pay the minimum best strategy

When are Extra Payments on Student Loans a Bad Idea?

Michael Lux Blog 0 Comments

Aggressive repayment has a well deserved reputation for being the smart way to repay student loans.  The faster the debt is paid off, the less money that gets spent on interest.  Even though aggressive repayment is usually the smart thing to do, it isn’t always the best idea.

In a few circumstances, just paying the minimum on student debt is the best approach…

Don’t Ignore Higher Interest Debt

For many millennials, eliminating student loan debt is their biggest priority.  In many cases, this can be a good idea and an admirable goal.  However, if you also have thousands of dollars worth of credit card debt, the Visa bill should probably be a higher priority.

Credit cards and personal loans can both have interest rates that greatly exceed most student loan interest rates.  The idea behind aggressive repayment is to save money on interest.  Attacking the highest interest debt first will result in the biggest savings.

This point is especially true for anyone with a payday loan.  These loans have terrible interest rates and fees so excessive that even the worst student loan lenders would blush.

Finally, this is true for student loans as well.  If you put a little extra towards all of your student loans, you are probably making a mistake.  Smart aggressive repayment calls for attacking one high interest loan while making minimum payments on the rest.  Paying a bit extra towards all loans is less efficient and can end up costing more.

Student Loan Forgiveness Instead of Aggressive Repayment

If you are pursing a student loan forgiveness program it usually doesn’t make sense to pay more than the minimum on your student loans.  However, with at least 12 different types of student loan forgiveness available, the best strategy will depend upon the loan forgiveness you seek.

As an example, suppose you are going after Public Service Student Loan Forgiveness (PSLF) through the federal government.  In the case of PSLF, borrowers get their remaining balance forgiven in full along with any interest that the loans have generated.  In this instance, it makes sense to just pay the minimum.  However, if your desired forgiveness program has a cap on the amount that can be forgiven, it may make sense to pay a little extra.  It will all depend upon how the math shakes out.

Important Note
Don’t make the mistake of assuming that you will qualify for loan forgiveness or assume that chasing forgiveness is the least expensive option.  Many borrowers make forgiveness eligibility errors and cost themselves thousands of dollars.  Others chase after forgiveness and end up spending more trying to get forgiveness than they would have if they just paid the loan off in full.  Be sure to know the rules of any desired forgiveness program and run the math to make sure it is the cheapest route.

It is also worth noting that paying a little extra, even for borrowers with $0 IBR payments, will not enhance forgiveness eligibility.

Emergency Fund Comes First

There are a lot of opinions on how much money people should put in an emergency fund and how it should be used.  What isn’t up for debate is that it is a great idea to have an emergency fund available in case of any sort of financial hardship.

The classic uses for an emergency fund would be unexpected medical bills, home repairs, or fixing a car.  However, the uses go far beyond these limited scenarios.  Nobody knows what the future holds and it is a good idea to have some money set aside just in case.

Some people view the available credit on a credit card or a home equity line of credit as an emergency fund.  While these sources can certainly be utilized in a true emergency, they are not reliable enough to be the only emergency fund.  Getting cash from a credit card account can be incredibly expensive, and banks may choose to close an existing line of credit at their discretion.  If the economy heads south and people start losing jobs, the first thing that many banks may do will be to close lines of credit.

Once money is paid towards a student loan, you cannot get it back.  Don’t make the mistake of leaving yourself without any room for an emergency by putting every penny you have towards your student loans.

You want to buy a new car or take a vacation

Just kidding… Buying a car off the showroom floor or taking an expensive trip are exactly the type of thing that should be avoiding when you are battling student loan debt.  Making memories is great, but it can be done without tanking your budget.

Aggressive repayment on student loans isn’t always a good idea, but don’t think for a second that excessive spending on luxuries is justified.

You Have Better Opportunities Elsewhere

This is a student loan site, so we are as guilty as anyone of looking at things just from a student loan perspective.  However, it is important to view your financial health and strategies from a more global point of view.

Borrowers who have the opportunity to have an employer match their 401(k) contributions should seriously consider this route.  These contributions lower your tax burden and increase your compensation from your employer… a true win-win.  Don’t pass up the chance to accelerate your retirement savings so that you can pay off your student loans faster.  Ideally, you max out whatever employer match is available AND pay down your student loan aggressively, but if you have to pick one or the other, retirement may be the better choice.

Similarly, if you have extremely low student loan interest rates, it could make sense to try to invest the money rather than paying down the debt.  Historic stock returns are way more than the 2.5% interest rate charged by many student loan refinance companies.  Borrowers who feel brave may choose to invest and hope they come out ahead.  They run the risk of losing money on their investments, but for some the idea of earning a larger return is a bigger priority than wiping debt off the ledger.

It Can Make Sense to Make Minimum Payments

Most borrowers will find that aggressive student loan repayment is the smartest decision.  However, there are certainly circumstances where another option is a reasonable selection.

The key is to be making responsible financial decisions.  Weigh your options carefully and don’t be afraid to do a bit of math.  It isn’t always fun, but careful financial planning can really pay off.