There’s no question that student loan debt is at an all-time high. The latest statistics show that nearly 45 million U.S. borrowers owe more than $1.7 trillion in student loans.
Many graduates want to pay off their student loans as soon as possible. But is paying off the loans early always the best move?
That depends on a variety of factors, including whether you are carrying additional debt, if you have a savings account, and how you define your financial goals—among others.
For instance, if you’re carrying a large amount of credit card debt and are paying, say, 16% interest on it, but your student loans have a 5% interest rate, it may make more sense to pay off your credit card before you pay off your student loans.
Here’s a look at the pros and cons of paying off student loans early.
Pro: No Need to Worry about Prepayment Penalties
Whether you have federal or private student loans, lenders cannot charge prepayment penalties.
That means you can reduce the balance of a student loan by making extra payments and even pay off the entire balance before it’s due without being charged an extra fee.
Keep in mind that when you make an extra payment on your loan, the payment is applied first to any late charges and collection costs, then to outstanding interest, and then to outstanding principal, according to FinAid. Any amount beyond this total is considered a prepayment on the principal of your student loan.
Con: You Risk Missing Payments
Sometimes borrowers get so excited about making extra payments on their student loans that they forget to make consistent payments. Keep in mind that if you make an extra payment each month, but then miss a minimum payment deadline the next month, you will be charged a late fee for the payment you failed to make.
Doubling up on payments doesn’t give you the luxury of missing a monthly payment. Always make sure you are able to meet your monthly minimum payment deadlines. And if you have more than one student loan, consider making extra payments on the loan with the highest interest rate so that you pay less interest on the loan over time.
Pro/Con: Your Credit Score Might Change
While you might think paying off your student loans early will improve your credit, that isn’t always the case, according to the National Foundation for Credit Counseling. Most lenders like to see a history of money being borrowed and paid back on time before they give you credit.
If student loans are your primary source of open credit, once you close your student loan accounts, you could lose a significant factor driving your credit history. And don’t forget that “a shorter history typically means a lower credit score,” according to the foundation.
Con: You Could Miss Out on Other Financial Goals
Repaying your student loans shouldn’t be your only financial goal (and it probably isn’t). You might also be thinking about saving for a car or a house, or investing for retirement. If you focus solely on repaying your student loans, you might miss opportunities to save for retirement, children, or a down payment on a house.
It’s also important to have an emergency fund—typically at least three to six months’ worth of living expenses saved up—in case you lose your job or get hit with an unexpected big bill.
Rather than using a tax refund or bonus to make an early payment on your student loans, you might want to put that money toward an emergency fund first.
FYI: Most Student Loans Survive Bankruptcy
Let’s say you’re making headway on student loan payments but face a crisis and consider filing for bankruptcy, thinking that’s one way to get your loans off your back. But student loans aren’t typically discharged if you file for bankruptcy.
In fact, to attempt to have a student loan discharged in bankruptcy, the borrower must file for an “adversary proceeding,” requesting that a bankruptcy court find that repayment would impose an undue hardship.
Bankruptcy courts do not use a single test to determine “undue hardship.” According to the U.S. Department of Education’s Financial Student Aid office, bankruptcy courts typically look at three factors (part of the “Brunner Test”) to determine if requiring you to repay your loans would cause an undue hardship:
• If you are forced to repay the loan, you would not be able to maintain a minimal standard of living.
• There is evidence that this hardship will continue for a significant portion of the loan repayment period.
• You made good-faith efforts to repay the loan before filing bankruptcy.
In an adversary proceeding, borrowers must present evidence showing that they meet the undue hardship standards while lenders present opposing evidence. The proceeding can be invasive and expensive for borrowers and rarely results in discharge of all debt.
Bankruptcy judges have a lot of discretion in determining eligibility. In many cases, borrowers will be required to repay their loans but with different terms, such as a lower interest rate.
The Takeaway
Is paying off student loans early always the best move? Not necessarily, if it gets in the way of paying down high-interest debt, creating an emergency fund, or saving for a down payment or retirement.
Instead of paying off student loans early or looking for an escape route altogether, it might make more sense to refinance with a private lender like SoFi. If you qualify, refinancing your private and/or federal student loans can change the terms and the interest rate.
Refinancing could potentially get you a lower monthly payment and a more flexible student loan repayment plan. (Know that if you refinance a federal loan to a private loan, you’ll forfeit your right to federal loan benefits like income-based repayment. You may pay more interest over the life of the loan if you refinance with an extended term.)
Refinancing results in one loan with a single interest rate and one monthly payment.
SoFi Student Loan Refinance
If you are a federal student loan borrower, you should consider all of your repayment opportunities including the opportunity to refinance your student loan debt at a lower APR or to extend your term to achieve a lower monthly payment. Please note that once you refinance federal student loans you will no longer be eligible for current or future flexible payment options available to federal loan borrowers, including but not limited to income-based repayment plans or extended repayment plans.
IF YOU ARE LOOKING TO REFINANCE FEDERAL STUDENT LOANS, PLEASE BE AWARE THAT THE WHITE HOUSE HAS ANNOUNCED UP TO $20,000 OF STUDENT LOAN FORGIVENESS FOR PELL GRANT RECIPIENTS AND $10,000 FOR QUALIFYING BORROWERS WHOSE STUDENT LOANS ARE FEDERALLY HELD. ADDITIONALLY, THE FEDERAL STUDENT LOAN PAYMENT PAUSE AND INTEREST HOLIDAY HAS BEEN EXTENDED TO DEC. 31, 2022. PLEASE CAREFULLY CONSIDER THESE CHANGES BEFORE REFINANCING FEDERALLY HELD LOANS WITH SOFI, SINCE THE AMOUNT OR PORTION OF YOUR FEDERAL STUDENT DEBT THAT YOU REFINANCE WILL NO LONGER QUALIFY FOR THE FEDERAL LOAN PAYMENT SUSPENSION, INTEREST WAIVER, OR ANY OTHER CURRENT OR FUTURE BENEFITS APPLICABLE TO FEDERAL LOANS. CLICK HERE FOR MORE INFORMATION.
This article provides general background information only and is not intended to serve as legal or bankruptcy advice or as a substitute for legal counsel. You should consult your own attorney and/or tax advisor if you have a question requiring legal or bankruptcy advice.
Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.
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