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The Question Nobody Asks: Invest or Pay Back Your Loans?

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The Question Nobody Asks: Invest or Pay Back Your Loans?

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Andrew Rombach, Guest writer. Content Associate at LendEDU

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You have just graduated college, landed a decent job, and you are starting an exciting new career. You have got the world by the tail—but now you are faced with an important decision.

You are about to enter the repayment phase of your student loans. You may be planning to throw every spare penny at paying down your debt, but you also just read about how critical it is to start saving for retirement early. If you do not get started, you might miss out on a chance to grow your nest egg, but if you do not focus on your loans, then you risk falling behind on your first serious debt obligation.

It is hard to know which path to choose.

Should you put all your money into paying down your debt? Or should you make minimum payments on your student loans and use the extra cash to start on your investments? Let’s look at the pros and cons of each approach and see how they stack up.

Option 1: Try to Invest While Paying Down Debt

If you decide to multi-task, you wouldn’t be alone. Some graduates can pull it off, especially if they’ve secured well-paying jobs out of college or if they have a low student loan balance. These individuals may be able to devote a percentage of their income to a retirement fund or 401k, while simultaneously being able to make their monthly student loan payment.

There are several advantages to investing during your repayment period. The math behind investing shows that compound interest will do a lot of the work for you as the nest egg builds. The earlier you start the better. As interest accrues in a retirement fund, it compounds on the previous growth, creating an exponential cycle that can yield more over time. Relatively speaking, small contributions count significantly down the road.

However, this approach has its drawbacks. If you have an unexpected large expense (such as car maintenance or medical bills), then you may find yourself in trouble financial when your disposable income is tied up in investment accounts. Keep in mind that you have a monthly student loan obligation, and you risk falling behind on this debt. Student loan default can negatively impact your credit; this can have an adverse effect on your financial plans in the near future.

Option 2: Focus on Your Student Debt

Your other option is to forego your investments until your student loans are paid off. In this scenario, you put every spare dollar you have towards paying them off, expediting the process as much as possible. Student borrowers who need to do this most likely don’t have much spare income outside of their cost of living, so it becomes important to focus on this debt obligation at the onset.

Paying down debt is always beneficial, but here are a few reasons why focusing on student debt makes sense. By devoting more to your student debt, you may be able to pay off your loans sooner. If you can get rid of that monthly obligation, then you may be able to start bigger on your retirement plan later. On top of this, paying off your loans quickly means you’ll pay less in interest. While starting early with an investment is beneficial by increasing interest yield, paying off a loan early is beneficial by limiting interest accrual and reducing the cost of a loan.

There are also a few drawbacks to be aware of with this scenario. If you are not investing early, then you may be leaving money on the table, impacting your net worth over time.

Whatever decision you make, you should be able to take positive steps. Paying off debt is always a good idea as is investing for retirement. Straddling both options may give you the best of both worlds, but you will have to think hard about your particular financial situation. Weigh the merits of either option and decide which will help more in 5 years. How about 10 years? How about 50?

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The Question Nobody Asks: Invest or Pay Back Your Loans?