Should Paying Off Student Loans Be a Priority? What to Consider

Millions of Americans carry student loan debt.

A graduation cap on a pile of hundred dollar bills.
(Image credit: Getty Images)

 An estimated 44 million Americans carry student loan debt — that’s about 17% of the adult population. If our student loan borrowers were a country of their own, they would be the size of Spain. 

The balances run the gamut. The average balance for a recent graduate is about $40,000, with an average of $37,000 of that owed to the federal government. Of course, those are just averages, and many borrowers owe hundreds of thousands of dollars. 

If you’re one of the millions of Americans with student debt, you face a decision: Should you make paying off that debt a priority? 

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Maybe.

Your budget isn’t infinite. If it were, you wouldn’t have had to borrow for your education in the first place. Yet, the demands on your funds do at times seem infinite. 

“There is a certain peace of mind in being debt-free,” Sonia Joao, chief operating officer of Houston-based RIA Robertson Wealth Management, tells Kiplinger. “But if you’re comfortable carrying debt, paying off your student loans might not be the best use of your funds. You might find that you have other more pressing financial priorities.” 

First things first: Do you have to pay?

Again, it depends. If you owe the U.S. federal government, then yes, barring loan forgiveness – which is a political hot potato right now – you have to pay. Federal student debt is generally not dischargeable, even in most bankruptcy proceedings. You really have to be in dire financial straits for a bankruptcy court to consider discharging it, so you should just assume that you have to pay it back. If you don’t, the government can go so far as to garnish your wages or take it out of any tax refunds they’d otherwise owe you.

With private lenders, the process really varies from state to state. In order to garnish wages, the bank would have to successfully sue you, and depending on the amounts, that may or may not be reasonable. But even in the absence of a lawsuit, a default on your private student loans will potentially wreck your credit score and make it hard to borrow. So, simply walking away from the loans is going to generally be a bad idea.

How should you prioritize?

Again, your budget isn’t unlimited. So, where does student loan repayment fit in the pecking order?

“Student loans subtract from your net worth,” Joao continues. “But putting too much emphasis on debt repayment can actually set you back if it means you’re not investing in your future.”

As an example, consider your company’s 401(k) plan. The average employer with a 401(k) plan matches around 4% to 6% of your salary. That’s potentially an immediate 100% return on every dollar that gets matched. There are also tax benefits, as every dollar that goes into your 401(k) goes in tax-free. Assuming you’re making at least the minimum payments on your student loans, it makes sense to prioritize the 401(k) over debt repayment, at least until you’ve gotten the full employer match.

What about a down payment on a house? 

While high prices and high mortgage rates over the past year have made home ownership more difficult, it’s generally a good financial move to own a home. Home prices generally keep pace with inflation, and your mortgage interest is tax deductible. You can clearly buy too much house and put strain on your finances. But assuming you’re getting a home that is in line with your budget, it’s generally going to make more sense to dedicate that marginal dollar to buying a home than paying down student debt. 

The same may be true of other investments. The rate you pay on federal student debt is fixed. So, if you borrowed within the past decade, the rate on your loans is probably somewhere between 3% and 5%. If you have a reasonable expectation of earning more than that in an investment – and the long-term average annual return of the S&P 500 is 8% to 10%, depending on what specific years you use – then it makes more sense to invest that marginal dollar of savings rather than use it to pay down your debt faster. 

This isn’t to say you should leverage yourself to the hilt. You don’t want to put yourself in financial distress if you lose your job or hit any financial speed bumps. But you should balance the benefits of investing that marginal dollar over using it to reduce your debt load. 

The elephant in the room

Of course, the single biggest reason to consider slow-rolling your debt repayment is political. President Joe Biden has made student debt forgiveness a priority, as have many high-ranking Democrats. And while meaningful debt relief is not likely in a dividend Congress, we have elections coming up next year that could alter the balance of power in Washington. It’s impossible to assign odds to it, but there is certainly a chance of at least some form of debt relief in the coming years. 

So, it might make sense to take a wait-and-see approach. With market rates as high as they are today, you could even put the cash you intend to set aside for debt repayment into bank CDs or U.S. Treasuries for the time being. If debt repayment never materializes, no problem. You can use that cash to pay down your debt in the future. But if some form of debt relief is passed, that cash you would have used for debt repayment is yours to keep. 

Charles Lewis Sizemore, CFA
Contributing Writer, Kiplinger.com

Charles Lewis Sizemore, CFA is the Chief Investment Officer of Sizemore Capital Management LLC, a registered investment advisor based in Dallas, Texas, where he specializes in dividend-focused portfolios and in building alternative allocations with minimal correlation to the stock market.