While it may seem like a good idea, early student loan repayment has some big downsides.
by Christy Bieber Sep 19, 2019 at 7:30PM
Student loans seem to go hand-in-hand with diplomas these days, and many graduates with educational debt are eager to repay what they owe and shed this financial burden as soon as possible. But while it’s tempting to use all your spare cash to service your student loan, student loans actually shouldn’t be repaid early in most situations.
Why wouldn’t you want to pay off your debt ASAP? There are a lot of reasons, but they mostly come down to the fact that most of us have a finite amount of money. That means you have to choose between early student debt payoff and doing other things, such as saving for retirement, paying off other debt, buying a house, or making other investments in your future.
Since there’s only so much money to go around, here are three big reasons why it makes no sense to put extra money toward paying off student loans ahead of schedule.
1. Student loans have very flexible repayment plans
With most types of debt you owe, you’re stuck making payments in accordance with the agreement you reached with your lender when you borrowed. Mortgages, auto loans, and personal loans, for example, all come with set monthly payments that you can’t change without refinancing.
If you have federal student loans, on the other hand, you can change your payoff plan as needed. You can stay on a standard plan that allows you 10 years to repay what you owe and charges fixed payments. Or you can opt for a graduated plan so payments go up over time. You even have the option to extend repayment for as long as 30 years by consolidating federal loans, or picking an income-driven payment plan that caps monthly payments as a percent of what you earn.
Not only can you change your payment plan to make loan repayment more affordable, you also have options to suspend payments altogether through deferment or forbearance. Other lenders aren’t going to allow you this leeway if you go back to school or experience financial hardship, so you’d always want to pay off other debt first rather than sending money to the lender that gives you the most flexibility.
2. Interest on student loans probably costs you very little
Federal student loans generally have low fixed interest rates, with the APR on student loans generally well below what you pay on most types of consumer debt. The interest rates are so low that it’s reasonable to expect you could get a better return on investment by putting your money into the stock market rather than sending extra payments to your student loan servicer.
Not only are federal student interest rates below what you could likely make with a diversified portfolio, but you can also get interest subsidized on some of your federal student loans if you need to put them into deferment because you’re going back to school or doing something else that qualifies you to pause payments. This means you could suspend paying when you need to without incurring any additional interest cost.
And there’s another reason why student loan interest costs you hardly anything: You can deduct up to $2,500 in student loan interest from your taxable income as long as you don’t make too much money and are legally responsible for paying back the loans. This makes the interest cost even less. If you are in the 22% tax bracket and take the full deduction, you save $550 per year, so your interest only actually ends up costing you $1,950.
3. You could potentially get some of your loans forgiven
When you have federal student loans, there’s a chance you may not have to pay back the entire amount you owe. You can get the remaining balance forgiven if you qualify for Public Service Loan Forgiveness because of your job and you make 120 on-time payments in an eligible income-driven repayment plan.
You can also get loans forgiven after making payments for 20-25 years on certain other income-driven payment plans, regardless of what your job is. If you’re on one of these plans, you make monthly payments equal to a specific percentage of income, and any balance remaining at the end of the repayment term is wiped clean.
And various presidential candidates in the lead-up to the 2020 election are also floating the possibility of loan forgiveness or cancellation for a broad range of borrowers, so the number of situations where forgiveness is available may soon expand. Even if you don’t qualify for loan forgiveness now, there’s a chance you might if circumstances change. So don’t rush into paying off your loans when there’s a chance the government may just decide you don’t have to pay them in full.
Paying off student loans early just doesn’t make sense
While it may not be fun to owe money to your student loan lender, paying off your loans instead of doing other things with your cash makes very little sense. Keep paying the minimums and use your money for better purposes, such as investing in a 401(k) or IRA for retirement or saving for your other financial goals.
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