Before diving into methods to expedite student loan payments, it is important to assess at the beginning whether paying off student loans early is right for you. It seems like a foundational principle of financial success that people should strive to be debt-free as soon as possible. Many would also argue that student debt is one of the worst kinds of debt and should be paid off as soon as practical. However, there are certain situations that could make paying off student loans early unwise.
Individuals who do not have student loans might not realize that interest rates on individual loans could vary greatly. For instance, around $90,000 of my student loan debt had an interest rate of 7.8 percent. This rate is higher than the interest rate of most mortgages, many car loans, and other types of debt. However, I also had around $9,000 of student loans that had an interest rate of 3.25 percent. The reason why interest rates on student loans vary widely is because private and government loans generally have different interest rates and terms. Also, interest rates on student loans can vary depending on when the loans were originated. In any case, your strategy for student loans could differ greatly depending on the interest rates of the individual loans.
If you have student loans that have interest rates below four percent, it might not be worth it to pay off your student loans early. Any extra money could be safely invested in a variety of places and earn interest in excess of the interest accrued on the student loans. Also, interest rates that low are very close to the rate of inflation, which essentially means that there is no monetary penalty for keeping the loans. However, if the interest rates on your student loans are above six or seven percent, it might be more advisable to pay off the student loans early.
Of course, if you are debt-adverse like me, you could certainly pay off all of your student loans early. As I mentioned above, I had around $9,000 of student loans at the enviably low interest rate of 3.25 percent, but I still paid off these loans early so this burden was finally eliminated. However, I want to point out now (and I’ll get into this further in future posts) that my credit score dropped around 90 points when I finally paid off my student loans, since I had less open credit accounts. As a result, it might be wise to keep some low interest debt accounts active to improve your credit score.
Furthermore, it might not make sense to pay off student loans early if you can refinance your loans at a more favorable rate. Some of my friends were able to refinance their student debt at interest rates around five percent or better which is right on the edge of whether you could safely surpass this amount by investing any extra money you might have. I personally did not refinance my student loans since I was worried that refinancing might make me ineligible for income-based repayment plans (more on this below) in case I switched careers. However, if you are able to obtain reasonable terms through refinancing your debt, paying off student loans early might not be advisable.
It might also not make sense to pay off your student loans early if you are in a public service field. I will discuss this topic more thoroughly in future posts, but in brief, people who have public service jobs might be eligible for student loan forgiveness after paying 10 percent of their income toward student loans over 120 months. Of course, if your student debt is low enough that you could pay off the loans in significantly less time than ten years, you might not benefit much from this program and could consider paying off your debt earlier. However, this is a powerful program that might obviate the need to pay off student loans early.
Furthermore, some universities have programs by which institutions will pay the 10 percent monthly payments for graduates taking advantage of public service student loan forgiveness. My own law school alma mater has such a program, and I have many friends who have benefited from these programs. It should be noted that institutions typically have their own eligibility requirements for these loan repayment assistance programs, but this is worth researching for those in public interest fields.
In addition, under the current income-based repayment scheme, people who have qualifying loans and work in the private sector can still have their student loans forgiven after paying 10 percent of their income toward their student loans for 20 years. As I noted above, if your income and outstanding loan balance are such that you would pay off your loans in 10-15 years or so while applying 10 percent of your income to student debt, then you might want to accelerate your payments. However, if your income and debt are such that you would not be able to pay off your student loans in 20 years after applying 10 percent of your income to debt, then you might not want to accelerate payments and just take advantage of this program.
I will discuss this point in later posts, but there is some uncertainty as to the viability of these income-based repayment plans. There have been some proposals to cap the amount of total debt forgiven, and restrict the types of jobs that are eligible for public service student loan forgiveness. If you are risk adverse, and are at the borderline of whether these income-based repayment plans are right for you, it might be advisable to accelerate your student loans payments. Furthermore, unless changes are made, student loan forgiveness might constitute taxable income so it might make sense to pay off the balance early if this option is available to you.
Ultimately, the decision of whether to pay off student loans early is a highly personal choice, and depends on many factors. Indeed, there are a few categories of student debt borrowers that might not benefit from paying off student loans early. In any case, if you decide to expedite your payments and commit to conquering your student debt, this website will provide you with the guidance and support you need to vanquish your student loans.
Be caution with loan forgiveness plans. As you earn more income, you may no longer qualify for these programs. Also, if the loans are forgiven, that debt is taxed as income on top of any other income. So in the example above where our friend owed around 99k, he would be taxed on the additional 99k come tax time. Which may equate to perhaps 20k you’d then owe the IRS.