Like most of the process of attending college, dealing with student loans can be tricky and even overwhelming at times. One question, in particular, that commonly appears during the student loan repayment period is whether a borrower can repay their student loans early without a penalty.
Fortunately, there are absolutely no fees associated with paying off a student loan early.
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What Is a Prepayment Penalty?
A prepayment penalty is a fee that is incurred when you pay off a loan early. This is typically created by the lender to assure that they make back at least a portion of the interest that they planned on receiving from you over the duration of the loan.
Some of the different kinds of loans that may have prepayment penalties include:
Even when it is allowed by law, the existence and size of a prepayment penalty depends on the individual practices of the lender involved.
When it comes to student loans, the right to proactively pay off educational loans without punitive financial consequences was set in stone with the Higher Education Act of 1965. In that piece of legislation, it was explicitly stated: “The borrower has the right to prepay all or part of the loan, at any time, without penalty.”
While this initially pertained to federal loans, the 2008 Higher Education Opportunity Act expanded the legal protection by stipulating that “It shall be unlawful for any private educational lender to impose a fee or penalty on a borrower for early repayment or prepayment of any private education loan.”
Thus, regardless of the originating point of the loan, any student can repay their loan early and not suffer any financial fees or penalties for the early reimbursement of the loan funds.
Issues With Prepaying Student Loans
While the news that there are no prepayment fees for student loans may be a relief, there are still some things you should consider before you begin pouring your extra cash into the principal of your student loans.
When it comes to federal loans, you can typically put money towards your principal loan amount without an issue. However, you will want to make it explicitly clear that the funds are being used for the principal balance, or it can interfere with factors such as being approved for student loan forgiveness.
Crystal clear communication is crucial here, as any confusion can lead to your account being put in “paid ahead” status. This will not apply the funds directly to the principal but will direct them to typical payments — which include interest.
If you’re dealing with private loans, considerations such as paid ahead status and student loan forgiveness evaporate. This simplicity means you can apply extra cash towards the principal of your student loans without complication or penalty.
Should You Pay Off Student Loans Early?
The question that still remains is should you actually put that extra money towards your student loans or not? You already know it won’t lead to extra penalties, fees, or payments, and it’ll likely save you from paying a significant amount of interest. What’s to lose?
The question doesn’t hinge on whether paying off your student loans is beneficial, though. Instead, it revolves around whether it is the most beneficial thing you can do with your money at the moment.
As you decide whether to apply your extra money towards your student loans, here are a few other financially savvy considerations that also should be kept in mind:
- Do you have your basic expenses covered? If you pay off your student debt but you don’t have enough money left to put dinner on the table or cover your rent this month, you’re going to run into issues quickly.
- Do you have a well-established emergency fund? If you don’t have any cushion in your budget for an unforeseen expense, putting money into your debt can leave you with little to no wiggle room if a financial emergency arises.
- Do you need to save a lump sum for a down payment on a car or house? If you’re planning on making a larger purchase soon, it may prove difficult if all of your liquid assets have been spent on reducing your debt.
- Should you be saving for retirement? If you’re young, retirement may not be on your radar, but saving at a young age will have a dramatic effect on the health of your retirement fund later on in life.
- Do you have other debt that has a higher interest rate? If you have a credit card, car loan, or personal loan with a higher interest rate, you should probably funnel your available funds towards paying down this more expensive debt first.
- Are you going to pursue loan forgiveness? If you’re trying to get to the point where you can pursue loan forgiveness, paying extra money towards your debt may not be as effective as applying it to other investments or debts.
Against these questions, you should consider the various benefits that come with paying off your student loan debts early, including:
- Less stress: The simple fact that you won’t have another payment looming every month can be reason enough to pay off your loans early.
- Maintaining a lower debt-to-income ratio: If your debt-to-income ratio is low, you’ll be able to get approved for other loans easier.
- Possibly increasing your credit score: Paying down non-revolving debt such as student loans can demonstrate financial acumen and help you boost your credit score.
- Saving money by paying less interest: Finally, there’s the obvious fact that you’ll save money by not paying interest over the entire course of the loan.
Once you’ve gone over the importance of each of these items in your own finances and budget, you can make a final decision regarding exactly how much extra money you should apply towards your student loan balance.
Perhaps you’re already financially healthy and paying off debt is just another win for your bank account. However, if you’re struggling to get by or you’re living paycheck to paycheck, you may want to slow down and consider the best place to invest each of your hard-earned dollars.
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