, risk tolerance, and financial goals. There’s no one-size-fits-all answer.

Factors to Consider When Deciding Between Paying Off Student Loans and Investing

Paying off student loans or investing isn’t always a clear-cut choice. Although it’s often good to get out of debt earlier, sometimes it pays off more in the long run to put more of your funds toward building up your investments. 

Below are some of the most crucial factors to consider when deciding which to prioritize:

Interest Rates vs. Investment Returns

When you have outstanding debt, you’re essentially losing money thanks to interest. This is because unpaid interest gets added to your outstanding debt and can capitalize. Fortunately, with a traditional payment plan, your minimum monthly payment will cover the interest that accrues. Making a larger-than-required payment, meanwhile, can reduce the principal balance, which means paying less in interest in the long run.

Given all of this, it might seem like a no-brainer to prioritize paying off your student loans. However, you have to weigh any interest savings against potential investment returns.

Suppose you have $10,000 in student loans at an average interest rate of 4%. That means you’d accrue $400 in interest over the next year. By comparison, if you invest in a certificate of deposit (CD) at a 5% annual percentage yield (APY), you’d earn $500 in interest on a $10,000 investment—a $100 net gain. However, the choice is rarely that simple. If you’re instead paying 7% in interest, you’re unlikely to find a CD with a higher APR.

Risk Tolerance and Time Horizon

Your risk tolerance—or your willingness to chance suboptimal financial outcomes for potentially higher rewards—should also be considered. For example, if you have a high risk tolerance, you might be comfortable investing in stocks to try to capture that roughly 10% annual historical return. However, if you have a low risk tolerance, you might prefer the essentially guaranteed return of paying down your student debt.

You’ll also want to take your time horizon—or how long you expect to keep your funds invested—into account. If you only have one year of student loan payments left, it might make more sense to put more funds toward closing that account even sooner. But if you have 20 years of repayment ahead of you, you might not want to put off investing for that long.

Lastly, you’ll also need to consider how your risk tolerance and time horizon intersect. If you’re investing for retirement, then you likely have a higher risk tolerance, as you’ll have several decades to weather market volatility. However, you may prefer to limit your risk if you’re saving for a down payment on a mortgage, as short-term losses could mean delaying your home purchase.

Student Loan Type: Private vs. Federal

Private student loans often have fewer benefits compared to their federal counterparts, including access to federal loan forgiveness programs, such as:

• Being on an income-driven repayment (IDR) plan, which allows you to pay a relatively low monthly amount and, after 20 or 25 years, then forgives whatever balance remains
• Being employed by a government or not-for-profit organization, meaning you may be eligible for Public Service Loan Forgiveness (PSLF) after making 120 qualifying monthly payments
• Being a teacher at a low-income school or educational service agency, making your eligible for Teacher Loan Forgiveness

As such, you might be better off prioritizing repaying your private loans over your federal ones, so as not to lose access to any debt cancellation options you can qualify for.

Tax Considerations

There are also tax considerations to take into account. For example, you can deduct up to $2,500 in student loan interest payments, potentially lowering your taxable income. Once you pay off your student loans, you’ll no longer be able to take advantage of this deduction.

Investing can also have tax benefits, such as potentially being able to deduct up to $7,500 in traditional individual retirement account (IRA) contributions. However, investing can have tax consequences too. For instance, if you sell investments for a profit without holding them for a full year, then you generally incur taxes at your ordinary income tax rate.

Your Financial Goals

Personal finance is personal. What works for someone else might not be best for you, because your goals may differ. For example, your primary goal might be becoming debt free, even if it’s not the most optimal financial choice compared to investing.

High student loan payments can also limit your ability to take on new debt. In that case, if homeownership is your primary goal, then you might focus on paying down your student loans so you can more easily qualify for a mortgage.

Benefits and Drawbacks of Prioritizing Student Loan Repayment

Pros Explained

• Accrue less interest: The sooner you pay down debt, the less interest it can accrue, which will save you money in the long run.
• Improve credit eligibility: Lenders may be unwilling to issue new loans if you have a lot of student debt, so paying off those outstanding loans can improve your ability to access credit.
• Minimize stress: Some people may find that the relief that comes from being debt free is worth missing out on any potential returns from investing.

Cons Explained

• Miss out on potentially higher returns: The savings on student loan interest might be overshadowed by the opportunity cost of losing out on higher investment returns.
• Lose potential forgiveness benefits: Particularly with federal loans, you might be able to qualify for loan forgiveness down the road, so repaying that debt early might mean paying more than if you waited.
• Lose potential tax benefits: For certain taxpayers, the student loan interest tax deduction is worth hanging onto.

Advantages and Disadvantages of Prioritizing Investing

Pros Explained

• Higher return potential: Investments often have a higher return potential compared to the “guaranteed return” of repaying student loans. This is especially true if you have access to benefits like an employer match on retirement contributions or will likely be eligible for debt forgiveness later on.
• Possible tax advantages: Investing within a retirement account can have tax advantages, such as deductions for contributing to a traditional IRA, or the ability to grow and withdraw your investments tax free with a Roth account.
• Make progress toward other financial goals: Even if the math doesn’t fully work in your favor, you might psychologically benefit from seeing some progress toward goals like saving for retirement. Once you’ve started growing your nest egg, you might feel more comfortable shifting your focus back toward tackling your student debt.

Cons Explained

• Risk of losses: There’s often no guarantee your investments will gain value, and you might even lose money.
• Less certainty: Even if you don’t lose money by investing, there’s still less certainty regarding returns. In contrast, by paying off student debt sooner, you know that you’re saving money on interest.
• Remain in debt longer: Focusing on investing means carrying student loan debt for longer. That might be mentally taxing for some, and it could even cause financial issues, such as making it harder to qualify for new credit.

The Bottom Line

There’s no one right answer when it comes to whether you should prioritize paying off student loans or investing. There are monetary and psychological aspects that will both likely factor into your decision. Weigh your options in regard to your own financial situation, think about what you’re comfortable with, and consider speaking with a trusted advisor if you need further assistance.