While there are both drawbacks and benefits of paying off student loans early, the decision ultimately depends on your financial priorities and standing.
Should I Pay Off Student Loans Early?
Ask yourself the following questions:
#1: Do you have at least 3-6 months’ worth of emergency funds?
Having a rainy-day fund that can last you roughly 3-6 months is crucial in being prepared for unexpected circumstances. Before directing your extra money to pay off your student loans, make sure you are financially prepared for any emergencies.
#2: Are you saving for retirement?
While retirement may seem far away, investing in your retirement while young is crucial to having long-term financial security. If your retirement fund is lacking, consider prioritizing it first.
Once you’re in the position to pay off your student loans while still adding to your retirement fund, then you may want to start directing some extra money to your student loan payments.
#3: Have you paid off all high-interest debt?
High-interest debt is extremely volatile, as the initial amount of money you borrowed can quickly grow larger. Any high-interest debt you have should be a priority to pay off so that the consequences of compound interest do not work against you.
#4: Do you have a “sufficient” income?
If you are able to comfortably make larger student loan payments, you’re in a good spot to pay off your loans early. However, if doing so will place some strain on your financial situation, it might not be the best idea. You’ll want to be able to meet your basic expenses like your bills, rent, and car payments first.
Pros and Cons of Paying Off Student Loans Early
Before making your final decision, carefully weigh the pros and cons.
Pros
Save Money on Interest
Student loans collect interest over time. If you pay off your student loans early, you’ll pay less in interest, saving more money overall.
For example, let’s say you have a loan of $10,000 with a 5% interest rate and a 10-year repayment plan. If you opted to pay off the loan early by adding an extra $200 to your monthly payment, you’d pay off the loan in 3 years and pay a total of $10,850, saving you $1,878 and 7 years of your time.- Lower Your Debt-to-Income Ratio
Your debt-to-income (DTI) ratio is used to compare how much you earn (your gross income) against how much you owe (your total debt). [DTI = Monthly Debt ÷ Gross Monthly Income]
For example, let’s say your total debt payment per month is $3,500, including expenses like your mortgage, student loan payments, and credit card bills. Your gross monthly income, or how much you earn every month before any deductions, is $6,000.
Using the formula above, we would calculate $3,500/6,000, which is roughly 58%.
A “healthy” DTI is 36% or less. Having a DTI over 50% indicates that you owe more than half of what you make, which is a very poor ratio that lenders do not look kindly upon.
If you pay your student loans off early, you can lower your DTI quickly. Having a lower DTI will help you secure lines of credit more easily, such as a mortgage, a new credit card, and more.
- You Can Focus on Other Financial Goals
If you knock out your student loans early, you can focus on other financial goals like buying a house or saving for retirement.
Cons
Monthly Payment Will Be Higher
To pay off your student loans early, your monthly payment must be higher. For example, let’s say that you are paying $250 per month to pay off your student loan in two years. If you want to pay your loans off in just one year, your monthly payment must double to $500 because your repayment plan is halving.
If affording a higher monthly payment would be nearly impossible, or put you in a risky financial situation, it may be best to hold off.- You Won’t Be Eligible for Student Loan Forgiveness
The federal government offers several student loan forgiveness programs, such as Public Service Loan Forgiveness (PSLF) or the Income-Driven Repayment Forgiveness (IDRF).
If you are eligible for a federal student loan forgiveness program that requires you to make payments for a certain amount of time, you should not pay off your student loans early. Doing so could make you ineligible for forgiveness.
If you are not eligible for student loan forgiveness, paying your balance off early would be wise.
This only applies to borrowers with federal student loans, as private student loan borrowers do not have the option for loan forgiveness.
- You May Not Be Able to Focus on Other Financial Goals for the Time Being
By directing more money towards paying off your student loans, you may not have enough money to focus on any other financial goals, like saving for a down payment on a home or contributing to a Roth IRA. So, consider your financial priorities before directing all extra funds toward student loan payoff.
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Is It Worth It To Pay Off Student Loans Early?
Yes, it is worth it to pay off your student loans early if you are financially stable enough to do so. If you can afford to put more money onto your loan, it will save you both time and money in the long run.
However, there are instances when it is not worth it to pay your loans off early. For instance, if you qualify for federal student loan forgiveness, have debt with a higher interest rate, or do not have an emergency fund, it might be more advantageous to prioritize other aspects of your finances.