Are You Afraid of Your Student Loan Debt?
October 30, 2014What’s really scaring you this Halloween? If you have student loans, getting that bill might rank pretty high on the list. After all, no one likes owing tens or even hundreds of thousands of dollars that will seemingly take forever to pay off. That doesn’t mean paying off your student loans should be your only or even top financial priority though. Here are some other goals that you might want to prioritize first.
Emergency fund
If you don’t have at least $1k or ideally 3-9 months’ worth of necessary expenses in emergency savings, you might want to focus here first. Otherwise, a job loss or other financial emergency could mean not being able to make your student loan payments at all. (If you think paying student loans is bad, wait until you see the consequences of default.)
The exact amount you need depends on how risky your income is and what other resources are available to you. For example, if your income is unsteady or if you’re concerned about layoffs, you may need a bigger emergency fund than if you’re a tenured professor. If you can borrow from family or a retirement account, you may need less than someone with no other resources.
With most bank accounts still paying practically 0%, you might be wondering where you should put it. Here are some places to make it work a little harder for you. Just keep in mind that having an emergency fund is about minimizing risk not maximizing return.
Max the match
If your employer is matching your retirement plan contributions, you want to try to take full advantage of it if possible. Otherwise, you’re leaving free money on the table. Even the highest interest student loans can’t beat a 50% or 100% return on your money.
Higher interest rate debt
That large student loan balance may be scarier than a small credit card balance, but you’ll save more in interest by paying down any higher interest rate debt. This is especially true when you consider that up to $2,500 of your student loan interest may be at least partly tax deductible. You’ll also pay the smaller balance off faster, which can provide a sense of accomplishment and motivation to keep going. Trying to tackle the student loan debt first can be discouraging.
Investing
Even if you have no higher interest debt, it may still make sense not to pay your student loans off early if the interest is less than the 5-7% (depending on how aggressively you invest) you can expect to earn by investing any extra savings instead. That’s why student loans are generally considered “good debt” along with mortgages and car loans. On the other hand, if the interest rate is above 5-7%, you’ll probably save more in interest by paying down this “bad debt” than you’ll earn by investing extra money.
Of course, if you’re having trouble making your student loan payments, that is a problem and there are a variety of steps you can take. But if you can afford the payments and even have some extra savings, there may be a better option than to pay your debt off early. Don’t you wish you had learned that in school?