Should I pay off my student loans?

It depends. 

Do you have federal or private student loans? Are you pursuing loan forgiveness?

Federal vs. private student loans

Federal student loans are extremely flexible in comparison to private student loans. Let’s break down some of their differences.

Federal student loans are backed by the United States government. You are limited to the amount that you can borrow annually, but they can still rack up quickly for both undergraduate and graduate students. They also offer flexible repayment terms for students struggling to repay.

Private student loans are more rigid and similar to a traditional loan. You agreed to take out a loan from a bank to fund your education, most likely cosigned by your parents. Sometimes you will receive a lower interest rate than federal loans, but you won’t have any of the flexibility offered by federal loans.

Many people refinance their federal student loans into private student loans post graduation to reduce their interest rate. You will lose all flexibility once you make this decision. In certain circumstances, it can make the most sense as long as you understand the risks associated with the decision to refinance a federal student loan into a private student loan.

Establish an emergency fund first

It is important to establish an emergency fund before accelerating any student loan debt payoff. This should be 3-6 months worth of living expenses depending on your situation and comfort level. The funds should be safe in an online savings account, and not invested. It’s extremely important to do this first so you can address any financial issues as they arise without incurring high interest debt. An emergency fund is simply the buy in before you should even start thinking about other goals such as accelerating your student loan repayment.

If you have an emergency fund and significant discretionary income then it might make sense to pay the loans off as quickly as possible. Consider the opportunity cost of paying them down. For example, if the loans are a low rate such as 2-3% then would it be more beneficial for you to pay them down according to the standard terms and use your discretionary income for other financial goals such as investing, starting a business, etc? There is an opportunity cost to consider with the funds you’re using to accelerate your payments. Could they be better used elsewhere in your financial plan?

Are you debt averse? Would you sleep better at night knowing that your loans are paid off? If that sounds like you, and you have an emergency fund, then you have permission to pay them off! You can’t calculate a good night's sleep on an Excel spreadsheet.

Federal student loans during the pandemic

When you hear about student loans in the news being discussed for loan forgiveness, these are federal student loans. Private loans are mostly excluded from this discussion. Anything is possible but it’s unlikely. There are a lot of rumors swirling about federal student loan forgiveness right now that make it challenging to plan for. Luckily, you don’t have to make payments until September 2021 (as of now) which will allow for the forgiveness speculation to become more clear before you make a decision.

When the pandemic hit in March 2020, the U.S. Department of Education took swift action and suspended payments and interest from accruing on federal student loans to curb the financial impact on millennials. 

Stay up to date on the impact of Coronavirus and federal student loans.

Currently, payments and interest accrual on federal student loans are suspended until September 30th, 2021. This provides a lot of flexibility to borrowers.

Save your normal payments

There isn’t much of a benefit to paying off federal student loans right now other than the peace of mind knowing you’ve paid off your loans. Would you be upset if you paid off your loans today and Congress forgave $10,000 - $50,000 (both amounts have been floated around by Democrats) and you missed out? Even if you don’t support student loan forgiveness, you’d still probably feel ripped off!

Good news, you don’t need to!

An alternative option is to continue making your scheduled payments, or accelerated payments, but instead to a dedicated savings account! Rather than paying your student loan servicer, you can pay yourself. You aren’t being penalized at all for not making payments and the only benefit to continue making payments is to reduce the principal with 100% of your payments, which you can still do up until they resume payments and interest accrual. So continue to set those payments aside but don’t actually pay them towards the loans yet. Give yourself flexibility by waiting until the payment suspension is set to expire (this is what I’m doing with my student loans too!).

Here’s how the scenario could play out:

Scenario 1:

You think I’m a genius and listen to me and begin “making your payments” to a dedicated savings account. Between now and September, student loans are forgiven at some level this year. Great! You now have those funds accessible to you for your other financial goals.

Scenario 2:

You think I have no clue what I’m talking about but you take a chance and listen anyways. You begin “making your payments” to a dedicated savings account, and student loans are NOT forgiven at some level this year. Let’s be honest, promises in politics fall through all the time. No harm no foul though. You can now make a lump sum payment on your student loans from the savings account. Make sure you make the payment before the payments and interest accrual resume. You’ll either pay them off completely or pay off the same amount of principal had you made your normal payments.

Wait and see

I’m not necessarily a fan of mass student loan forgiveness, but it’s my job to plan using the information we have now. There seems to be some serious traction towards a level of forgiveness and there are no consequences for borrowers with federal student loans to wait until at least September 30th, 2020. There is also no clarity on how the forgiveness would work. What would happen to borrowers who recently paid off their balances? I don’t know about you, but that’s not a chance I’d want to take.

In the meantime, we wait and see..

Have questions about your student loans? Schedule a free intro call with us.

Disclaimer: This blog shouldn’t be considered advice, or recommendations. If you have questions pertaining to your individual situation you should consult your financial advisor.