I’ve recently had a few clients and children of retired clients ask me questions about paying off their student loans early, so I thought a blog post was in order. Like most posts here, this is a snapshot of my thoughts on a pretty broad topic, so please contact me if you have any questions and I’ll do my best to answer them.
Like many financial planning issues, there are a number of sub-questions that can help you decide if paying off your loans early is a great idea. Below are my top five questions to consider:
- What’s your interest rate? – The interest rate on your loans plays a critical role in deciding if paying them off early is a good investment. Student loans that were consolidated several years ago likely have a quite low interest rate (I’ve seen as low as 2.25%), where those who have recently completed programs normally have an interest rate of 6.8%. By repaying a loan early, in some sense you’re guaranteeing yourself that rate of return by saving yourself future interest. Therefore, the higher the interest rate, the more benefit you have from paying off this debt early.
- Do you qualify for loan forgiveness? – There are many employers, and a new Federal Government program, that can provide loan forgiveness for borrowers. Like many financial things the devil is in the details so you’ve got to really read the provided documents to make the choice that is right for you. A few other factors to consider: — How long do I need to work here to qualify for forgiveness? I’ve seen some programs kick in with as little as 3 years of service, where the Federal program requires 10 years of service and 120 payments. — Will your loans qualify? Many programs offer forgiveness for federally guaranteed student loans, fewer for private loans. Read the details of what you’re being offered and ask questions. (There are a lot of other provisions that the federal program is subject to that will likely require its own blog post in the future, so be on the lookout for that one)
- How much are you earning? – In an ideal world, you’d be able to make additional loan payments, build an emergency fund, and begin saving for retirement in the early stages of your career. Chances are you can’t do all of these, so you’ve got to prioritize on which will give you the best long-term return for your hard-earned dollars.
- Do you have a retirement plan with a match? – If your employer offers a retirement plan with a match, it’s hard for me to recommend passing that up to repay student loans. In some sense, a match is a guaranteed return on your investment, because you can get additional dollars contributed to an account, on your behalf, without you having to take them out of your paycheck. Grab the match and then decide if you want to put additional dollars towards student loans over saving for retirement while considering #5.
- How do you feel about debt? – This shouldn’t be an afterthought as it’s as critical as the other pieces. While few people truly like having debt, I’ve seen a wide range of true feelings with clients about the debts they carry and manage. Some are perfectly comfortable with making the monthly payments over an extend periods of time, others have huge emotional responses when they think about the payments and amount of debt outstanding. If your student loans are causing you emotional distress, then make paying them off a high priority, and free up that energy for more positive things in your life. Even if that delay caused you to have to work another 6 months before retiring, wouldn’t that be better than carrying around the emotional agony for 10 years because putting money away for retirement was the ’smart thing’?