If you have a low-interest student loan, it opens the door for many repayment and strategy options.
Loans in the 2-4% interest rate range are preferable, but they present unique challenges. A double-digit interest rate loan is straightforward to manage because immediate elimination is an obvious priority. A low-interest student loan has no obvious route.
Even though the decision isn’t necessarily easy, the good news is that there are many excellent options for borrowers.
The Big Perk of Low-Interest Student Loans: Saving for Retirement
There is plenty of debate over how much savers should expect their retirement accounts to earn. Most experts and financial planners project the long-term number to fall between 7-10%, but some people project slightly higher or slightly lower interest rates.
What isn’t up for debate is that in the long run, retirement investments should earn more than the 2% or 3% charged by a low-interest student loan. This means that retirement contributions should grow faster than the interest generated by the student loan. Tipping the scales further in favor of saving for retirement is the tax breaks. Retirement contributions to 401(k)s and IRAs can dramatically lower your tax bill. Additionally, the student loan interest paid also qualifies for a tax break.
Borrowers who choose to focus on retirement can make minimum payments on their low-interest student loans so they can maximize retirement contributions.
Building Up an Emergency Fund
Some people view having an emergency fund as a luxury. I tend to see it as a necessity.
With most savings accounts currently paying far less than 1%, it might be tempting to knock out debt before putting money into a savings account.
However, the value of an emergency fund doesn’t come from the interest it earns. Instead, the value comes from being prepared for unexpected expenses. Surprise medical bills, car trouble, or housing costs add up very quickly. Those without emergency funds often resort to high-interest credit card debt or payday loans. Things can quickly spiral out of control.
Having an emergency fund helps prevent one problem from causing many more problems. Even borrowers with high-interest student debt should still set aside some money for a rainy day. Having low-interest student loans makes it easy to build up your emergency fund.
The Case for Aggressive Repayment of Low-Interest Student Loans
I can’t make an argument using math that says knocking out low-interest debt as quickly as possible is a good idea.
However, for many borrowers, it is a good idea.
Eliminating student loans isn’t just about interest rates or optimizing financial assets. It is also about peace of mind. Student loans are stressful, and erasing them feels good.
I aggressively paid off a student loan with a 3% interest rate. I probably would have been better off by putting that money in a retirement account or investing it. Yet, I have no regrets. That student loan was my last private student loan, and I wanted it gone. Many people have an aversion to debt, and there is a real peace of mind that comes with paying off loans.
Some people might want to just make minimum payments on their low-interest student loans and invest.
Whether or not this is a good idea depends upon your investments and your risk appetite. Putting a bunch of money in Bitcoin or GameStop stock is a very risky move, but if you did it a year ago, it would have paid off handsomely.
Before jumping into the stock market, student loan borrowers should have an investment strategy in place. They should also be ready to accept the consequences if their investments do poorly.
Putting Other Financial Goals Ahead of Student Debt
Here again, the decision isn’t an accounting question. It is a question of personal preferences. If you have $15,000 of student loans at 2.5% interest, you are spending $31.25 per month to carry that debt. Some people might want to eliminate that monthly interest accrual immediately. Others may choose to live with the monthly interest and get started on other financial goals.
Essential Step: Locking in the Low Interest Rate
While there are many options for borrowers, one essential step should be taken by those who elect to pay the minimum long-term.
Many private student loans have variable interest rates. The obvious danger to a variable-rate loan is that the rates can go up. Borrowers that want to take advantage of low student loan interest rates to save, buy a house, or start a business are vulnerable to interest rate changes wrecking their plans.
Refinancing variable-rate loans into a fixed-rate loan is an excellent opportunity for these borrowers.
At present, the lowest fixed-rate loans are with the following lenders:
|Rank||Lender||Lowest Rate||Sherpa Review|
|T-1||3.99%||Splash Financial Review|
The borrowers that want to lock in the lowest possible monthly payment and still have a low-interest loan may elect to go with a 20-year refinance loan. This option may help maximize long-term retirement contributions.
|Rank||Lender||Lowest Rate||Sherpa Review|
|2||5.64%||Splash Financial Review|