Now that you have graduated, you probably have enough extra money and you’re trying to figure out should you pay off student loans early?
We’re going to answer things like, should you pay off student loans or save your money, it is bad to pay off student loans early, and what the benefits of paying off student loans early are.
So, when you’re faced with the question of should I pay off my student loans early, there are a few things to consider.
Should I Pay Off Student Loans Early?
Before you sink all of your extra money into paying off your student loans early, you want to make sure that you have built a solid financial foundation.
This means that you have accomplished the following items:
- You have a minimum of two months worth of expenses saved up in an emergency fund.
- You have automatic contributions set up with your employer and you are getting at least the 100% employer’s match.
- You have paid off all of your debts with higher interest rates, like your credit cards.
You may be a little anxious to pay down your student loans faster even if you have NOT accomplished building this financial foundation.
Building Your Emergency Funds
Emergencies are inevitable. Our cars will break down, we will have unexpected medical bills, and our hours could easily get cut at work.
If you don’t have an emergency fund set up, when one of these emergencies happens to you, you’re gonna be screwed.
Most likely, you’re going to end up having to put charge those emergencies to a credit card, which means that you’re going to lose a lot of money to high-interest rates.
How Much Money Should You Have In An Emergency Fund?
Normally, it’s recommended that you have 3-6 months of expenses in your emergency fund.
Honestly, this can be as intimidating as paying off your student loans early.
And as much as I COULD preach to have 3-6 months, it’s not always realistic for most people.
But in reality, you should REALLY have at least $1,000 in your emergency fund.
I say this because every single time my truck breaks down, it has cost us about $1,000 to repair it.
Where Should I Put My Emergency Fund?
The best place to put your emergency fund is a high yield savings account.
High yield savings accounts give you the flexibility to pull your money out when you need it quickly.
But they also are going to give you some of the best interest rates on such a flexible bank account so that you can earn a tiny bit of money on your emergency funds.
How Long Should It Take To Build An Emergency Fund?
The short answer to this is… it depends.
It depends on how large your emergency fund is going to be and how much money you have to put into it each month.
Let’s assume you’re going to save $1,200 and you have an extra $200 per month.
If you divide $1,200 by $200, you end up with 6 months.
So, in this scenario, it would take you 6 months to build up your emergency fund.
In addition to your emergency fund, you also want to start automatically saving for retirement.
Invest In Your Retirement Accounts
The first thing that you should do when it comes to your retirement accounts is to invest in your 401k enough to at least get 100% of your employer match.
If you don’t get a 401k employer match, or you want to invest more than that amount, save as close to 10% of your income as you can into an IRA.
Even if you are paying 7% on your student loans, you will always be better off investing into a 401k with an employer match first.
This is because when you get the employer match, you earn 100% on the money that you have invested.
Should you pay off student loans early or invest?
A conservative investment return is 6% per year.
So, if your student loan interest rates are higher than 6%, you would save more money by paying off your student loans early.
If your interest rates are lower, put your money into an investment account.
This advice is based on normal investing.
As you saw earlier, the advice is different when you’re considering a 401k with employer matching.
So, now that you have set up your emergency fund and you have set up your retirement investments, let’s talk about how to pay off student loans early.
How To Pay Off Student Loans Early
The first thing that you should do is pay off higher interest rate debts first.
These debts are things like your credit cards and personal loans.
After you have paid off these higher interest debts, it’s time to start tackling paying off your student loans early.
Remember that when you pay off your student loans early, there are no penalties for this.
Let’s talk about the how to pay off your student loans early.
The first one is to pay off your capitalized interest first.
1. Pay Off Capitalized Student Loan Interest
If you are still in your student loan grace period, you can pay off any interest that has accrued during this period.
Your grace period is the 6 months between the time you graduate from school and the day you have to start making your student loan payments.
Paying on your student loan interest during this period will keep your student loan from increasing in size.
This is because, even though you’re in a grace period, you are still getting charged interest.
And that interest compounds, making your balance grow exponentially over time.
2. Make Extra Student Loan Payments
Let’s say that you borrow $20,000 in student loans with an interest rate of 5%.
Your monthly payment for 10 years would be $212 and you would end up paying $5,440 in interest.
But if you can pay an extra $100 per month towards your loan, that means you would be paying $312 per month.
But you would end up paying about $2,000 less in student loan interest and be debt-free nearly 4 years early.
The more payments you can add on, the less you’ll pay in interest and the quicker you can get out of debt.
If you have extra money lying around each month, try making bi-weekly payments, which means you’ll be making a full extra payment each week.
For the same example as before, if you double your monthly payments, you save $3,000 in interest and pay off your 10 year loan in just 4.5 years.
3. Get A Job That Pays Your Student Loans Off
I know there are some fields that offer this and some that don’t.
But just because you have never heard of any employers doing this in your industry does not mean they do not exist.
As an engineer, I have never met an employer that offers student loan forgiveness.
But my wife can work for the government as an attorney for the JAG program and they will pay off her student loans for her.
There are contingencies here though. She would have to work at this job for 10 years.
But for someone who has a quarter million in student loan debts, it is something that should be considered.
If you have $20,000 in student loan debts, it’s not worth committing 10 years of your life to one job.
This is because getting a new job could easily allow you to be making $20,000 more per year when you’re in the first 5 years of your career.
4. Refinancing Your Student Loans
You can also shorten the number of years it takes to pay off your loans, and the amount of interest you’ll pay, by refinancing your student loans.
With good credit and a reliable income, you can get a student loan with a lower interest rate through a private student loan company.
Is It Worth Refinancing Federal Student Loans?
It can be worth refinancing your student loans if you have a steady job, an emergency fund, and you plan on paying your debts off faster.
Refinancing your student loans is a good way to reduce your monthly payment by reducing the amount of interest that you pay on your student loans.
Why You Shouldn’t Refinance Your Student Loans
You shouldn’t refinance your student loans if you don’t have a stable income, you have bad credit, or your interest rates are already low.
Another reason not to refinance is if you ever think you’ll need an income driven repayment plan or student loan forgiveness.
Who Should I Refinance My Student Loans Through?
There are plenty of private student loan companies to chose from, but SoFi has some of the best rates and the greatest convenience.
They allow you to set up extra payments and bi-weekly payments on auto pay so that you don’t have to call a crappy customer service every time you want to make an extra payment.
They also provide customers with career coaching that helps them get higher-paying jobs in the long run.
When you use this student loan link, you get $300 in cash back.
And that’s the scoop on whether or not you should pay off your student loans early.