Chances are, if you are a new college graduate, you have some federal and/or private student loans that need to be repaid.
Because managing debt can be a burden and keep you from achieving life goals like moving out on your own or getting married, paying off student loans early might seem like a good idea. But debt and finances are intertwined, so there are several things to consider before you start applying any extra cash toward retiring student loans early.
When paying student loans off early makes sense
It’s important to plan to pay your student loan debt back, and quicker may be better. To determine if paying off your student loans early is an advantage, ask yourself questions about:
- Important life goals: Will your student loan debt keep you from moving forward on important objectives like moving out of your parents’ house, traveling, getting married, having a child or starting your own business? If your answer is “yes,” paying off your student loans early will help you meet these important aims.
- Buying a house: Is buying a house on your radar? When you pay off your student loans, your debt-to-income ratio improves. Lenders carefully consider this ratio, the percentage of your gross monthly income that goes toward paying debt, before approving you for a mortgage.
- Private loans: Does your student loan debt include private loans? If so, those loans probably have variable interest rates, unlike your federal loan that has a fixed interest rate. In the years ahead, it is likely that interest rates will rise, so your private student loan payments will increase, as well. Paying a private student loan early can head off potential rate increases and save you money.
- Paying interest: How comfortable are you with paying interest on your loans? For federal student loans and most private loans, your current balance accrues interest – often daily. The longer you take to pay back your loan, the more interest will accrue and the more money you will end up paying back.
When an early pay-off could hurt you
Paying back your student loans is one part of your financial life. Once you leave school and begin your new post-college life, you need to consider all aspects of your fiscal future. Before you plan to pay back your student loan debt earlier than necessary, consider these points:
- Balance is key: Consider all your financial goals, not just your goal to pay back student loans. Now that you are out of school, it is important to start an emergency fund with a goal of having at least $1,000 to cover unexpected expenses. It is equally important to begin contributing to a retirement account, especially if your employer matches those contributions. If paying back a student loan early gets in the way of doing either of these money management must-dos, an early pay-off should probably wait.
- Understand loan repayment options: First, make sure none of your current loans have early repayment penalties. Then, consider that federal student loans offer flexible repayment options that can help you establish a workable fiscal plan early in your career. For example, you may be able to tie your monthly payment to your income. In some instances, you can also have a portion of your loan forgiven. If you pay off your loans early, you miss out on these benefits.
- Look at all your debt: Before you plan to pay off your student loans early, look at your entire debt picture. If you have credit card debt, it likely carries a higher interest rate than your student loans. Pay off the credit card debt first.
Make an effective debt management plan
Still keen on paying off your student loans early?
First, rank your student loans by interest rate, highest to lowest. Concentrate on paying off the highest interest rate debt first. Also consider refinancing or consolidating your student loan debt, which can reduce the number of monthly payments you will need to make.
Getting rid of student loan debt as quickly as possible can help free you up from the pressure of owing money and allow you to meet important goals. And you can make headway in small ways that make a big difference.
Check out our Student Loan Refinancing Calculator to find out how much you could save by refinancing.