If you have the money, (maybe you got a generous birthday gift or a bonus at work), should you use it to pay off your student loan early or should you look into investing it? It’s a good, solid question and one that most new grads ask when they come into some extra money. The first thing to know is that there is no one answer that is right for everybody. There are pros and cons to paying off student loans early. It may be the right option for some students but it may not be the best financial decision for you.
Understanding the pros and cons can help you make the right choice when deciding whether or not to use your money to pay off your student loans early.
Pros Of Paying Off Student Loans Early
Adds up to substantial savings – Paying off your student loans early immediately reduces the amount of interest that accrues over the life of your loan. This can add up to some serious savings and is the biggest benefit of paying off your student debt early.
Frees up money for your monthly expenses – Once you have paid off your loan, you no longer have to contend with monthly payments and accruing interest, freeing up money that you can use for your daily expenses, with extra to spare for investing, building a retirement fund, or splurging on luxuries.
Lowers your debt-to-income ratio – A lower debt-to-income ratio makes it easier for you to get approved for a mortgage and other loans. It also increases your chances of getting a lower rate of interest on your loan.
Gives you much-needed peace of mind – Imagine the relief that comes from knowing that you have cleared off all your debt and whatever money you earn is yours to spend on whatever you want. No worrying about monthly payments or loan default. It can be incredibly freeing and that itself is worth it.
Cons Of Paying Off Student Loans Early
Unfortunately, paying off your student loans early does have a few downsides. These are a few cons you must take into consideration if you are looking into clearing your debt early.
You pay a higher interest rate on future loans – Student loans tend to have much lower interest rates as compared to any other private loans. If you pay off your low-interest loans early and then borrow money for some other purpose, you will pay a much higher rate of interest. In this case, early payment on your student loans will result in you losing money.
You forfeit the tax advantage – Interest on student loans is tax deductible but you can only deduct up to $2,500 each year. Depending on the rate of interest and how much interest you are paying annually, it may or may not be worth it to pay off your student loan early.
It could be draining your emergency fund – Saving towards an emergency fund may not seem really necessary when all is going well, but it only takes a minute or even less for something to go wrong. Putting money towards your emergency fund should be your priority, even if it means paying a little more in accrued interest on your student loan.