Is It Smart to Pay Off Student Loans Early?

If you’re interested in paying your student loans off early you should make sure you are financially secure to do so. And we don’t just mean having the money to do it right now, we mean so your future self doesn’t suffer one bit!

 

Paying off student loans early is certainly tempting. After all, student loans are typically the largest debts that most young people have and require monthly payments for 10 years or more after graduation. Even with a good interest rate, that kind of time can result in a significant cost for the overall interest.

 

While it may seem counterintuitive, there are times when paying off your student loans early isn’t your best financial move. It’s therefore important to first weigh the pros and cons before coming to a final decision.

 

The pros and cons of paying off your student loans early

To make the most educated decision regarding whether or not to pay off your student loans early, here are some advantages and disadvantages to consider. Take stock of these against your specific financial situation before deciding what’s best for you.

 

Pros

  • You can save a lot of interest. One of the main benefits of paying off student loans early is that you can save a ton of interest that you would otherwise pay over the life of your loan. For example, if you have a $40,000 student loan at a 6% interest rate over ten years, you will pay more than $13,000 in interest over the life of the loan. You can calculate how much you’re paying in interest on your own loans with this amortization calculator.
  • Your credit score will improve. Your debt-to-income ratio and the total amount of debt that you owe affects your credit score in a big way. When you pay off your student loan debt, you will have overall lower debt and a more favorable debt-to-income ratio. This will improve your credit score and allow you to be approved for other loans and get better interest rates.
  • You can work toward other financial goals. Once your student loan is paid off and your credit score is higher, you can work toward other large financial goals such as purchasing a house or investing in your own business. Having this debt gone can take enough of a load off your shoulders that you will be confident to pursue other financial ventures.

 

tip jar with funny saying about student loan debt

Photo by Tad Hanna

 

Cons

  • You will eliminate one of your tax deductions. One of the drawbacks of paying off your student loans is that it could affect the deductions you take when tax season rolls around. The interest you pay on your student loan debt is deductible up to $2,500 on your tax return, which can be deducted whether you itemize or not.
  • It can prevent you from saving money. When you’re making large installments so you can pay off your student loans early, you’re pulling that money away from other uses, like savings. For example, it might be better to put that extra money into a company 401k, especially if your employer makes matching contributions. Those additional payments can also prevent you from building an emergency fund, which could be a problem in the event of unexpected expenses.
  • You give up the possibility of deferment or forgiveness. In some situations, you may be able to defer payments on your student loans or have a portion of your debt forgiven altogether.

 

What can you do to pay off your student loans even faster?

Maybe you want to buy a house, get married, or start a business, and you feel it would be in your best interest to pay off your student loan debt as soon as possible. There are a few things you can do to help reduce this debt more rapidly.

 

Bring in more money

Consider getting a part-time job or side hustle to boost your income if it can be worked into your current school or job schedule. If your main income is enough to sustain your regular monthly payments, then all of the extra money from a side job can be used to help pay down your debt more quickly.

 

Pay as much as you can during your grace period

Most federal student loans and some private student loans have a six-month grace period after you graduate before monthly payments are due. If you can make your monthly payments during this time, do so. You should note that if you have a Stafford loan made by the U.S. Department of Education, the interest does not start until after the grace period expires. If you can pay more during this time, you will be able to shave a significant amount off of the total interest you will be paying.

 

Consider refinancing

If you have a good income and good credit, you may be in a position to refinance your private student loans for a lower interest rate. If you refinance and keep your payments the same or higher, you will be putting more toward the principal, which will help you to pay down the debt faster.

 

piggy banks, graphs and money illustration

Photo by Megan Rexazin

 

More >> Need more inspiration? We have 6 smart money moves to pay your student loans off faster. Let us help you dream up the possibilities

 

Other things to consider

Once you have the funds to begin paying off your student loan debt early, you want to make sure that you approach it in the smartest way possible to keep you in the best financial situation.

 

Clear your credit card debt first

Before tackling your student loan, you will want to pay off any credit card debt that you have. Credit cards have significantly higher interest rates than student loans. If you carry credit card debt in order to pay off your student loans early, you’ll wind up paying even more interest.

 

Have an emergency fund set up

An emergency fund is important to start putting money towards. We suggest you do this before you pay off your student loan debt. Why? Because there are never guarantees that your job is secure. Think of the coronavirus causing millions of Americans to lose their jobs in such a short amount of time.

 

The sweet spot for an emergency fund it typically three to six months’ worth of expenses, but do what you can that works for your financial situation. It can feel intimidating to contribute money to both your emergency fund as your paying your student loan debt off, but you’ll be happy you did this.

 

You can put money toward your emergency fund while also making a dent in your student loan debt, just make sure you have a plan that way you’ll have some money if that plan gets kicked a bit by a financial emergency later down the road.

Make extra payments

If you can’t pay off your principal all at once, start reducing the amount owed by making extra payments. You can try doubling your payments so that more goes towards the principal, or you can even make weekly or bi-weekly payments.

 

Make sure you’re investing in your retirement fund 401(k)

Contributing to your retirement fund is crucial so you want to make sure you’re doing this as soon as you can. Check with the company you’re employed with to see if they do a match on 401(k) and if they do set it up.

 

You’ll be on track for your retirement in no time if you can get your company to match, but if not, think of contributing at least 10% of your income to start. You want to make sure you can have this deducted from your paycheck without it crushing your budget and making you live pennies to pennies.

 

Look at all of your options

Don’t overlook any opportunities you have to reduce your debt. Ask your employer if they offer student loan repayment assistance or workplace benefits programs. Estee Lauder is one company that helps its employees in this way: they contribute $100 per month up to a maximum of $10,000. Hulu, Fidelity, AI computing company NVIDIA, and finance company SoFi, are just a few of the other businesses nationwide that offer student loan repayment help to their employees.

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