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The Downside or Danger to Paying Off Student Loans in Full

Elimination of student debt is the goal of any student loan borrower, but there are few items to consider before making that last payment.

Written By: Michael P. Lux, Esq.

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Scenario: After saving and sacrifice, you finally have enough money in your bank account to pay off your entire student loan balance. Before sending off the final check, you want to make sure that there are not any negative consequences you are overlooking.

Knocking out a student loan balance in full is a dream come true for many borrowers.

As the dream starts to become a reality, fear sets it. Am I making a mistake? What is the downside to sending in that final big check to pay off my student loans?

Before spending thousands of dollars on anything, it is a good idea to double-check your decision. In the case of a final payoff of student loans, most borrowers will find that the pros of a final massive payment outweigh the cons of debt elimination.

However, it is worth looking at the potential negatives to paying off your student loan because it is a big decision. Once you understand the possible consequences of your choice, it becomes much easier to move forward.

The Main Downside to Paying Off a Full Student Loan Balance

If you have hundreds or thousands of dollars sitting in your bank account, that money probably isn’t earning much interest. Meanwhile, your student loan is generating interest for your lender every day. Making a big final payment means interest stops working against you.

Unfortunately, in addition to giving up a bunch of money, you are also giving up flexibility. In your bank account, that money can be used for anything. Once the money goes to the lender, it is gone forever. Borrowers should think about what would happen if they lost their job, had medical bills, or ran into another unexpected expense.

People with debt, even those with high-interest loans, should still maintain an emergency fund. The size of an emergency fund for student loan borrowers will depend upon several circumstances. However, the constant is that everyone should have an emergency fund.

Completely emptying your bank account to make a final student loan payoff could be risky.

A Tiny Concern: The Student Loan Tax Break

In the interest of making sure nothing gets overlooked, we should discuss the tax consequences.

There is a student loan interest deduction available to all borrowers. However, losing a small tax break isn’t much of a downside to paying off the full student loan balance.

The tax help for student loan borrowers comes as an interest deduction. Payments towards the principal balance do not trigger any tax relief. As a result, many borrowers only get to deduct a small portion of their student loan payments.

Additionally, it is a deduction rather than a tax credit. If you spend $700 on student loan interest, you don’t save $700 on your taxes. Instead, the government will tax you as though you made $700 fewer dollars that year. If you are in the 12% tax bracket, spending $700 on student loan interest will save you $84 at tax time.

In short: yes, you lose your student loan interest tax deduction. No, it isn’t much of a concern.

Can I negotiate a discount by paying the loan off in full?

Some borrowers may think that they can negotiate a break by making a large final payment.

Unfortunately, this is rarely the case.

Lenders know that borrowers are contractually obligated to pay off the entire student loan balance. They will not be inclined to offer a discount to someone following the terms of the agreement.

In some limited cases, borrowers may be able to negotiate a reduced final payment. However, these instances usually only apply to borrowers who have struggled to the point the lender fears they may not ever receive payment in full.

Thus, missing out on the chance to negotiate isn’t much of a concern in making a large student loan payment.

Opportunity Costs: A Con to Consider

In economics, an opportunity cost is the loss of a benefit because of a decision you made.

For example, if you make a large payment towards your student loans, you miss out on the opportunity to put that money into a retirement account.

The larger the final student loan payment, the higher the opportunity cost.

Borrowers should consider their other financial goals before making the big final payment. These other goals might include:

  • Buying a house,
  • Saving for retirement,
  • Having children, and;
  • Starting a business.

The opportunity cost will vary from one borrower to the next. However, all borrowers should consider the missed opportunities as potential downsides to paying off a student loan balance.

Finding a Middle-Ground Alternative

If your student loan interest rates are brutal, but sending in the big check sounds too scary, there is a middle-of-the-road approach.

Borrowers that refinance can lower their student loan interest rates and keep their money in their bank account.

For those not familiar, in a refinance, a new lender pays off your old student loans. A new loan is created that gets repaid to the new lender. The process works because the refinance companies targets low-risk borrowers. As a result, they can charge a lower interest rate and still make a profit. As someone with enough cash set aside to pay off a loan balance in full, you probably fall into the lower risk category.

Going the refinance route can make living with student loans a little bit more bearable. It can also allow for maintaining an emergency fund or saving for retirement.

Most borrowers will lean towards just getting rid of their student loans, but for those truly on the fence, refinancing could be the best of both worlds.

At present, the following lenders are advertising the lowest interest rates on student loan refinancing:

RankLenderLowest RateSherpa Review
T-1ELFI5.28%ELFI Review
T-1Splash Financial5.28%*Splash Financial Review
3Laurel Road5.49%Laurel Road Review
About the Author

Student loan expert Michael Lux is a licensed attorney and the founder of The Student Loan Sherpa. He has helped borrowers navigate life with student debt since 2013.

Insight from Michael has been featured in US News & World Report, Forbes, The Wall Street Journal, and numerous other online and print publications.

Michael is available for speaking engagements and to respond to press inquiries.

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