My clients with student loans often want to know whether they should just pay the minimum on these loans or pay them down more aggressively. Like most financial planning questions, the answer depends on the situation. Below is a list of what I believe are the four most important questions to consider, if this is a question that you are asking.
1. Do you qualify for loan forgiveness?
The government offers a Public Service Loan Forgiveness (PSLF) Program for individuals who have worked for the government or a non-profit organization for 10 years and have made 120 qualifying payments. Some employers may offer loan forgiveness on their own terms. In order to qualify for these programs you often have to meet a number of requirements, so it is important to thoroughly research the details of the program to make sure that it is right for you. If you do qualify for loan forgiveness, it may be in your best interest not to pay your student loans off early.
2. What is the interest rate of the loan?
Individuals who have recently taken out student loans likely have an interest rate of 6.8%; however, depending on when the loan was taken out (or consolidated), the interest rate could be less than 3%. In most cases the interest on the student loans is tax deductible, making the interest rate a little lower than stated. Whatever the interest rate on the loan, you are in essence guaranteeing yourself that rate of return by paying it off early. Therefore, the higher the interest rate, the more benefit you gain by paying it off early.
3. What will you do with the funds if you don’t make additional payments to your student loans?
If you have a comfortable income that allows you to save for retirement, maintain proper insurance, build an emergency fund, and aggressively pay down your debt; then it may be clear that you can pay off your student loans early. If on the other hand, your income is not quite this comfortable – like most people – then you will have to prioritize your financial goals. In general, I’d recommend that you are contributing enough to your work retirement plan to get your full employer match, that you are insured against catastrophic risks, and that you have an emergency fund in place, before making extra payments on student loans.
4. What are your beliefs about debt?
I’d propose that this question carries more weight than any of the other three. Proverbs 22:7 says that “the borrower is slave to the lender.” If your student loan debt is a weight in your life or keeping you from doing the things to which you feel called, then it may be wise to pay down your debt as aggressively as you can, regardless of the other factors.
Hopefully these four questions get you started in the right direction. If you’d like additional help as you try to determine how much money to put towards your student loans each month, please let me know. I’d be happy to be of assistance in any way possible!
Photo courtesy of Simon Cunningham