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Your student loans are cancelled. Should you pay off other debts or invest in the stock market?

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Hello and welcome to Financial Face-off, a MarketWatch column where we help you weigh your financial decisions. Our columnist will give her verdict. Let us know if you think she’s right in the comments. And don’t hesitate to send us your suggestions for future Financial Face-off sections.

The Biden administration’s highly controversial student loan forgiveness plan is set to launch soon, with online applications expected to roll out in early October. Individual borrowers who earn less than $125,000 a year (or $250,000 of household income) will see up to $10,000 in federal student loan debt forgiven; eligible Pell Grant recipients will receive another $10,000 rebate.

With borrowers having some financial leeway, what should they do with the “extra” money that will appear in their monthly budgets: pay off other debts or invest in the stock market?

why is it important

Student loan debt is a heavy burden for many Americans. Some 45 million people collectively owe $1.6 trillion in federal loans, according to the White House. The average monthly payment is $460, according to the Education Data Initiative.

This debt has changed the course of some borrowers’ lives, forcing them to postpone goals like buying a house, getting married or having children.

Student loan debt is long-lasting: it takes the average borrower 20 years to pay off their loan.

The verdict

Invest it – even though the Dow Jones Industrial Average DJIA,
+1.88%
and the S&P 500 SPX index,
+1.97%
are down this year.

My reasons

If you’re a student borrower, you may feel like you’re getting by. You may have taken advantage of the student loan payment suspension to pay for basic expenses. But now that some student loan relief will be permanent, you have the opportunity to be intentional about what you do with that extra cash, said Kelley Long, certified financial planner, CPA and founder of Financial Bliss in Oro Valley, Ariz. . .

Borrowers who have been shut out of major financial milestones due to debt can finally act on the “pay yourself first” maxim by creating an investment account.

This can be especially important for people who thought they couldn’t afford to invest because their budget was being eaten up by their student loan repayments. Some people assume that investing is only for wealthier people with established financial lives. Now is the time to revisit that assumption, Long said.

“There’s so much psychology to your identity as a financial person,” Long said. “When are you going to start thinking of yourself as someone worth investing in? What situation has to exist? The answer is – what I’m hoping you’ll say is – ‘Oh my God, I probably need to start thinking of myself like an investor yesterday, or tomorrow, or today, now.”

One way to make investing easier is to start with your own personal amount of money “don’t think twice about it,” Long says. For example, you might have no problem spending $11.99 on a shirt at a discount store and only wearing it once or twice. “You invest in these disposable retail garments knowing you’re not getting anything back,” Long said. “Whatever that amount is, you can afford to put that amount in an investment account on a monthly basis.”

By using a low-cost investment provider that has no minimum account balance or fees, you can create an account where that amount of money is paid into an index fund every month.

“Before you know it, you’ll have a comma in your count, then you’ll have five digits and it’s happening faster and faster,” Long said.

Of course, investing right now, as the markets enter bearish territory this week, can seem scary.

But Jack Hills, director of Icono Capital’s investment office in Rochester, NY, said there’s no better time than the present.

“Imagine seeing something you need, already buying every month, and normally paying full price for a 15% to 25% discount,” Hills told MarketWatch. “It’s the stock market right now.”

He added: “How many of us are cursing ourselves for not buying more in the first quarter of 2020 or even buying nothing at all? Admittedly, it’s terrifying to see the markets lose so much so quickly, and always impossible to know where the bottom really is, but we’re also realistic in a similar opportunity now. Moreover, it is money that is going to be used on a monthly basis, which means that it is an average cost in dollars and compensates for the decreases as well as the increases.

Is my verdict the best for you?

On the other hand, if you have debt with interest rates of 7% or more, it usually makes more sense to pay off that debt first, Long said. Indeed, carrying that debt costs more than what you could earn on average with long-term stock market investments.

It’s also true that paying off debt can be mentally liberating, regardless of the interest rate.

“Some people might sleep better if they know they’ve paid for their car,” Long said. “Maybe they have private loans or a 401(k) loan or something else that isn’t a bad debt, but they would feel more comfortable not having that obligation.”

Paying off other debts can also have real-world consequences you might not have thought of, like improving your credit score and helping you qualify for a lower-rate mortgage, says Chris Haigh, certified financial planner and general manager of Icone Capitale.

He proposed two scenarios: in scenario 1, you pay off other high-interest debt, which increases your FICO score, and you qualify for a 5.875% mortgage with a balance of $300,000, which which would make your total loan cost $638,000. In Scenario 2, you invest in the stock market, your FICO remains the same, and you receive a 6.5% mortgage on a balance of $300,000. This brings the total cost of your loan to $682,000. This is a considerable difference that you may not have taken into account.

Are you hesitating between investing and repaying other debts? You could try dividing the money in three, Long suggested. A third party “overtakes” you by paying off additional debts; a third party takes care of “your future” by putting it towards retirement (or emergency savings if you don’t have enough cash savings); and a third goes to “introduce you,” spending the money on something that will improve your current life, like a cleaning service, club membership, or monthly massage.

“No matter what you do, the most important thing is to be intentional with the ‘extra’ money, especially if you’ve gotten used to not having the payment already due to the payment break – it’s easy to absorbing extra money into our expenses without noticing any difference, even though the payment itself seemed painful when it happened,” Long said.

Let us know in the comments which option should win in this financial head-to-head. If you have ideas for future Financial Face-off sections, send me an e-mail.