Is It Smart to Pay Off Student Loans Early?

Student loans can feel like an anchor holding you back from your dreams. If you’re like most students, you dream of making that final payment and being free.

But is it a good idea to pay off your student loans?

Read on — the answer may surprise you!

Is It Worth It to Pay Off Student Loans Early?

There’s no one right answer to whether it’s worth it to pay off your student loans early. The answer really depends on your current financial situation and long-term financial goals.

On the one hand, the longer you pay on a loan, the more interest you pay — and you could pay a lot more if you take a long time. For instance, say you have $25,000 in student loans at 4.66% interest and pay it off in 10 years. That loan will cost you $31,323 if you pay it off on time. But if you take out that same loan and pay it off in 15 years, your loan will now cost you $34,794.

On the other hand, paying extra on your student loans probably means you’re not putting as much money into savings, retirement, or paying off more expensive debt — and that could cost you money down the line.

Most financial experts suggest new graduates do three things:

• Build an emergency fund
• Start saving for retirement
• Pay off your most expensive debt first

Once you have those things in hand, you can pay your loans off early if you want to. Or, you can start working toward other financial goals.

Consider Your Loan Type

If you’re thinking about paying off your student loans early, think about the type of loans you have. Federal student loans usually come with low interest rates and flexible repayment plans compared to other kinds of debt. That’s why experts often suggest paying off other debt before paying off student loans.

Some borrowers with federal student loans are also eligible for loan forgiveness through the Public Service Loan Forgiveness (PSLF) program. If you’re eligible for PSLF, then paying off your loans early doesn’t make sense.

Borrowers with private student loans might benefit from paying off their loans early depending on their terms, but, often, refinancing is a better option.

When to Pay Off Your Loans Early

Many of us have negative associations with student loan debt and feel hurried to get rid of it so it doesn’t hold us back. But there are other important things you can do to take care of yourself financially such as building an emergency fund and putting money into a retirement account. 

Most experts agree you should only pay off your student loans early if:

• You have an emergency fund that can support you for 3 to 6 months
• You are making regular contributions to your retirement and are maxing out any employer match contributions
• You’ve paid off other, more expensive debt

Pros and Cons of Early Payoff

There are definite pros and cons to paying off your student loans early. Below are some of the things you should consider.

Pro: Pay Less Interest Overall

You’ll pay a lot less overall if you pay off your student loans faster. Lenders charge interest on a loan for every month you have it. Even a low interest rate can cost you hundreds of dollars over time.

Pro: Improve Debt-to-Income Ratio

Your debt-to-income ratio is a comparison of how much you earn versus how much you owe. It can be hard to take out loans or open credit cards if your debt is high compared to what you’re earning. For most people, paying off their student loan reduces a big part of their debt, making it easier for them to buy a car, a house, or open credit cards.

Pro: Tackle Other Financial Goals

It’s hard to meet your personal financial goals if a large part of your income each month goes to paying off debt. Paying off your student loan could mean freeing up hundreds of dollars per month for other stuff.

Pro: No Prepayment Penalty

With many types of loans, borrowers can be charged a prepayment penalty fee for paying off their loan early. (This fee is intended to replace the interest the lender loses.) But federal law prohibits lenders from charging prepayment penalties on federal and private student loans, so it won’t cost you extra to pay off your loans early. 

Pro: Reduce Financial Anxiety

Student loans are only discharged once the borrower has repaid them or died. Even if you file for bankruptcy, student loans are not usually pardoned. You’ll have greater financial security once your loans are paid off.

Con: Less for Emergency Funds and Savings

One of the best ways to protect yourself financially is to have a dedicated emergency fund. This is a savings account you only touch if the worst happens — job loss, serious illness, or essential home or car repairs. With money set aside for the unexpected, you won’t have to rely on credit cards or other expensive solutions.

Similarly, stashing money in savings is a great way to avoid overdrafting your checking account or taking on more debt for big purchases like vacations or appliances. It’s much safer to save than to pay ahead on loans.

Con: Missed Savings Opportunities for Retirement 

Don’t pay off your student loans early if doing so keeps you from saving for retirement. You may think it’s too early to start thinking about retirement, but some experts believe that each dollar you invest in your 20s could be worth as much as $15 by the time you retire. The best way to prepare for retirement is to choose a retirement account, start saving early, and be consistent. 

If your job offers employer-matched contributions, then you should try to put in the maximum amount they will match. Over time, these investments grow even if you started small. Don’t miss out on important savings opportunities in a rush to pay off your student loans.

Con: Larger Monthly Payments 

You’ll need to make larger monthly payments on your student loans if you want to pay them off early. That can affect your cash flow — in other words, you’ll have less money for essentials like groceries, rent, or mortgage payments. You’ll also have less money for nonessentials like nights out with friends.

Con: Can Lower Your Credit Score

Paying off your student loans can actually lower your credit in some cases. Your credit score is made up of five main factors. One of them, credit utilization, is the amount of debt you’re using compared to the amount of credit you have available. When your student loan is paid off, that line of credit is closed, lowering your total available credit. This can cause your credit score to dip.

Student loans also affect your credit score through your credit mix. Credit mix refers to the kinds of secured and unsecured lines of credit you have. You credit score will be higher if you have a blend of both types of credit. Closing out your student loans changes your credit mix and may lower your score. 

Of course, how your student loans affect your credit score depends on your financial situation. In some cases, the long payment history you establish with student loans could offset the drop from these other factors.

Con: No Loan Forgiveness

Students enrolled in the Public Service Loan Forgiveness program (PSLF) must make 120 qualifying payments to have their loan balance discharged. You won’t be qualified for loan forgiveness if you pay off your student loans early. The average balance forgiven by PSLF is $97,221 as of August 2022, so you could really miss out by paying ahead and skipping loan forgiveness.

Is It Better to Pay Off Student Loans or Have Savings?

Both saving and paying off your student loans are important. But saving is one of the best ways to keep from accumulating more debt. 

Inflation, recessions, cutbacks at work, global pandemics — you never really know what’s around the corner. That’s why saving matters. You don’t want to rely on credit cards or loans in a financial emergency because you’ll end up with costly debt. And unfortunately, debt can easily snowball into more debt.

You don’t have to choose between saving and paying off your loans. By creating a personal budget, you can do both at the same time. (If you’ve tried budgeting before and weren’t successful, check out our article on difference budgeting strategies to find one that works for you.)

How to Pay Off Student Loans Early

There are a number of ways to pay off student loans early if you decide that’s right for you. Here are a few ways you can try.

Use Autopay 

If you have federal student loans, enrolling in autopay will reduce your interest rates by 0.25%. Many private lenders also offer similar incentives. 

This may not seem like a huge reduction compared to the size of your loans but remember that interest adds up over time and you’ll likely pay on your loans for a decade or more.

Autopay also ensures you don’t miss a payment, which could lead to late fees or other penalties.

Make Extra Payments

Every little bit you pay over your monthly payment helps reduce your loan balance. Even paying $100 more per month could help you pay off your debt years early.

Another way to make extra payments is to break your normal monthly payment in two parts and pay every two weeks. By the end of the year, you’ll have made an entire extra loan payment.

Debt Payoff Strategies

Debt reduction experts often promote two strategies for paying off credit card debt, the debt avalanche and the debt snowball. You can use these methods to tackle your student debt, too, if you have more than one loan.

Debt Avalanche

With the debt avalanche method, you pay off your loan with the highest interest rate first while making minimum payments on your other loans. Once your most expensive loan is paid off, take the money you were paying on that loan and combine it with your payment on your loan with the second highest interest. Once you pay down the second most expensive loan, move to the third and so on. 

This method helps you eliminate your most expensive debt first, saving you money and freeing up more money to pay on your other loans.

Debt Snowball

The debt snowball method is similar to the debt avalanche method, but you’ll focus on paying off the smallest loan first while making minimum payments on your other loans. Once the smallest loan is paid off, take the payment for that loan and apply to the next smallest loan along with your regular payment. By the time you reach your most expensive loan, you’ll be making very large payments and pay it off quickly.

The advantage to the debt snowball method is that you’ll pay off one loan quickly, which feels great! That motivation can be powerful in helping you stick to your goal and eliminate your student loans. 

Refinance Your Loans

Refinancing is a popular way to pay off student loans faster. When you refinance your student loans, you take out a new loan and use it to pay off your old loan. You’d do this if the new loan offered better terms like a lower interest rate or longer term. Refinancing can also consolidate multiple loans into one.

Although borrowers often want a longer term when they refinance, you can also choose to refinance at a shorter term. A shorter term means you’ll make bigger monthly payments, but you’ll pay less interest overall.

Pay Off Capitalized Interest 

With federal student loans, your minimum monthly payment includes your interest and part of the principle of your loan. But if your loans enter deferment or forbearance, your interest will add up and get added to the principle of your loan.

This unpaid interest is called capitalized interest and it increases the total amount you owe. If your federal loans have been in deferment or forbearance, you can contact your lender to pay off your capitalized interest and get back on track to pay off your loans.

You can also have capitalized interest on private loans. Some private lenders don’t require you to repay your loan while you’re in school, but still may charge interest during that period.

However, you can ask your lender if you can pay the interest on your loan while in school to keep it from accruing. If you’ve already graduated, you can increase your monthly payments and ask to have the extra money applied to your interest.

The Takeaway

Paying off your student loans is important, but it may not be the most important financial goal. Remember to invest in your future through savings and retirement accounts, too. You’ll be glad you did in the long run.