Should You or Shouldn’t You Pay Off Your Student Loans Early?
A life free of student loan debt may look very rosy, particularly since an average student graduating in 2016 had $37,172 in debt. The good news is that financing an education is well worth it for the vast majority of Americans. An analysis of U.S. Labor Department statistics demonstrates that those holding a four-year college degree make 98% more money per hour on average than those who don’t have a degree. But now that you’re out of school and trying to decide the best way to spend your money, you will need to decide if it’s to your advantage to pay off your student loans early or put your money elsewhere.
Benefits of Paying Off Student Loans Early
Paying off your student loan debt will lower your debt to income ratio, which means it will be much easier to get a loan when you really need one, such as when you want to buy a house. Once free of your student loan debt, you could put that money into an investment such as a mutual fund. And remember, if your fortunes sink and you must declare bankruptcy, you must still pay off your student loan debt. That means it makes some sense to pay them off when you are sure you have the money to do so.
Arguments for Not Paying Off Student Loan Debts Early
However, there are valid arguments for not paying off your student loans early if you must pay more money per month to do so. You must look at your individual situation and determine what is the most advantageous plan for you. One thing to take into consideration is that student loans have low interest. Mortgage debt is typically even lower while credit card debt is quite high. You should, therefore, want to consider your needs and lifestyle. If paying off your student loan means you will have to buy needed items with credit cards, you might want to rethink that strategy.
Flexible Repayment Plans
Another reason you may not want to pay off your student loans early is that the federal government offers quite a bit of flexibility in repaying your loans. The Department of Education offers eight different payment plans and some are for borrowers with low incomes. Private lenders are not so flexible. In fact, four of these federal payment plans can result in debt forgiveness after 25 years. If you are struggling to make your student loan payments now, it is a good idea to consider these options.
Saving Money
If paying your loans early means you cannot put money in the bank for a rainy day, that is another reason to rethink early repayment. Everyone should have an emergency fund in case of job loss, medical emergencies or other urgent needs. Financial experts recommend you should have three to six months of expense money set aside. If all your money is going to paying off student loans, you will not be able to build an emergency fund. But if you have enough income to save a bit and still pay off your student loans early, then it may make sense to do so.
Investing
One of the arguments for paying your students loan early is so you will have money to invest. But if you are paying more monthly to pay off your student loans early, you could just take that extra money and invest with it now instead of waiting until your student loans are completely repaid.
How to Pay Off Student Loans Early
Once you have decided it’s in your best interests to pay off your student loans early, you have many options, and you’re in good company. According to the Consumer Financial Protection Bureau (CFPB), approximately 25% of people pay off their student loans within a year. About 70% fully repay before the tenth year. Let’s look at some of the ways they do it.
Pay Extra on Your Principal Every Month
One of the most straight-forward ways to pay your student loan off early is to just pay extra every month. Let’s look at a couple examples.
- If you have a 10-year loan for $20,0000 at 6.8% interest and pay an extra $100 every month (over your required $230.26), then you will reduce your loan term by 3.8 years and save $3,281.30. The amount you will save is 41.8% of the $7,849.47 interest you would have paid over the full 10 years.
- If you have a 10-year loan for 6.8% interest and pay just an extra $20 every month (over your required $230.26), you will reduce your loan term by a year and save $1,136.95. The amount you will save is 14.48% of the $7,849.47 interest you would have paid over the full 10 years.
Set Up Automatic Payments
If you have decided to pay extra, the most effective method is to set up an automatic payment, so you don’t have to think about it every month. Even if you don’t increase your monthly payment, you may be able to get a 0.25% interest rate deduction on federal student loans for enrolling in automatic payments. This isn’t much, but every little bit counts. The bigger advantage is that it keeps you on track, so you don’t miss payments and hurt your credit.
Refinance and Consolidate Your Loans
Look for student loan refinancing rates that are lower than your current student loan rate. If you can reduce your rate, then more of your payment will go to the principal and you will pay your loan off faster. Let’s take our same example where you have a $20,000 loan at 6.8% over 10 years. If you can refinance at 3%, you will save $1,683 in interest. If you have more than one student loan, you could refinance and get one consolidated loan with one monthly loan payment.
Seek Forgiveness for Student Loans
You may qualify to have your federal student loans forgiven if you work in public service or certain professions such as teaching. Of course, there are specific requirements.
Public Service
Currently, 34,000,000 are eligible for the public service loan forgiveness program, but only 552,931 are enrolled in it. To qualify for the program, you need to
- Make 10 years of qualifying on-time payments (120 in total) toward your federal student debt. Once that is completed, the U.S. Department of Education will forgive your student loan debt.
- Work in public service at least 30 hours a week after October 1, 2007. You can meet these criteria with more than one job.
- Work for a qualifying public service employer. These include
- Government organizations
- Emergency services
- Public health
- Public education
- Legal services
- 501(c)(3) nonprofit organizations
- Have a direct loan. If the word direct appears in the name of your loan, it should meet the criteria.
Teaching
If you don’t qualify for public service loan forgiveness, you may still qualify for loan forgiveness if you work in some other professions. If you are a full-time teacher who has taught for five consecutive years at an elementary school, secondary school, or educational service agency that serves low-income students, you may qualify.
Student Loan Repayment Assistance Programs (LRAP)
The assistance described above apply only to federal loans and not to private loans. If you have private loans or otherwise don’t meet the criteria of the public service and teacher loan forgiveness programs just described, you may want to consider Student Loan Repayment Assistant Programs (LRAP) to help you pay off your loans. These programs have varied criteria and may prioritize people who received degrees from state schools, work in specific regions or are employed in specific fields. If you have not yet gone to college, you may want to ask your college if it partners with LRAP and get details. However, you do not need to enroll until after graduation.
Take Your Rightful Tax Deductions and Credits
You may deduct the lesser of $2,500 or the amount of interest you paid during the year on a qualified student loan. You don’t even need to itemize to get this deduction. Of course, you must meet certain qualifications.
These include
- You paid interest on a qualified student loan in the last tax year;
- You’re legally obligated to pay interest on a qualified student loan;
- Your filing status isn’t married filing separately;
- Your modified adjusted gross income is less than a specified amount which is set annually; and
- You or your spouse, if filing jointly, can’t be claimed as dependents on someone else’s return.
In addition to deductions, also check to see if you are eligible for any tax credits. There are no tax credits that relate directly to student loans, but if you qualify for the American Opportunity Tax Credit, you can qualify for a maximum annual credit of $2,500 for educational expenses for each student. You may want to see Publication 970 (2016), Tax Benefits for Education for more information as well as Form 8863, Education Credits.
Pay Every Two Weeks Instead of Every Month
Just because your student loan payment is due every month doesn’t mean you can’t pay more often. Consider making half your payment every two weeks, which works out well if you are paid every two weeks. You will be making an extra payment over the course of a year, but it won’t feel much different than the way you are paying now. This can knock almost a year off a 10-year loan.
Pay Student Loans with the Highest Interest First
Interest is extra money you must pay to get a loan, but you don’t really get anything for it. So, if have more than one student loan and want to pay extra every month, put that extra into paying off your highest interest loan. In the meantime, look for ways to refinance these loans at a lower rate and possibly consolidate all your loans.
Seek Employment with Student Loan Assistance
It’s not common, but according to a recent survey, a small number of employers, (about 3% of companies surveyed), offer assistance with student loans. It’s certainly worth asking when you are interviewing. Employers who offer assistance typically match your payments up to a ceiling, similar to many 401K programs. It may become increasingly common for employers to offer student loan assistance to attract talent.
Summary
Whether paying off your student loan debt early is a good thing or a bad thing largely depends on each borrower and their financial situation. Paying off your highest interest loans should take priority over what type of loans they are. If you determine that your student loans should be paid off first, then the tips provided in this article can greatly help if you apply them.
