Money Smart Kids
Save or Pay off Loans
Even if you have just a little spare cash, save it rather than pay off your student loans early.
By Janet Bodnar, Editor, Kiplinger's Personal Finance
July 22, 2004
What I would like to know is, should I first pay off my college debt and then start saving, or should I do both and just start saving a small amount per month?
Even if you have just a little spare cash, I'd recommend saving it rather than paying off your student loans early.
Student loans represent an investment in your future, which will pay off in increased earnings over time. And right now the interest rates on student loans are at rock bottom. So there's no need to rush to pay them off.
But I'd also recommend that you consolidate your loans at the current record lows. If you just graduated in the spring, you have until November to refinance your Stafford loans at a fixed rate of 2.77%. If you have been out of school for a while, you can still consolidate at a bargain 3.37%.
You can cut the rate even further by arranging for your loan to be paid automatically each month, and by making on-time payments for a certain number of months, as stipulated by your lender.
Once you've consolidated your loans and put them on autopilot, just make the payment every month and you'll be fine.
If you have high-rate credit-card debt, pay that off before even thinking about prepaying your student loans. Paying off a credit-card balance on which you're being charged 18% interest is the equivalent of earning an unbeatable 18% return on your money.
On the other hand, paying off student loans on which you're paying 2.77% interest is the equivalent of earning a return of 2.77%. And you can certainly do better than that in the stock market, on which the historical return averages about 10% a year. The stock market is an appropriate place for someone your age to invest, especially in a retirement account that you won't need for decades.
Even if you keep your emergency savings in a bank account paying 2%, I'd still recommend saving versus prepaying the student loans. In fact, you should set a little something aside even if you're paying off expensive credit-card debt. Nothing beats the security and psychological satisfaction that comes with having money in the bank.
Once you establish the discipline of saving, it will stick with you for the rest of your life. Starting now and starting small are the keys to becoming a millionaire tomorrow.
