While there is no penalty for paying off student loans early, you should make sure the decision to do so is part of a larger financial planning strategy. Before deciding to increase your student loan repayments, you should first evaluate if that money can be put to better use.
Benefits of Prepaying Student Loans
Whether you have federal or private student loans, you can pay back any education loan early without having to cover the cost of penalties. That means you can pay a little more than you owe each month, make a large prepayment, or even pay off the rest of your balance in a lump sum without worrying about extra fees.
In some cases, prepaying student loans comes with some key benefits. If your student loan isn’t subsidized, paying it off early can save you hundreds or thousands of dollars in interest. In addition, prepaying your student loans can lower your debt-to-income ratio, which can give you a better chance of qualifying for a mortgage, a car loan, or a high limit on a new credit card.
Drawbacks of Paying Off Student Loans Early
While prepaying your student loans does mean you’ll have one less bill to deal with in the future, this strategy isn’t right for everyone. First, most federal and private student loans have low-interest rates, which makes them some of the most cost-effective ways to borrow money for school.
If you prioritize paying off your student loans while letting your credit card debt grow, for instance, you could end up paying more over time. Plus, if you pay your student loans on time, they can help you build a credit history and a good credit rating.
In addition, student loans offer a wide range of repayment, deferment, and consolidation options that you won’t find with other loan types. You’ll lose the ability to delay repayment, apply for income-based repayment, or consolidate student loans into a single low-interest loan if you focus on prepaying education-related debt.
What to Do Before Prepaying Student Loans
If you want to allot extra funds in the smartest way possible, make sure you’re first set up for financial success. While making standard payments on all of your debts, set aside an emergency fund that enables you to support yourself for up to six months in case you encounter any financial surprises.
Next, organize your debts from high-interest to low-interest, and consider applying any extra funds toward high-interest debts first. This strategy can help you save money on interest and can stop your total debt from growing so quickly. Finally, consider whether contributing to a retirement fund or pursuing other investments could pay off more in the long run.
As you’re assessing your budget and your loan repayment options, remember that your financial situation is unique. Take your own income, savings, and debt repayment goals into consideration as you map out a plan, and don’t hesitate to talk with a financial for expert-level advice.