Should I Pay Off My Student Loans Early?

FT Contributor  | 

Some loans, such as mortgages, charge a penalty for early repayment, but student loans won’t penalize you for paying off the debt quickly. However, before you start funneling all of your extra cash toward paying your student loan in full as soon as possible, there are some factors to take into account — such as your monthly budget — to make sure it’s the best decision for your overall financial health.

Benefits of Paying Off Student Loans Early

There’s no doubt that paying off your student loans early has some benefits, both financial and psychological.

1.Less stress: Carrying debt can be stressful. When you owe thousands of dollars in loans, that obligation is always in the back of your mind, and it can influence a lot of your decisions and how you live your life. For example, your friends might want to plan a fun getaway, but you may feel guilty spending the money because you have such a large loan balance.

When you have made progress toward reducing the debt, though, or eliminating it entirely, you’re in a better position to say yes to things, and you aren’t as likely to worry about your finances every month and whether you’ll have enough money to make all of your payments. Paying off your loans takes that weight off your shoulders and lets you focus attention on other things.

2. Lower debt-to-income ratio: Conventional wisdom states that the lower your debt-to-income ratio (the percentage of your income that you pay toward debt each month) the healthier you are financially, and the lower your risk of falling behind or defaulting on payments. Most lenders look for a debt-to-income ratio of 43% or less.

When you want to take out a loan for a home or car, or even open a new credit card account, the less money you’re paying toward debts, the better. By paying student loans early, you reduce your debt-to-income ratio while also freeing up money in your monthly budget for savings or other expenses, and you may qualify for more favorable terms on other loans.

3. Pay less interest: As with any debt, the longer it takes to pay off your student loans, the more interest you’ll pay over time. By paying off the balance early, you’ll reduce the amount of interest you pay, saving money in the long run.

Consider the Opportunity Costs

While the amount you pay toward your student loan every month might feel like it takes a  huge bite out of your budget, it’s actually only one aspect of your overall financial situation. Before you start sending extra money to the student loan servicer every month, you need to consider how doing so will affect your entire financial life, and whether doing so will cost you in other ways.

For example, in addition to student loans, you probably need to pay for housing, food, utilities, and transportation every month. While you may be able to trim expenses in those areas in order to make larger loan payments, you shouldn’t prioritize paying off the debt at the expense of your health and safety.

You also need to consider whether other debts or expenses should take priority over reducing your student loan balance sooner. Do you have an emergency fund? If there is one certainty in life it’s that you need to expect the unexpected. Being prepared for an unplanned car repair, a big medical bill, or even a job layoff is an important part of financial security, and if you don’t have any money squirreled away for those emergencies, you could end up in a deeper hole than just your student loans.

Ideally, you should have about 3-6 months’ worth of expenses in savings, but even just $1,000 set aside can be a good start. Without those savings, even making the minimum payment on your student loan might prove difficult if the worst-case scenario actually happens.

Emergency savings aren’t the only thing to consider when determining whether you should pay off student loans early. Retirement might seem like a lifetime away, but it’s never too early to begin saving for it, especially when your employer offers matching contributions to a retirement account.

Opting to pay your student loans instead of contributing the maximum to a matched retirement account is basically like throwing money away, and even when you consider the interest you’ll pay on your student loans, you’re likely to come out ahead when you focus on retirement instead. Your loans will be paid off eventually either way, but it’s much harder to catch up on retirement savings when you start putting money away later.

Examine Short- and Long-Term Goals

Paying more than the minimum toward your student loan balance will get you out of debt quicker, but you need to consider how doing so plays into your short- and long-term goals. If one of your goals is to become debt-free as soon as possible, then focusing your resources on your loans is a smart choice.

However, if you have other goals, you’ll need to think about how they stack up against quickly paying back student loans. For example, do you have your sights set on owning a home or a new car? Do you want to travel or start a business? It’s important to balance your resources so you’re making progress toward those goals as well.

When evaluating your goals, it’s useful to think about your debts in terms of good and bad debt. Bad debt is debt that doesn’t support your overall financial well-being because it has a high-interest rate or is related to a depreciating asset, such as a car. A credit card with a 19% interest rate you opened to get a discount on a purchase, resulting in an outstanding balance, is bad debt. On the other hand, debt that is tied to an appreciating asset — such as real estate — or helps produce income — such as a student loan — is good debt. Bad debt will slow your progress toward reaching your goals, while good debt can help you get where you want to be faster.

Therefore, instead of asking yourself, “Should I pay off my student loans early?” ask, “How will putting extra money toward student loans help me reach my goals?” You may discover that you’re better off putting your money toward another goal, such as starting your business, which will ultimately prove to be a better investment.

Research Your Repayment Plan Options

Before you begin working toward paying off your loans early, carefully evaluate your repayment options. In some cases, paying off your loans early isn’t advantageous because you could qualify for loan forgiveness when you meet specific qualifications.

For instance, when you work for a government organization, teach, or work for a qualifying nonprofit organization full-time for 10 years and make all of your student loan payments on time during that period, you could have any remaining balance of your student loans completely forgiven. When you combine a public service loan forgiveness program with an income-driven repayment plan, which bases your monthly payment on your earnings and gradually increases the payment amount over time, you could save thousands of dollars.

Even if you don’t qualify for a student loan forgiveness program, it’s important to understand your repayment options and what they mean for your balance in terms of interest and the time it takes to repay the loan. Evaluating all of the options ensures that you pay enough to reduce the balance without making unnecessary payments that divert funds from your other goals.

Compare Interest Rates

Finally, understanding interest rates on your loans and other debts will help you prioritize your payments effectively. Regardless of how much you owe on your student loans, you should always work toward paying down high-interest debt first. That being said, the interest rate on your student loan should factor into your decision about how you repay your loan.

Currently, federal student loan rates vary from 4.53% to 7.08%, based on the type of loan. If you borrowed from another source, you may have a higher or lower interest rate. If you borrowed money for school at a higher rate, for example, you took out a $50,000 loan at 12%, then paying down that balance might be a bigger priority than a federal loan for the same amount with an interest rate of  4.53%.

Before you begin making extra payments, consider whether consolidation or refinancing is a better option. When you consolidate your loans, you roll all of your loans into a single payment. Although consolidation can simplify repayment, it can also extend your repayment term and increase the amount of interest you pay.

Refinancing your loans means replacing your current student loan lender with a new lender at a lower interest rate. Refinancing can potentially significantly reduce how much you pay in interest and help you become debt-free faster, but you need to have a steady income and a good credit score to qualify. Still, refinancing is worth considering if you want to free up cash for other expenses while still reducing your student loan balance quickly.


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This post was updated November 7, 2019. It was originally published November 7, 2019.