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Extra Payments on Federal Student Loans Rarely Make Sense

The conventional wisdom is that extra payments to eliminate debt is the best approach. For federal student loans, these extra payments are often a mistake.

Written By: Michael P. Lux, Esq.

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Paying extra toward your federal student loans seems like the responsible choice. By paying extra each month, you spend less on interest and eliminate your debt faster.

The problem is that we can’t look at federal loans in a vacuum.

Most borrowers will find that another priority takes precedence over eliminating their student debt. Additionally, with programs like income-driven repayment and student loan forgiveness, moving student loan elimination down the list of financial goals can make a lot of sense.

An Emergency Fund is the First Priority

In terms of financial priorities, having an emergency fund is far more important than paying as much as possible toward your student loans.

To be clear, I’m not suggesting that you don’t make student loan payments until you build up an emergency fund. Instead, I suggest you make minimum student loan payments while building up your emergency fund.

One recent study found that 57% of Americans were uncomfortable with their emergency fund reserves. The same survey found that 22% had no emergency funds at all.

At present, many high-yield savings accounts pay over 5% interest, so the gap between student loan interest rates and savings rates is especially small for many borrowers.

How much should I set aside for an emergency? For student loan borrowers, a properly sized emergency fund will take into account many different circumstances. This emergency fund guide for student loan borrowers will help identify the right size fund to protect yourself and your family.

Knock Out Riskier Debts First

Federal student loans are a nightmare, but they provide borrowers with unique perks. For example, a borrower who loses their job can immediately qualify for $0 per month payments for at least a year. This borrower protection alone makes student loans less of a risk to your financial future than other forms of debt.

Before making extra payments on federal student loans, borrowers should first focus on eliminating the following debts:

  • Credit Cards – Credit card interest rates are usually significantly higher than student loan interest rates. The most efficient way to eliminate debt is often by paying off the highest-interest debts first. Knocking out credit card interest payments from your budget is a huge first step.
  • Private Student Loans – Federal loans may offer forgiveness and protections for times of hardship, but private loans offer no such perks. Even if your private loans have a slightly higher interest rate than your federal loans, knocking out this debt first might make more sense.
  • Personal Loans – Many Americans use a personal loan to consolidate credit card debt or to make a large purchase. The interest rates on these loans are not usually as high as credit cards, but they are often much larger than student loan interest rates. Paying off personal loans before student loans is usually the smart move.

The Homebuyer’s Dilemma

Aggressive student loan repayment and buying a home usually don’t work well together.

Even though federal loans can cause a headache on mortgage applications, the best option for most is to sign up for a plan like SAVE that offers low monthly payments.

Generally speaking, if you want to buy a home, the best path is to save for a down payment, knock out high-interest credit card debt, and find a repayment plan with low monthly payments on your student loans.

Surprisingly, if you cut your student loan balance in half from $100,000 to $50,000, there is a good chance that it won’t move the needle on your mortgage application. However, changing to a different repayment plan could have a dramatic impact.

The advanced mortgage guidance page explains how the various debts and financial goals can impact your ability to buy a home.

Maximizing Retirement Opportunities

If student loans are the financial crisis of the present, retirement is the financial crisis of the future. Many of the retirement resources utilized by previous generations may not be available for younger borrowers.

Pensions, social security, and home appreciation are tools used by current retirees that may not help those of us who are decades away from retirement.

Thus, setting aside money for retirement could be critical. For example, if your employer matches retirement contributions, borrowers are almost certainly better off maximizing this benefit than they are paying down federal loan balances.

Here again, the terms of federal student loans allow borrowers to set money aside for retirement and lower their monthly student loan bills. This can mean a more secure retirement and more federal debt forgiven.

When it Finally Makes Sense to Attack Your Federal Loans

Some fortunate borrowers may reach the point where they have eliminated all of their risky debt. They have built up an emergency fund and made the necessary moves to get ready for retirement.

These financially secure borrowers might realize they don’t need income-driven repayment or loan forgiveness. For the borrowers in this category, it isn’t a question of if they will pay off their federal loans, it is a question of when.

Even for this group of borrowers, I’d argue that making extra payments on their federal loans might not be the best move.

In this situation, utilizing a private lender to refinance could be the ideal strategy. The refinance lender pays off the existing federal balance in full, and the borrower repays the debt at what is hopefully a much lower interest rate.

This move is risky because it permanently eliminates all of the valuable federal loan perks and protections. However, for the borrowers who don’t need these tools, it can result in significant savings.

As of April, 2024, the following lenders offer the lowest interest rates on student loan refinancing:

RankLenderLowest RateSherpa Review
1Splash Financial6.08%*Splash Financial Review
2ELFI6.64%ELFI Review

The Time to Pay Extra on Your Student Loans

Determining whether or not you should make extra payments on your student loans is a process of elimination question.

If you have examined all of the alternatives, and none of them apply to you or seem like good options, then making extra payments to knock out your loans quickly could make sense.

If you identify a bigger priority or a better alternative, you can revisit your student loan strategy whenever circumstances change.

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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