Pay Off Student Loans Early?
Temptation runs great to whittle today’s enormous student loans as fast as possible. As with many financial planning issues, a number of questions help you decide if paying off your loans early is in fact a good idea.
First, paying loans off quickly may actually seem more possible than headlines about a looming student-debt crisis claim. According to a recent report from the Brookings Institution:
- Roughly a quarter of the increase in student debt since 1989 stems from Americans simply obtaining more education, especially graduate degrees;
- Increases in the average lifetime incomes of college-educated Americans more than keep pace with increases in debt loads; and
- The monthly payment burden of borrowers remained about the same – or lessened – over the past two decades.
The report ignited debate that continues. Your immediate and key considerations:
What’s your interest rate? The rate plays a critical role in determining if paying off your loans early is a good investment.
Student loans consolidated several years ago likely carry a low interest rate (I’ve seen as low as 2.25%) and loans for more-recent graduates normally run 6.8%. Repaying a loan early, in some sense, guarantees you the current rate and heads off future increases in rates.
The higher the interest rate, the more benefit you see from paying off the debt early.
Do you qualify for loan forgiveness? Many employers and a new federal program can forgive loans. As with many financial matters, though, the devil is in the details of the provided documents.
Other factors for both graduates and parents to consider:
- How long does the new graduate need to work to qualify? Some programs kick in with as little as three years on the job; some federal programs require 10 years of service and 120 payments.
- What loans qualify? Many programs offer forgiveness for federally guaranteed student loans, fewer for private loans. Read the details of what you’re offered and ask questions.
How much do you earn? In an ideal world, you make additional loan payments, build an emergency fund and begin saving for retirement early in your career. Chances are you can’t do all of these, so prioritize which gives you the best long-term return for your hard-earned dollars.
Does your retirement plan have a match? If so, it’s hard for me to recommend passing that up to repay student loans.
In some sense, a match guarantees return on your investment: You get additional dollars contributed to an account without taking that money out of your paycheck. Grab the match and then decide if you want to reduce your student loans instead of save for retirement.
How do you feel about debt? Some people are perfectly comfortable making monthly payments over an extended time; others get upset when they think about the payments and amount outstanding. If your student loans distress you, make paying them off a high priority.
Even if the resulting delay in your savings means you work another six months before retiring, that’s probably better than emotional agony for 10 years because putting money away for retirement seemed like a smart move at the time.
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H. Jude Boudreaux, CFP, is a fee-only financial planner and founder of Upperline Financial Planning based in New Orleans.
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