Savings vs. student loans

Question: I am 25 years old and am debating paying down my student loan or saving the money for a larger emergency fund. Currently I have 18k in student loan debt from a mix of private and federal loans all with interest rates below 7%. I have no other debt and have approximately $800-$1000 to put towards payments every month. I am not planning on saving for a home for another year and have 3 months of emergency savings ready to go. Should I pay down my student loan or save for a 6 month emergency fund or put that money into investment? (I already put 4% into my 401k). Any advice would be great, I think I like the idea of not having debt. Hayley, Seattle, WA

Answer: You're saving for retirement, good. You have emergency funds, terrific. And when you are debt free that will bewonderful, both emotionally and financially.

In a sense, a saver like you can't go wrong whatever you decide. However, for every financial goal there is a season. So, I would put a priority on putting the bulk of your extra money into your emergency savings account. Put it on on auto-pilot by establish a set sum that automatically goes into your savings every month.

I would work toward the 6 month safety net. The goal is more than reaching a certain target, however. It's all about building the habit of savings.

The advantage of a healthy savings cushion is that it will give you greater financial flexibility over time, whether you eventually decide to buy a home, shift jobs, change cities, dial back on work for awhile, or take a vacation. Of course, the money is also a resource to draw on if you did lose your job.

You could also put some extra money toward paying down the private student loans. You're in good shape now, but if you did get into a cash crunch you could always defer or lower the monthly tab on the federal student loans. The same isn't true for the private loans. That's why I would emphasize eliminating it first. It will get you closer to being debt free, too.

Once you've built your savings some more you could cut back on your automatic payments and increase the amount that goes toward eliminating the student loans.

It isn't an either/or question but a matter of emphasis. Your financial priorities will change over time.

One last thought. When you get pay raises--I hope you do soon and often--hike the amount of money going into your retirement savings plan.

About the author

Chris Farrell is the economics editor of Marketplace Money.

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