Graduating from college can be exhilarating, ushering in a fresh beginning, a new career, and financial independence. But it also means the time has come to seriously consider how to repay your student loans, and that implies asking yourself an important question: should you pay off your student loans or invest your money elsewhere?
Before deciding whether to invest or not, it is important to arrange your loans in a hierarchical manner, starting with the loans with the highest interest rates first. One of the cardinal rules of financial planning is to”pay off debts with the highest after-tax interest rates first,” said Pat Scherschel, consolidation and debt management strategist at Nellie Mae, a higher-education loan provider. High-interest consumer debt should be repaid first.
With federal student loan interest rates at their lowest in over 30 years, recent graduates can consolidate their loans to lock in the low rates and extend the amount of time over which they pay back their loans. Also, recent amendments to tax laws have made the interest for some student loans tax-deductible for as long as it takes to pay them back.
“The money that you save each month by consolidating your loans can be invested,” said Brent Carlson of NextStudent, an organization providing advice pertaining to college loans.
Teresa Surichamorn, 23, graduated from college in 2001 and took advantage of the drop in the interest rate last year by consolidating her various student loans, thus locking in a rate that hovers at just above four percent. Surichamorn now has the luxury of being able to put more than she owes towards her student loans every month, and considered investing the extra money.
Thinking logically, it makes sense to invest extra money if you can earn a higher interest rate than you are paying on your student loans. For example, if the interest rate on your student loans is four percent and you invest in a mutual fund that promises a higher return, then you will be netting a gain.
By now, everyone has heard how getting a head start in investing in a 401(k) plan can make you a millionaire by the time you retire. Some companies will match every dollar you contribute to a 401(k) plan, which means that the return on your investment is 100 percent. There is a cap to how much you can invest in your 401(k) plan annually: $11,000 for ’02, $12,000 for ’03, $13,000 for ’04, $14,000 for ’05 and $15,000 for ’06. If you contribute the maximum amount and still have money left over, you might consider opening an IRA, or an individual retirement account.
Surichamorn has enrolled in her company’s 401(k) plan, and has chosen to put any extra money she has left over each month towards her loan.”I have a big problem saving money, and it’s also hard to set aside money,” she said. Since she is paying more than she owes monthly for her student debts, she hopes to drastically cut back on the number of years left on her loan.
Ultimately, there is no easy answer when it comes to whether you should invest or not. But just remember, even if you choose to solely put your money towards repaying your loans, student debt is actually a long-term investment in yourself.
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