Dear SoFi planner,
I just refinanced my student loans, and now I have $120K left in loan debt at an interest rate of 3.5%. Since I’ve refinanced, I’m paying about $500 less per month than I was before.
My question is: Should I put that extra money towards paying off my loans faster, or saving for other goals, like retirement and buying a home someday? I’ve been putting money into my 401(k) because my employer matches, but I don’t have an IRA or a house fund yet. I want both of those things, but I feel guilty investing in them if I still have student debt. What should my strategy be?
—A happy but confused refinancer
Congrats on refinancing! It’s always a good feeling to have some extra money in your budget, but it can be confusing to know what to do with it, especially when you have multiple financial goals you’re saving toward.
Here’s what I recommend: Given the low rate on your student loan, it might be a smarter move to continue paying the minimum and put your extra cash flow elsewhere—like saving for retirement or buying a home, which are likely going to be your biggest financial goals in life. Why? It all comes down to opportunity cost!
Your student loan only costs you 3.5%—but if you can invest your money in an asset with the potential for appreciation and earn a return of more than that, you can achieve your goals more quickly than if you pay down your student loans and have to wait years to invest. Of course, all investing comes with risk, so you’ll want to take an inventory of your personal aversion to loss when start thinking about investing.
You are already contributing to your 401(k) and taking advantage of your employer matching, which is great—keep it up! Ideally, you can max out your retirement savings and put in the full $18,000 (in 2017) or $18,500 (in 2018).
If you are already doing this, I’d recommend you start thinking about the house fund before an IRA. Why? Three reasons. First, a house is often one of the the only assets on your balance sheet from which you get utility. In other words, it’s the only thing you can use now! Second, in the current housing market, the return on a home is likely higher than the interest rate on your student loan.
Look into the past and predicted rates of real estate appreciation in the location you’d like to buy in, and see if it’s higher than 3.5%, the interest rate of your student loan. (Though keep in mind that the past does not necessarily predict the future, so an investment in a home does come with the possibility that its value could decline.)
There can also be tax benefits to homeownership that make it attractive since you can itemize property taxes and mortgage interest on home indebtedness up to $1.1 million (though note that this could definitely change with new tax laws). This potential tax deduction could make the return on your home even higher! The third reason to pick saving for a house over the IRA is diversification. You don’t want to have all of your investment eggs in one basket, do you?
The equity markets have provided solid returns in recent years, which might be a consideration in a decision to invest. If it’s going to take you more than three years to save for a house, consider putting your money in an investing account and give it the best chance of growing. SoFi Wealth is a great option for first time home-buyers who are looking to invest their way toward a down payment.
Of course, keep in mind that investing is not risk-free and you could lose money in the markets. If your retirement is still a few decades off, you can afford to take more risks, while you may want to be more conservative if you want to buy a home sooner. Check out this Retirement Calculator to see if you are on track for retirement!
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