If you have done any research on student loan repayment strategy, you know that paying your loans off “aggressively” is highly encouraged. Many borrowers read this and think there might be a bonus of some sort by paying off the debt right away.
Suppose you owe $15,000 to a student loan lender. If you are in a position to pay $14,000 right now, would your lender consider the loan paid in full? You might even think you are deserving of some sort of benefit for paying the loan off sooner than required.
The Reality of the Situation
Unfortunately, lenders offer no bonus to people who pay off their loans early. The reality of the situation is that they don’t want you to pay off your loans early.
Lenders do not make money by principal balance being repaid. They make money on interest. A small loan that takes years to repay can be much more profitable to a lender than a large loan that is repaid very quickly.
It is also worth noting that for many student loans there is very little risk to the lender. Student loan debt is a special category of debt that has almost no bankruptcy protection. With a mortgage or credit card debt, the lender faces the possibility that the borrower may declare bankruptcy and never pay the debt. With student loans, there is little to no risk of that happening. Additionally, many student loans have cosigners attached to the loan. All of these lender protections mean that the lender has every incentive to encourage you to drag out the repayment on your loan.
The longer you owe a balance, the more money they make.
What’s the point of paying off loans early then?
If there is no bonus to eliminating a student loan quickly, why should I pay all that money now?
The answer is simple: paying off the loan now can save you a ton of money on future interest payments.
You are paying interest on your student loan on a daily basis. With every day that passes, you owe a little bit more money on your student loan. As a result, when you make your monthly payment, much of that payment can be applied towards interest and only the part that is applied towards the principal balance actually reduces what you owe.
If you pay your loan off in full, it eliminates years of payments towards interest. Even if you can’t pay the loan off entirely, extra payments knock down the principal balance and save money in the long run. The ongoing battle with interest is part of the reason why many people refinance their student loans at lower interest rates. The less you spend on interest, the less the debt actually costs you out of pocket.
Lenders want you to drag your feet on repayment. It maximizes their profits. Your goal should be to minimize their profits. The less they make on the loan, the better you are doing.
As a result, lenders certainly won’t be offering you any incentive to pay off your loan early… but the lack of incentive shouldn’t matter. Eliminating debt and the interest that comes with it should be all the incentive you need.