The Major Pros and Cons of Paying Off Student Loans Early
Paying off your student loans quickly can have benefits. This article will help you understand if this is a good option for you.
When student loan debt is weighing you down, you obviously want to get rid of it as quickly as possible. For some people, that means putting as much money as possible toward their student loan balance every month.
While that's a great strategy in many cases, it comes with secondary consequences you might not be aware of. Here are the benefits and drawbacks of paying off your student loans early.
Pros of Paying Off Student Loans Early
Don’t feel motivated to tackle your student loans? Here are the main benefits to knocking out student debt early:
Makes it easier to qualify for a mortgage
When you apply for a mortgage, the lender will calculate your debt-to-income (DTI) ratio, which is your monthly debt payments divided by your monthly gross income. Lenders use the DTI to determine how much of a mortgage you can comfortably afford. Most lenders cap the DTI between 36% and 43%, depending on the lender and the type of mortgage.
If your current DTI already exceeds those figures, you may not be approved for any kind of loan. Eliminating student loans can lower your DTI, making it easier to buy the home you want.
Let’s say your monthly student loan payment is $500 and your monthly gross income is $2,500, which comes out to a 20% DTI. The lender you’re looking at allows a 36% maximum DTI, so in this case you would qualify for a $400 mortgage payment. But if you paid off your student loans completely, you would qualify for a $900 mortgage payment.
DTI also affects the interest rate you receive. Borrowers with a lower DTI are seen as having a lower default risk and therefore receive a better interest rate, while borrowers with a high DTI will receive a higher interest rate.
Improves mental health
For many borrowers, paying off student loans early isn’t fueled by math or logic. It’s fueled by emotion. Carrying debt can exacerbate feelings of anxiety and stress, so paying off student loans can improve your mental health. If you feel burdened by your loans, removing them can make you feel better about your finances.
Fewer monthly expenses
Being debt free often leads to more opportunities for consumers. Eliminating student loans early could give you the freedom to change careers, start a new business, become self-employed or go back to school.
For example, if you no longer have a $400 monthly student loan payment, you could funnel that money toward another major goal. It could also free up money to get married, start a family or move to a new country.
Cons of Paying Off Student Loans Early
Getting out of debt is always good, right? Wrong. Sometimes, it pays to keep your loans around. Here are the main drawbacks to getting rid of your student loans early:
Less money for emergencies
Prioritizing student loans instead of a rainy day fund could backfire later on. If you lose your job, get furloughed or have a medical emergency, you’ll need money to cover those expenses.
If you never built up an emergency fund because you were too focused on paying down debt, you may have to take out high-interest loans or credit cards to pay for those surprise expenses.
Before you channel extra money toward your student loans, save up an emergency fund with three to six months of necessary expenses. Make sure to include rent, car insurance, health insurance, gas, groceries, debt payments and other bills in your calculation.
Less money to invest in
Every dollar that you put toward your student loans is a dollar you can’t use to invest. In some cases, you may earn more money by investing than by paying off debt early.
For the past 100 years, the US stock market has averaged about 10% a year, not counting inflation. If your student loans have an interest rate of 6% or less, you’re likely better served by only making the minimum payments on your loans and investing the extra funds.
May be eligible for loan forgiveness
Some student loan experts recommend keeping your federal student loans intact, just in case President Biden cancels student loans at some point in the future. You’ll be out of luck if that happens and you’ve already paid off your student loans.
Even if President Biden does not pass sweeping loan cancellation, you may still be able to qualify for Public Service Loan Forgiveness (PSLF), income-driven repayment (IDR) forgiveness or career-specific loan forgiveness.
Refinance Student Loans
If you’d rather not pay off your student loans early, you can still save money on interest by refinancing your loans to a lower rate. Refinancing involves switching your loan to a new lender, usually in exchange for a lower interest rate or a lower monthly payment.
Depending on your current rate and what you qualify for, refinancing could result in huge cost savings. Let’s say you have $50,000 in federal student loans with a 6% interest rate and a 10-year term. If you refinance to a 3.5% interest rate and a 10-year term, your new monthly payment would be $494, which is $61 less than your previous payment. You would also save $7,280 in total interest over the life of the loan.
You can use the difference to invest for retirement, save for a down payment or pay off other debts. Refinancing to a lower monthly payment will also reduce your DTI, which could improve your ability to qualify for a mortgage or be able to buy a more expensive home.
Zina Kumok is a freelance writer specializing in personal finance. A former reporter, she has covered murder trials, the Final Four and everything in between. She has been featured in Lifehacker, DailyWorth and Time. Read about how she paid off $28,000 worth of student loans in three years at Conscious Coins.
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