No one likes to be in debt, but pushing yourself to pay off your debt as fast as possible isn’t always the right answer either.
Federal student loan payments are scheduled to resume this year after a three-year pause spurred by the pandemic. Once payments resume, you may feel inspired to get rid of your debt as fast as possible so you can return to a payment-free lifestyle.
However, to pay off your student loans quickly, you may need to divert funds from other areas, such as retirement savings or paying off other debts. So before discussing how to pay off student loans fast, it’s important to consider if you should.
Is It a Good Idea to Pay Off Your Student Loans Quickly?
On the one hand, “the faster you pay off your student loans, the less you’ll pay in interest and the sooner you’ll be debt-free,” says Will Sealy, CEO and co-founder of Summer, an employee benefits provider for student loans. On the other hand, there are situations when paying off student loans quickly isn’t the best use of your income.
If you’re able to put extra money into paying down your loans without neglecting other priorities such as establishing an emergency fund, saving for your retirement and paying off higher interest debt, it may make sense to go for a faster student loan repayment.
As you make your decision, you can compare your student loan interest rate with the expected returns for other uses of your funds. For example, new federal undergraduate loans have an interest rate of 4.99%. This means every dollar of your student loans that you pay off effectively earns you about a 5% return. Meanwhile, the annualized total return of the S&P 500 over the last decade is more than 12%.
Of course, some years will fall short of this, and future returns are not guaranteed, but the stock market has historically trended up over the long term. If you want to maximize the return on your money and have a lot of time to keep your money invested, it may make more sense to invest extra cash rather than making extra payments on your student loans.
A similar story can be told about high-interest debts. You will get a higher return by putting extra cash toward paying down debts that have higher interest rates than your student loans.
“Historically, undergraduate subsidized student loan interest rates have been lower than other types of debt, including automobile loan interest rates, home mortgage interest rates, credit card interest rates and personal loan interest rates,” says Sean P. Salter, assistant dean for assessment and associate professor of finance in Middle Tennessee State University’s Jones College of Business.
Another consideration in paying off student loans fast is your tax filing status. Once you hit a certain income level, you can no longer deduct any of your student loan interest on your taxes.
“If a consumer’s income is above the allowable threshold, then the consumer gets no tax benefit to paying student loan interest, and paying off the debt early becomes a more attractive option,” Salter says. “However, if a consumer is getting a big tax deduction from student loan interest, he or she should probably consult a financial professional to get some advice that is specific to his or her situation.”
For student loan interest paid in 2022, your modified adjusted gross income, or MAGI, must be no more than $70,000 for single filers or $145,000 for married filing jointly to be eligible for a deduction of up to $2,500. The amount of eligible deduction phases out for higher incomes, with no deduction available if your MAGI is $85,000 or more for single filers or $175,000 or more for married couples filing jointly. Borrowers are also ineligible for the student loan interest deduction if they are married but file separately or if they are married filing jointly but either spouse can be claimed as a dependent on someone else’s tax return.
In short, it may be a good idea to pay off student loans early if:
- You can afford extra payments without forgoing other key financial goals.
- You don’t have other higher interest debt.
- You aren’t getting a tax deduction for your student loan interest payments.
It may not be the best idea to pay off student loans early if:
- You cannot afford extra payments without forgoing other key financial goals.
- You have other higher interest debt.
- You get a tax deduction for your student loan interest payments.
How to Pay Off Student Loans Early
If you’ve decided to pay off your student loans early, there are some strategies you can use to make the process easier.
1. Live on a Budget
Making a budget can help you maximize your available savings. To create a budget, Salter says to examine sources of income and expenses, including your monthly subscriptions. Your Disney+ subscription may seem like a small price to pay, but those monthly charges can quickly add up.
“Consumers who live on a household budget tend to have more control of their finances and, therefore, more income to apply to debt or retirement,” Salter says. “Hard choices made now can translate into less debt later.”
2. Pay More Than the Minimum
Every dollar you pay above the minimum required payment on your student loans reduces the outstanding principal balance on the loan and the amount of interest you’ll need to pay over the life of the loan, Salter says. If you can afford to pay more than the minimum each month, this will help you pay off your student loan faster.
3. Pay Your Bill More Than Once Per Month
Your student loan payments will have a monthly due date, but this doesn’t mean you have to make payments on only this day. If you can make additional, voluntary payments – even if they’re small – in between your required payments, this can reduce the principal balance and overall interest, just like paying more than the minimum monthly payment.
“This really works well for consumers who get paid weekly or biweekly, as they can schedule a small, automatic payment from each paycheck using their online banking app,” Salter says. You can also make extra payments through your bank’s website and without making them automatic.
4. Set Up Automatic Payments
You can also streamline your student loan payments by setting up automatic payments through your student loan provider.
“This typically comes with a small interest rate reduction and is a great way to ensure that you’re never missing a monthly payment,” Sealy says.
5. Pay Off the Most Expensive Loan First
“We’ve already talked about prioritizing other, more expensive debts, but the same idea applies to consumers with multiple student loans,” Salter says. “It’s always a good idea to put extra cash toward the loan with the highest interest rate.”
This strategy of paying off your highest interest debt first is sometimes called the debt avalanche repayment strategy. That said, some people find it helpful to pay off their lowest balance loans first so they can get the satisfaction of paying them off, says Sealy. This is the debt snowball method.
6. Put Windfalls Toward Debt
One way to chip away at student loans is by applying any one-time influxes of cash, such as tax refunds, bonuses or even your grandparent’s annual birthday check toward your student loan payments, Sealy says.
“There are also programs and tools that allow you to round up debit or credit card transactions or receive cash back when you make a purchase,” he adds. You can put those funds straight toward your student loans.
Find the Best Student Loans for You
7. Work With Your Employer
“It’s becoming increasingly popular for employers to offer student loan contribution programs as a benefit to their employees, especially now that they’re tax-advantaged,” Sealy says.
As part of the Consolidated Appropriations Act of 2021, employers can give employees up to $5,250 per year in tax-exempt student loan repayment assistance through 2025. Plus, beginning in 2024, the SECURE 2.0 Act allows employers to match employee student loan payments with contributions to the employee’s 401(k).
Sealy recommends asking your employer if they offer a student loan contribution program and, if they don’t, if they’d consider setting it up. “If they offer it, they’ll typically pay a set dollar amount into your loans every month or quarter, or offer the option to convert your unused (paid time off) into a student loan payment,” he says.
8. Refinance for a Lower Interest Rate
“For some borrowers with strong credit scores and debt-to-income ratios, refinancing loans for a lower interest rate can also help you pay them off sooner and reduce the interest you pay over the long term,” Sealy says.
Just be aware that refinancing federal loans into private loans would result in losing your eligibility “for all federal loan programs and repayment plans, including the current pause and any future forgiveness plans,” he says.
Not all of the above strategies are compatible with programs like income-driven repayment plans for federal loans, which tie your monthly payments to a set percentage of your income, or Public Service Loan Forgiveness, Sealy says If your goal is to lower your monthly payment, you may want to look to other strategies to make student loan repayments more manageable.