Pay Down Loans Or Invest? | Student Loan Planner

– Should you pay off your student loans or should you invest? The answer to that question is dependent upon what your interest rate is and what your income is
relative to your debt. If you owe more than
two times your income, then there’s a pretty good chance that you’re gonna go for a
loan forgiveness strategy. In that case, you don’t
wanna make big payments on your loans, because they’re eventually
going to be forgiven. That means you’re gonna
be paying a big tax on a forgiven balance,
because the forgiven balance is considered taxable income by the IRS. In that case, you
probably wanna take money that you would’ve been
putting towards the debt and putting it into a brokerage account and index funds instead. That is a decision that’s primarily based off of the forgiveness
math making more sense than paying down the debt
with a refinancing approach. If it does make sense
to refinance your loans and perhaps you owe less
than two times your income and you wanna cut your interest rate from 7% or 6% to four or 5%, then the question becomes
a little bit dicier. Do you pay down your
loans at a five year term instead of a 10 or 15 year term? What should you prioritize? My first suggestion for
pretty much anyone is that you focus on
retirement savings first. Retirement savings are very important because you’re not able
to catch up in prior years that you don’t max out your accounts, even though you didn’t put in as much as you were allowed to. So particularly for people who are higher income individuals, you should be putting
away the $18,500 maximum for the 2018 tax year for
your 401k or 403b plan. That will allow you to
shield money from taxes and if you’re going for a
forgiveness based approach, lower your student loan payments as well. Beyond that, if you’re
going for forgiveness, you wanna put the money
into a tax bomb account to cover your index fund investments and have that money ready
to go for the tax bomb. If that’s not your approach, if you do have the loans
that you have to pay down with the four or 5% interest rate, keep in mind that when
you pay down your debt, you’re not actually get
a four or 5% return. It’s actually less than that
for some complex math reasons. So you’re actually maybe getting two or 3% on a compounded basis. So that’s your hurdle rate for deciding whether or not you’re going to invest versus pay down your debt. Maybe if you wanna use
a rough rule of thumb, take your interest rate
and cut it in half, and that’s roughly equivalent to the compounded rate of return that you’re getting by
paying down your debt. And the reason for that is that
when you pay down your debt, the interest charge that you’re
experiencing is decreasing with every payment, so
it’s not the same thing as saving money on a compounded basis like you would have by investing. Now, what you’ll notice
there is paying down debt is vastly superior to
investing in a bank account or putting money into a
certificate of deposit at the bank or investing in treasury
bonds in your retirement plan. Certainly paying down debt
is a fantastic thing to do if you’re maybe a conservative
or moderate risk investor and you wanna reduce the
leverage in your life. And from a behavioral finance perspective, paying down your debt is one
of the best things you can do. Psychologically, it’s
enormously beneficial to take the burden off of your shoulders if that’s what the math says
to do, pay back your debt. So, what I would suggest is
start with retirement savings, then figure out what your approach is, forgiveness or paying it back. If you’re able to lock in
a low enough interest rate where it makes sense
to invest and you know that you’ll lose half of your
money occasionally on paper, then, sure, go ahead and invest. But I generally find
that behavioral benefits for people who have private debt and they need to pay
it down are tremendous by just paying it off
and getting rid of it. Those are a couple characteristics and things you might think about for debt, for whether or not you
should be paying it down or investing it. Thanks for listening. And if you are trying to
figure this out for yourself, feel free to send me an email, [email protected], and I’ll let you know if we might be able to help you or not. Thanks.

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