You’re a successful college graduate. You made it through all of your classes and secured a job in your chosen field. You’re on your way to building a successful career and establishing your life as an adult.
Now that you’re in full-on adult mode, you’ll have to start making some pretty big decisions. What are your short-term goals? What are your long-term goals? How are your finances stacking up to help you get there?
One of the questions many young adults face is whether it’s better to pay off student loans (or other debt), save, or invest. With rising levels of student debt across the nation, this is a common question. College students who graduated in 2019 with student loans owe an average of nearly $29,000.
You know that paying down debt is good for financial security, but saving and investing are important, too. The best course for many is not to think of it as choosing between one goal and another. With some strategic thinking and careful planning for your financial future, you can do all three.
Making a Budget
A good first step to any financial conundrum is to fully evaluate the situation. Start by gathering all of your financial documents including tax statements, bank statements, credit card statements, and statements on student loans or other debts. Then, list out all of your monthly expenses—fixed expenses, like rent, and variable ones, like dining out.
Now, tally up all sources of income and list out your savings. After you’ve done this, you should have a pretty clear idea of how much money you’re spending, what you’re spending it on, and how that compares with the money you are bringing in every month.
Now that you have a big picture view of your spending habits, look for areas where you might be able to make changes. Take a look at any of your current subscription services with monthly payments, for example. If you’re not actively using them, maybe it’s time to cancel.
If you’re willing to call your internet or cable provider, you could try to negotiate a lower rate. After you’ve made any changes to your spending, make a new budget—one that details how much money you’re going to put toward your student loans, your savings, and your investments.
Making Payments on Your Loans
Regardless of your financial goals, it’s important to prioritize your debt payments. Failing to make payments and allowing your loan to become delinquent or go into default can have serious consequences for your finances and credit score.
By paying at least the monthly minimum payments, you can make sure you stay in good standing with your loan servicer while still making progress toward your loan repayment.
Paying off High-Interest Debt
When it comes to debt, the interest rates on student loans are relatively low. While you are making monthly payments on your student loans, it could be smart to tackle any high-interest debt you may have.
Credit card annual percentage rates (APRs) average more than 16% in July 2021, which means debt can rack up quickly. If you are carrying credit card debt, you might try either the debt snowball or debt avalanche method to pay it down.
The Debt Snowball Method
With the debt snowball method, you’ll pay the minimums on all accounts first and direct any additional funds to the smallest debt first, regardless of the interest rate. The idea is that by paying off your smallest debt first, you’ll stay motivated to continue making payments on your debt. After you pay off your smallest debt, you take all of the money you were putting toward that balance and put it toward the next smallest debt (so the amount you pay gets bigger like a snowball), and so on, until all of your debt is paid off. The accomplishment of repaying your debts provides motivation to continue paying off the money you owe.
The Debt Avalanche Method
With the debt avalanche method you’ll focus on the debt with the highest interest rate first. Make a list of all your debts by order of descending interest rate. While making your minimum monthly payments on all the debts, you would “attack” the loan with the highest interest rate with as many extra payments as you can.
This method can require more discipline, but keeping track of how much you are saving in interest can be a great motivator.
Another option for getting your credit card debt under control is to consolidate it with a personal loan. Personal loans often have lower interest rates than high-interest credit cards and, as a result, you could save money on interest.
Another benefit of consolidating your credit card debt: Streamlined payments. You’ll only be responsible for making one monthly payment to one lender instead of multiple payments to a variety of credit card companies and lenders.
No matter which debt repayment method you use, a common tactic is to keep credit card balances low after paying them off, since running them back up has the potential to make your credit profile less attractive to lenders due to the increased total debt.
Lowering Your Student Loan Payments
If you are having difficulty making monthly payments on your federal student loan due to temporary financial issues, you could consider putting your federal student loans into deferment or forbearance. Just know that while many student loans are in forbearance interest will continue to accrue, making it more expensive to pay off later.
Depending on the type of loan you have, you may be responsible for accrued interest during deferment as well. If your issues with repayment will last more than a couple of months, consider adjusting your student loan repayment plan.
If you have federal student loans, you can change your repayment plan at any time, at no cost to you. The standard repayment plan for federal student loans is a fixed monthly payment over a 10-year term. If this is too much for your current financial situation, you might consider other repayment plans.
The Extended Repayment and Graduated Repayment plans offer repayment terms over 15 or 20 years, which could make your payments more manageable on a monthly basis.
There are also four Income-Driven Repayment plans which allow you to pay a portion of your discretionary income—usually 10%, 15%, or 20%—over 20 or 25 years. These options would lower your monthly payments, meaning you would have more money to save for a rainy day or to invest. But, it’s important to note that by extending your repayment term, you will be paying more in interest over the life of the loan.
Another alternative to consider is refinancing your student loans. Refinancing may allow you to lower your interest rate, adjust your monthly payments, or customize your repayment term. When you refinance, you take out a new loan with a private lender. However, this means you forfeit federal loan benefits, such as access to income-driven repayment plans, deferment, or federal loan forgiveness programs. So, if you’re taking advantage of a federal loan program, refinancing might not be for you.
Whether you’ve freed up some of your monthly budget with an income-driven repayment plan or by refinancing, or simply by better budgeting, you may be able to redirect some of those funds into other financial goals like saving and investing.
Building Your Emergency Fund
Now that you have a handle on your debts, it’s time to turn to your savings. The first order of business you might consider is building an emergency fund. A good goal is to have six months’ worth of expenses in a liquid account, such as a high-yield savings account. You can use this fund to cover any unexpected expenses that might occur due to a medical emergency, sudden layoff, car repairs, etc. Even starting with a small amount can help when emergency expenses pop up.
Saving for Your Retirement
When it comes to investing for your future, one of your biggest assets is time, but it’s important to start saving as soon as possible for retirement. Even a small amount of savings can add up over time, but you may want to aim to save at least 10% to 15% of your income for retirement. To see how your retirement goals stack up, take a look at SoFi’s retirement calculator.
The best place for most investors to start saving for retirement is in a tax-favored investment account, such as a 401(k) or IRA. If you are eligible for an employer-sponsored 401(k) plan, that’s a great place to start. Some employers offer a matching contribution up to a certain percentage when you contribute to a 401(k). Take a look at your employer policy and see if you’re able to contribute enough to get the full employer match.
Another option for retirement savings is setting up an IRA, or Individual Retirement Account. There are two types of IRAs: traditional or Roth IRA.
First, you can only contribute to a Roth IRA if your income falls below a certain limit. You won’t get an immediate tax benefit for money you put into a Roth, but the money grows tax-free, and you won’t owe taxes on it when you make withdrawals in retirement.
Depending on your income and whether you have a 401(k) at work, you may be able to deduct some or all of the money that you put into a Traditional IRA. That money grows tax-free, and you’ll also typically owe taxes on your withdrawals when you retire.
Is It Better to Pay Off Student Loans, Save, or Invest?
As you move through life, retirement will be just one of your many financial goals. You may also want to work toward buying a house, saving for a child’s education, or taking an extravagant vacation. No matter what your financial goals are, investing could help you meet them.
The key to understanding whether it is better to invest or pay off student loans is opportunity cost. Federal student loans often have relatively low-interest rates, and if you’ve refinanced your loans, you may have secured an even lower rate.
For example, say your student loan interest rate is 4%, while the stock market has (hypothetically) yielded average returns of 7% over the last five years. Generally speaking, earning 7% interest makes more financial sense than paying down debt at 4% interest.
Investing comes with risk, but investing can be a great way to grow your money in the long run. On the other hand, paying down debt can free up additional cash flow and improve your credit score, giving you more financial flexibility in the short term.
Whether it makes sense to direct any extra cash toward debt repayment, savings or investing (or some combination of the three) will depend on your current financial situation, your short- and long-term goals, and your risk tolerance.
If investing is part of your plan, a great way to get started is with SoFi Invest® automated investing platform. You’ll gain access to a team of financial advisors and cutting-edge automated investing technology, and we’ll work with you to determine your financial goals and risk tolerance.
Then, we’ll set up your account to meet those preferences and we’ll auto-balance your investments to keep them in line with your goals as the market changes. And anyone can invest—you can get started with as little as $5.
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