How fast should you pay off your student loans?
Have you seen the cost of a college education lately? It’s astronomical. And if you want to live on campus, you might as well ask your parents to mortgage their home, cause you’re gonna’ need access to some serious cash. There’s no sugarcoating it. College is expensive, and unless you’re smart enough to earn a full ride or lucky enough to have a trust fund, you’re going to have to pay for it.
It’s not surprising that most students will need to borrow money in the form of a student loan to fund all or a portion of their college education. For many, this is their first experience with high balance, long-term debt and it’s likely that all the debt management advice they’ve ever received was, “pay it off as soon as you can.”
Generally, that’s smart advice, but there are conflicting opinions about the speed at which you should pay down student loans. The basis of those differences comes down to a personal decision and the overall effect on your financial plan. We’ve looked at some important factors to help you decide which approach might work best for you:
Evaluate your overall financial picture
Consider all your income and all your liabilities. How much do you have in savings? Do you have an emergency fund? Do you have any other outstanding debt you may want to tackle before your student loan? Reducing the balance on any high interest, revolving, credit card debt before focusing on your lower interest student loan debt might be a smarter financial choice.
Once you pay your monthly bills, how much discretionary income to you have left? Can you afford to send additional money to pay down your student loan any more quickly? Would you have to forego any necessities that may affect your quality of life? It’s one thing to give up buying a new pair of shoes or going to a concert. It’s another to give up paying your health insurance premium or contributing to your 401(k) plan.
How much are your loans costing you?
The interest rate on your student loan is one factor that may help you decide which strategy to choose. Are you paying 2% or 6% interest? If your loan has a low interest rate, you may be better off tackling your higher interest rate debt because your student loan isn’t costing as much—and the little it costs you is tax deductible! However, if you’re paying 6% interest, that can really add up over time.
Not only does a higher interest rate significantly increase your outstanding loan balance, but it can also be used more wisely. Paying it off more quickly might allow you to use that money to invest in the stock market or other investments where you may find the opportunity to potentially earn a higher return.
What are your 1, 3, 5, 10-year plans?
What are your goals over the next few years? Is it paying down your debt or are you saving for some other goals? Saving for a house or starting a business? Getting married or backpacking across Europe? These plans should also be factors to consider. If you’re allocating more money toward your student loan debt, that means your devoting less to other areas of your life. Can you do both? Of course, but it’s important to create balance between the two so that you see progress in both areas. Not only does it help you reach your debt payment and your savings goals, but it also keeps you motivated as well.
Consider though, how your debt could impact some of those goals, like buying a house, for example. Paying off your student loan debt more quickly will reduce your debt to income ratio, which will positively impact your credit score and likely affect your mortgage interest rate. Your debt to income ratio is also a factor banks consider during the mortgage approval process.
What’s your repayment plan?
One way of lowering the cost of your student loan without changing your monthly cash flow is to refinance. Not everyone with a student loan is qualified to refinance and not every loan is worthy of refinancing, but it’s worth considering.
If you have the extra cash to repay your student loan, it’s definitely the wise choice. But, most graduates have to consider a number of factors when deciding whether or not to pay it down more quickly or stick with it for the long haul. Regardless of your choice, it’s important to have a plan so you can keep your financial goals front and center.