Should you pay off student loans early?

by on Sep 18 2012 - 57 Comments

Student loan debt is a reality for most of today’s college graduates. In 2011, the average debt at graduation for bachelor degree recipients was approximately $27,000. Some graduate with more, some with less, but almost everyone graduates with some student loan debt.

Student loan debt is so-called “good debt” because it is an investment in your future earning potential. Completing a undergraduate or a graduate degree program can pay dividends in the future from all the doors it can open. Student loan debt is different than other debt because even if you declare bankruptcy you will still have to pay it back.

The question I want to ask today is: Should you pay off student loan debt early?

Personally I would advocate against paying back your student loans early for these two reasons:

  • The interest rates on student loans are usually fairly low. Because interest rates are largely dictated by the Federal Reserve vs. the free market, interest rates are currently artificially low. True inflation is likely much higher than the stated amount (think 6-8% vs. the official percentages that are quoted by the government) because it takes a while for inflation to spread throughout the economy. Assuming your student loans have an interest rate that is less than 8%, you really aren’t losing much by only paying the minimum.
  • Build an emergency fund and build investments instead. Instead of paying off your loans early, use the additional money to build up an emergency fund or start stashing away money in your retirement accounts. As I already stated, the interest rates usually are pretty favorable on student loans so you aren’t losing as much as you think on the interest. Use your additional cash to build a safety buffer in the form of an emergency fund or get some exposure to the market in the form of investments.

There is one situation where you may want to pay down student loans early. If you are trying to get pre-approval for a home loan, the loan officer will look at your debt-to-income ratio. There is a limit (somewhere around 43%) to how high this ratio can be before you are automatically disqualified. Oftentimes student loans make up a big portion of an applicant’s debt. If your ratio is too high, then paying down student debt early can help you bring your ratio down low enough so that you can get pre-approved for a mortgage.

In the majority of cases it is best to not pay off student loan debt early and focus on other financial priorities: emergency fund and building investments.

Do you think people should pay off student loans as quickly as possible or should they only make the minimum payments?
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48 comments
Chris_E_Johnson
Chris_E_Johnson

Being a current undergraduate student, I found this topic very interesting and couldn't help but read all the comments to get other's opinions. I think both sides have good intentions but in the end it all comes down to what you can afford. Making sure you are able to make your minimum monthly payments on student loan debt is number one. But I also think that getting rid of that debt is equally important as I don't want to be paying off my loans for 10+ years (on a side note, student loan debt is considered "good debt" by lenders and isn't usually an issue to your credit score if timely payments are made). On the other hand, I find it very valuable to begin contributing to a Roth IRA immediately after school to take advantage of my time horizon opportunities. Thanks for the post and all the comments from both sides!

smniskan
smniskan

This is a tough one for me! I just graduated from college two weeks ago with about $64,000 in student loans and I don't have a job. Once I have a steady source of income (and God-willing, this will happen soon!) I can't imagine not putting my extra money towards my loans. I just don't think I'd feel comfortable having a nice wedding, or buying a new car, or even having kids until the debt I accumulated during college is payed off. It's a huge burden that if I had the money to pay off, I would in a heartbeat!

thetightwadtale
thetightwadtale

DC, I'll agree with you. I threw practically all my money into my student loans a week before my job ended...without an emergency fund...suffered for a good three months. It's not just about investing and saving up for an emergency fund for me though. It's about living comfortably, and having a better standard of living with the extra cash. That is, I could easily afford the minimum ($80/month) for the next six years of my life and live a slightly more care free life, or throw most of my income into it and hope I don't get an expensive dental bill...'cause then I'd just be screwed..

One Cent at a Time
One Cent at a Time

Any debt is to be paid off on priority unless there's some more compelling reasons like saving a life, etc. Sure you need to build emergency fund, but once you reach certain limit you got to stop that to pay off debt. My opinion..

moneyaftergrad
moneyaftergrad

What investments are getting you a return >8%?

 

Emergency fund, fine, but I don't think you should pay the minimum on your loans and use the rest of your money to build investments. Maybe split it and put 2/3's of your cash towards the loans and the rest towards investments..

Money Life and More
Money Life and More

My girlfriend's worst loan is a variable 8.25%. We're paying that off as fast as possible. She also has variable 4.75 and 5.75% loans and when the interest rates start going up we could be in trouble.

 

She does have fixed rate loans but they are at 6.8% which is pretty high. We'll just pay all of her loans off as fast as possible.

seedebtrun
seedebtrun

I had my answer in mind before reading, and it will stay the same after reading your post.  :)  YES!  I have credit card debt of ~10k, but it's at 0%!  0.  Goose egg.  It will remain 0% until past our debt-free goal date.  I know that a lot of people think of student loan debt as being not as dangerous or as awful or as evil as consumer debt, but DEBT IS DEBT imo.  As soon as we're through tackling this cc debt, we're onto the car loan, which should be paid off fairly soon after, then onto the house with the same tenacity.  We want to be debt-free, not just consumer debt-free.

-M

OneSmartDollar
OneSmartDollar

I think it all depends on your interest rate.  If it is low then there isn't much point in speeding up the payoff process.

KelseyJass
KelseyJass

We are paying significantly more than what we would be with a mortgage in student loans per month, and if we don't pay more than the minimum . Even with low interest rates, over 40% goes to interest if we pay only the minimums. Though that will change with time, we are working to get all our student loans paid off ASAP (or at least change that principal to interest ratio).

moneymatters
moneymatters

I think there are a lot of factors that go into whether or not to keep those student loans, and whether to pay them off or not.

 

I think things to take into account include the interest rate as you mention,  other debts you may have, and just how debt averse you are.

 

For us I was the only one with student loans when we got married, and I only had about 10k of loans left to pay.  For us our only other debt was our mortgage, and even though the loan was only 2-3% interest, I hated having that debt just hanging there. So we paid it off within a few month to free up that monthly cash flow, and be able to really start saving/investing.  Of course we had an emergency fund built up, and no real other obligations, which made it easier.

Veronica @ Pelican on Money
Veronica @ Pelican on Money

I treat my student loan like another bill - set it on auto-pay and forget it. The amount of interest I'm paying is not significant enough for me to throw extra money at payments (I like to use those funds and building new web properties instead that end up generating continuous revenues to pay the interest anyway).

OutlierModel
OutlierModel

I think that unless you had other debts, especially consumer debts, there's no reason not to pay off the student loans and free up monthly cash flow.  Brian paid off his student loans very quickly from income gained from an extra job and it's definitely great to not have the burden of an extra monthly bill.

Eyesonthedollar
Eyesonthedollar

I think it would have been smart to pay more toward student loans when I first graduated, but then I might not have been able to buy my business or a house, which were more of a priority. I am all for paying down debt, but not at the expense of missing retirement contributions. If you are smart and make decent money, you should do both. I wasn't and got into credit card debt, dumb, dumb, dumb. The remaining student loans  have are at a low rate and they will get paid off eventually.  

FrugalRules
FrugalRules

I would tend to agree with Holly, that it is personal preference.  You make great points about the interest rates and building up things like investments and an E-fund.  I would probably prefer to pay them off early, assuming I had other things covered, as I am no fan of debt and don't relish the thought of making payments for years on the loans

SenseofCents
SenseofCents

I want to pay my quickly. I want my student loans gone, and I expect to pay off around 30,000 by early next year.

bogofdebt
bogofdebt

I agree with Holly. I think it's a matter of personal prefernece.  Right now, I'm paying minimums (rounded up to nearest $5) but eventually I will be paying more on them.  I want to be able to start a family without having them hanging over my head.  I also had a late start so that could be why I really want them gone.

Holly at ClubThrifty
Holly at ClubThrifty

We prepaid Greg's studen loans - around $17,000 but it was mostly because we are so debt averse.  It was at a fairly low interest rate - 4%.  I don't regret it though.  We are debt free besides our home and it feels great!

 

I think it's just a matter of personal preference.  Of course, I wouldn't have paid off his student loans had we not had all of our other ducks in a row first!