The total student loan debt, between both federal and private loans, is $1.75 trillion. If your debt is contributing to this total, it’s time to pay it off.
Whether you borrowed private loans, federal loans, or a mix of both, deciding which student loans to pay off first can be difficult. However, it’s important to keep in mind that there is no single one-size-fits-all solution.
Instead, let’s explore a few tactics that can help you save money. This will help you determine which student loans to pay off first, based on your unique financial circumstances
Option #1: Pay Off Private Student Loans First
Private student loans are offered by commercial lenders like banks and credit unions. These organizations are autonomous, meaning they have the discretion to set interest rates, repayment plans, and borrower protections for loans.
Generally, in comparison to federal loans, private loans have less advantageous terms, with no option for loan forgiveness, higher interest rates, and fewer repayment plans.
If the lack of flexibility or the higher interest rates for your private loans is a cause of concern, pay those loans off first. By doing so, you are essentially targeting the “weightier” portion of your debt.
Additionally, consider refinancing your private student loans if it’s an option. Refinancing is the process of borrowing a new loan to pay off your current debt with better terms. This can lower your interest rate and monthly payments, which will be beneficial in the long-run. Keep in mind that you will need a relatively strong credit score to qualify for loan refinancing.
Option #2: Pay Off High-Interest Student Loans First
When Einstein said, “He who understands [compound interest], earns it. He who doesn’t, pays it,” he wasn’t kidding. The debt avalanche method is most effective for minimizing the costs of compound interest, which will save you the most money in comparison to other debt payoff benefits.
With this method, you’ll make minimum monthly payments on all loans while making surplus payments on the loan with the highest interest rate. Then, once you’ve paid off the highest interest rate loan, you’ll carry that payment amount to the next highest interest rate loan.
For example, let’s say you have two student loans:
- Loan A: $10,000 balance, 5% interest rate, 10-year repayment term
- Loan B: $5,000 balance, 3% interest rate, 2-year repayment term
In this scenario, you would make surplus payments on Loan A while still making minimum payments on Loan B. Doing so would minimize the interest costs for Loan, given that it will accrue a greater amount in interest than Loan B.
Option #3: Get Rid of Small Loans First
Targeting smaller loans is another debt payoff strategy known as the snowball method. The logic behind this method is to get rid of the loan with the lowest balance first.
The snowball method is relatively simple. First, organize your loans based on the total amount, without regard to the interest rate. Then, make paying off the smallest loan your priority. After the smallest loan is paid off, target the next loan in line.
For example, let’s say that your debt consists of the following:
- Loan A: $5,000 balance, 3% interest rate
- Loan B: $2,500 balance, 6% interest rate
- Loan C: $3,500 balance, 8% interest rate
In this scenario, you would pay off Loan B first, given that it has the smallest balance.
While the snowball method isn’t the best repayment option in terms of saving the most money possible, you’ll be able to knock out individual loans quicker and have more upfront victories. For some, these upfront victories are what motivates them to stay consistent with their debt payoff journey.
Which Debt Payoff Strategy Will Save You the Most Money?
The debt avalanche method, where you target your high-interest loans first, will save you the most money. This is because you’re targeting debt with the highest interest rate, which will grow the fastest.
However, even if the debt avalanche method will save you the most money, it may not be the most optimal way to repay your debt. According to a study done by Northwestern’s Kellogg School of Management, borrowers who use the snowball method are more likely to pay off all of their debt than borrowers who use other methods.
Closing Thoughts From the Nest
As you consider debt payoff strategies, remember that there is no “right” answer. Instead, think about what best fits your financial situation.
If it’s less financially straining to pay off smaller loans first, use the snowball method. If you want the most bang for your buck and are confident you will be able to stick to a plan, use the avalanche method. In the end, everything depends on what you feel is best for you.