Should I pay off my student loan or save money?
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UPDATED: Apr 25, 2013
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With college prices constantly on the rise and students graduating with an average of $26,000 in student loan debt, deciding how aggressively to pay off that debt is one of the first major financial decisions recent graduates make. Every situation is different, depending on a person’s starting salary, savings and student loan balance, but the rule of thumb is that you should save first and pay off debt later.
Save up first
There are two kinds of savings to consider: emergency funds and retirement plans. Jim Angleton, president of AEGIS FinServ Corp., recommends building up your emergency fund while making minimum payments on your loans.
“Ultimately you’re either going to want to rent a place, buy a car or obtain a home,” Angleton told loans.org. “Somewhere along the line you’re going to need emergency money in case of anything that’s off the radar. Once you have 10 percent of your annual income in savings then start paying off your debt as quickly as possible.”
Emergency fund saving should be your top priority, but if your employer offers a company sponsored 401K plan with matching, that’s free money that shouldn’t be ignored.
“We recommend that you jump in from day one and put in at least six percent,” Angleton said.
Are all loans the same?
Given all of the variables — the number of loans you’ve taken out, the type (subsidized or unsubsidized, federal or private), and the amount — everyone’s student loan debt is different. Should you still wait to pay off your loan if it’s $50,000 at 8 percent interest, or is a large loan more time sensitive? What if you have a $7,000 loan at 3.4 percent interest? Should you just get it over with?
According to Angleton, your debt reduction strategy should remain the same regardless of your debt burden.
“It’s all relative,” Angleton said. “Same theory, same plan, same advice.”
The argument for paying debt first
Despite the advice above, it may be tempting to tackle debt first. Up to $2,500 in student loan interest payments can be deducted from your taxes. And most people won’t be able to get a savings rate equal to their student loan interest rate.
There’s also the sense of relief and accomplishment people feel when they’ve paid off the last of their debt. From that point forward all of their income belongs entirely to them.
But for the debt-first crowd, the big question is “Well, what happens if you lose your job?”
As Wisebread points out, the main purpose of an emergency fund, in addition to paying for unforeseen expenses, is to tide you over if you lose your source of income. In a situation where you lost your job and have no emergency fund, you’ll quickly run out of money for basic expenses, let alone to pay down the principal on your loan. In the end, being debt free is an important goal, but not more important than being financially secure.