Should You Pay Off Student Loans Early?
Well, you did it: You graduated and you have your first real job. You can’t believe how large your paychecks are (compared to what you earned as a dishwasher at your college dorm). So, what are you going to do now? You have a mountain of student loan debt, but you’ve also heard whispers that investing some of your income may be more financially lucrative than aggressively trying to pay off student loans.
Pay Off Student Loans Early or Invest
No one likes the psychological stress of knowing a huge amount of debt is linked directly back to them. But take a breath, and look at your long-term financial health. Ask yourself what is going to help you in the long run.
Reasons Not to Pay off Student Loans Early
Build an Emergency Fund
Before tackling your loan head-on, Mayotte suggests setting up an emergency fund. That’s because without any savings, you might put unforeseen expenses on a credit card — which likely carries a higher interest rate than your student loans — and not pay it off right away.
Start small and set aside $25 or $50 a month until you’ve got at least $500. That pot of money will be there for you if your car breaks down, and it will keep you from going further into debt.
Take Advantage of a 401(k)
If you have a 401(k) at work and your company offers to match contributions, you should contribute at least as much as the matching amount. This is truly free money. It gets you on your way to saving for the future.
Maintain the Tax Deduction
Student loan interest is tax deductible. Normally, low student loan interest rates and a tax deduction combine to create a loan which can cost less than traditional loans.
Don’t keep your loan for the mere reason of the tax deduction, but if you need to allocate money elsewhere, remember your student loans don’t necessarily have to be a gigantic drain on your resources.
The interest rate you pay on your student loan can be under two percent. If you invest money instead of paying ahead on student loans, you could see annualized returns of more than seven percent.
Reasons to Pay off Student Loans Early
Lower Your Debt to Income Ratio
If you pay off student loans early, it lowers your debt to income ratio. The result is more available money when you want to buy a house, or borrow money. Without a student loan, your money is “freed up.” The less your debt payment is each month, the more you can invest in retirement or any other interest you may have.
Save on Interest Rates
An example from Sallie Mae shows how you save money if you pay a bit more each month.
- Current balance: $10,000.00
- Interest rate: Eight percent
- Repayment term: 10 years
If you pay only the amount due.
- 119 monthly payments of $121.32, with a final payment of $119.89
- It takes 10 years and a total payment of $14,556.97.
If you pay an extra $20 each month.
- 96 monthly payments of $141.32 with a final payment of $7.10
- It takes eight years and one month and you’ll save $983.15.
It’s Your Debt
How you pay off your student loan is your decision. Just make certain you evaluate your options and keep your long-term interests in mind.
Whether you decide to pay off debt as quickly as possible or take the longer road while you focus on other things, having a plan and sticking to it can help you reach your goals.