First of all, let me say that if you are a holder of school debt or credit card debt, my sincerest apologies go out to you. You see, I’ve had both of these types of debt. At one point, I had racked up $12K of credit card debt by eating out way too much. And then much later on in my career I decided to get a fancy Masters degree from a private university that set me back $40,000. Student debt is a killer, especially if you received a degree in underwater basket weaving that can’t get you a job that pays the bills.
Should you use your income and savings to pay off debt, or invest it instead? It depends…
Let’s look at credit card debt by itself. Credit cards these days charge at least 15% interest rate but usually are in the 20-something percent range. And if you miss a payment, the interest goes to an even higher rate. You would have to make a return greater than 15% to make sense for you to invest. This is pretty difficult and you would be hard pressed to find an investment that gives you this much return every year.
Student loans are usually in the tens of thousands and are usually around 5%. Discharging school debt is very difficult even through bankruptcy. Filing for bankruptcy destroys your credit score. If you don’t pay your loan within 9 months, the government has the power to garnish your wages and intercept any tax refunds.
So the question is what is the best use of your money: Which debt should you pay off first? Should you invest? If you can make a return that exceeds your interest payment then it makes sense to invest. Most young people and those coming out of degrees do not have enough money saved up to make such a high return.
On the flipside, if your school interest payment is higher than the return you can get in the market then pay off the debt. This is a simplified answer. The nuance here is if you have the temperament to see your money go up and down in the stock market without touching it.
If you pay off debt. I would target the highest interest rate debt and pay it off aggressively. You still want to make minimum payments on the other debts because you know what happens to your credit score when you don’t. I would also pause any IRA or 401k contributions temporarily and divert that money towards the debt.
Paying off your debt in one lump sum is incredibly psychologically liberating and definitely should not be underplayed. Once you pay off debt, you free up income that you can invest immediately.
If the stock market is in a strong bull market, and if you have considerable amount of money to invest, you could just invest the amount and use the gains to pay off school debt.