Could student loans be hindering you from building up a substantial nest egg? Perhaps you’ve thought, “I’ll start saving as soon as my debts are paid.” But for many Americans, that can take a lot longer than they may anticipate. Meanwhile, their retirement accounts remain stagnant…or worse–empty.
According to the Brookings Institution, the average household carrying college debt owes about $25,700 in student loans.
Since that’s a pretty big number, it makes sense for people to want to focus all their resources toward paying it down first, while putting their investing plans on hold. The upside is the quicker you pay off a loan, the less interest you’ll owe. But on the opposite side of the coin, by delaying investing, you’ll have much less time to take advantage of compound growth.
So how exactly should you decide if you designate extra funds toward student loan debts or retirement? Following is a checklist that can serve as a guideline in your decision-making process:
- Take a look at interest rates
If you have high interest rate of 8% or more on your student loans, you’ll probably want to prioritize paying those off as soon as possible.
If your interest rate is extremely low, however (between 2-3.5%), you get much more of a benefit from saving more for retirement versus paying off a student loan aggressively.
- Do your homework before consolidating
If you have multiple loans with different rates and you’re thinking about consolidating in hopes of getting a lower overall rate, make sure you do your homework first. Federal consolidation loans, for instance, are based on the weighted average of the underlying loans, so you wouldn’t actually improve your interest rate.
If you have private loans, on the other hand, refinancing through a bank may allow you open a new loan at a better interest rate. If you’ve drastically improved your credit score since initially taking out the loan, your savings could be significant.
Before making any moves, however, would suggest visiting this student loan website, where you can run your loan balances through a calculator to see how much you would potentially pay to consolidate. You can also check your credit score to figure out the probability of obtaining a lower interest rate via refinancing.
You may find that it makes more financial sense to keep your loans separate and put the bulk of your extra funds toward high-interest loans, while paying the minimum on the lower interest ones.
- Prioritize retirement saving if your employer offers a 401(k) match
Do the math: If your employer matches your contributions by 50%, then you would likely earn significantly more in a year by putting a certain amount into your 401(k) than you would save in interest on your student loans.
In general, financial experts recommend prioritizing retirement loans unless your student loan interest rates are particularly high. In the long term, your retirement investments could earn at least 6 or 7%, so unless your student loan interest rate is lower, it doesn’t make much sense to pay them off quicker.
The Bottom line: You should almost always focus more aggressively on building retirement savings rather than paying down student loans, because of your earning potential through compound growth.
While it may be hard to look past your education debt–especially if it’s significant–you’ll thank yourself later for multiplying your nest egg while slowly, but surely paying off your low interest loans. Once it’s all said and done, you’ll likely have much more to show for your efforts.