Paying Off Student Loans
Navigating the world of student loans can feel like a daunting task, but understanding the basics and developing a solid repayment strategy can make the journey much smoother.
What Kind of Loan(s) Do You Have?
Subsidized Loans: Subsidized loans are a type of federal student loan offered to undergraduate students who demonstrate financial need. The U.S. Department of Education pays the interest on these loans while you’re in school at least half-time, during the six-month grace period after you leave school, and during any deferment periods. This means that your loan balance doesn’t increase while you’re still studying, which can significantly reduce your overall debt.
A deferment is a temporary pause to your student loan payments for specific situations such as active duty military service and re-enrollment in school.
Unsubsidized Loans: Unsubsidized loans are available to both undergraduate and graduate students, and there is no requirement to demonstrate financial need. Unlike subsidized loans, you are responsible for paying the interest on unsubsidized loans from the time the loan is disbursed (i.e., while you’re still in school). If you choose not to pay the interest while you’re in school, during the grace or deferment periods, it will accumulate and be added to your principal balance.
Private Loans: Private student loans are provided by private lenders such as banks, credit unions, and online lenders. The terms and conditions of private loans vary significantly between lenders and they typically have higher interest rates compared to federal loans. Unlike federal loans, private loans do not offer the same borrower protections and repayment options. Thus it's crucial to thoroughly understand the rules and conditions of your private loans.
Should I Repay My Loans Early?
Here’s a summary of the pros and cons of early loan repayment.
The Pros
1. Saves Money on Overall Debt: By paying off your student loans early, you reduce the amount of interest that accrues over the life of the loan. This can save you a significant amount of money in the long run.
2. Reduces Your Debt-to-Income (DTI) Ratio: Paying off your student loans decreases your overall debt, which improves your debt-to-income ratio. A lower DTI ratio can make it easier to qualify for car loans, mortgages, and other types of credit.
3. Reduces Stress from Worrying About Unpaid Loans: The psychological relief of being debt-free is invaluable. Eliminating student loans from your financial responsibilities can greatly reduce stress and improve your overall mental health.
In this nine-minute video, Akieva Ellis, a recent college grad and Certified Financial Planner shares four strategies for repaying student loans early.
The Cons
1. The Money Could Be Used for Other Financial Goals: Paying off student loans early means diverting funds that could otherwise be used for investments, saving for a home, or building an emergency fund. If you have high-interest debt, like carrying a balance on your credit cards, it's usually better to pay off the high-interest debt first before you tackle lower-interest debt such as student loans.
2. You Give Up the Tax Benefit on Student Loan Interest: Student loan interest is tax-deductible, up to $2,500 per year. Paying off your loans early means losing out on this potential tax benefit.
3. You Don’t Take Full Advantage of Loan Forgiveness Programs: Federal student loans offer forgiveness programs for those who qualify. By paying off your loans early, you might miss out on these opportunities.
Here's a video by Caleb Hammer showing an example of the benefit you’d get if you kept paying your student loans on the normal schedule and invested the money you would have spent to pay off the loan early. This segment starts at 4:23 on the video.
Ways to Pay Off Your Student Loans Early
1. Make Extra Payments Above the Minimum: Any extra amount you pay will go directly towards your principal balance, reducing the overall interest you will pay. Make sure to specify that extra payments should be applied to the principal.
2. Make Payments Bi-Weekly: Instead of making one monthly payment, make half-payments every two weeks. This results in an extra payment each year and can reduce the interest you pay over the life of the loan.
3. Reduce the Interest Rate by Enrolling in Auto Pay: Many loan servicers offer an interest rate reduction if you enroll in automatic payments. This can save you money over time and ensure you never miss a payment.
4. Ask Your Employer About Repayment Assistance: Some employers offer student loan repayment assistance as part of their benefits package. It’s worth inquiring if your employer provides this perk.
5. Federal Student Loan Forgiveness: Explore programs such as Public Service Loan Forgiveness (PSLF) and Teacher Loan Forgiveness. These programs can discharge your remaining loan balance after you meet specific criteria.
6. Refinance High-Interest Debt: If you have high-interest private student loans, consider refinancing to secure a lower interest rate. This can save you money and help you pay off your loans faster.
Paying off student loans early is a significant financial milestone that requires careful planning and dedication. By understanding your loan types, weighing the pros and cons of early repayment, and implementing effective strategies, you can take control of your financial future and achieve the freedom of being debt-free.
Action Plan
Here are three actionable steps students can take to implement strategies for paying off their student loans early:
Set Up a Budget and Identify Extra Payment Opportunities
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Create a Budget: Review your monthly income and expenses to identify areas where you can cut costs. Use budgeting tools or apps to help manage your finances effectively. (See How to Spend Money and How to Save Money, our modules on budgeting.)
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Allocate Savings to Loan Payments: Direct any savings from budget cuts towards making extra payments on your student loans.
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Plan for Windfalls: Commit to using any unexpected income, such as tax refunds, bonuses, or gifts, to make additional loan payments.
Enroll in AutoPay and Optimize Payment Schedule
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Sign Up for Auto Pay: Contact your loan servicer to enroll in automatic payments, which can often reduce your interest rate by 0.25%.
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Switch to Bi-Weekly Payments: Instead of making one monthly payment, divide your payment in half and pay every two weeks. This results in an extra payment each year, reducing your principal faster.
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Monitor Payments: Regularly check your loan balance and payment schedule to ensure that extra payments are being applied correctly to the principal.
Explore Employer Assistance and Loan Forgiveness Programs
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Inquire About Employer Benefits: Talk to your HR department to see if your employer offers student loan repayment assistance as part of your benefits package. If they do, enroll in the program.
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Research Loan Forgiveness Programs: Investigate federal loan forgiveness programs like Public Service Loan Forgiveness (PSLF) or Teacher Loan Forgiveness. Understand the eligibility requirements and take the necessary steps to qualify.
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Track Progress and Documentation: Keep meticulous records of your payments and employment certification forms to ensure you meet the criteria for forgiveness programs.
Implementing these action items can significantly accelerate your journey to becoming debt-free and improve your overall financial health.