Generally speaking, when student loan borrowers acquire a chunk of money via a bonus, inheritance, or tax refund, using the money to pay down student debt has been a smart move. However, we are in unprecedented times due to Covid-19, and borrowers should use their stimulus checks accordingly.
Due to the many types of uncertainty surrounding the Coronavirus, most borrowers should not be using their stimulus check to pay down student debt. While there are some exceptions, borrowers will usually be better off by focusing on other financial priorities.
Many affected by the pandemic will need their stimulus check to pay for necessities like food, basic utilities, and housing. Those in more stable financial circumstances will still want to look at other objectives before using the money to pay down their student debt.
Biggest Priority: Build an Emergency Fund
There is definitely a temptation to cut corners or to raid an emergency fund for the sake of paying off student loans. It is frustrating to see money sitting in a savings account earning next to nothing in interest while student loan interest accumulates at a much faster rate.
Even though the interest rates will almost certainly be working against you, having an emergency fund in place has always been an essential part of financial planning. The events of the past month make this fact painfully obvious.
Experts may disagree on the ideal amount in an emergency fund, and different individual factors may influence how much should be saved, but an emergency fund should almost always be a higher priority than paying extra towards student loans.
Putting a $1,200 or $2,400 check from the government into a savings account is decidedly unsexy, but for many, it is the smartest use for stimulus money.
Pump the Brakes on Aggressive Federal Loan Repayment
As part of the Coronavirus relief package, the federal government stopped charging interest on federal student loans for at least six months. We suspect it may last even longer, given that there is an election in November.
For borrowers in aggressive repayment mode, it means there is no advantage to paying an extra $1,200 today versus paying an extra $1,200 in September. Even if you were certain that the money should be used towards your federal loans, you would still be better off by putting the money in a high-yield savings account, earning some extra money, then paying down your federal loans just before the rates go back up from zero.
A Note from the SherpaIn times of economic turmoil, I tend to be very conservative with the suggestions that are given. Some people may choose to continue aggressive repayment because they have excellent job security. However, because this site is for a large cross-section of people, my preference is to err on the safe side.
To be clear, there is nothing wrong with paying extra on your federal student loans. Many borrowers may opt to continue with their regular payments, even though it is not required. This move would mean no change to the monthly budget but could put a bigger than usual dent in the student loan balance. While this approach may not be the most efficient approach from a purely mathematical point of view, it might make sense in some households.
Ultimately, using the stimulus check to pay down federal student loans could pay off, but there may be better alternatives elsewhere.
Attacking High-Interest Private Loans
Unlike federal loans, private lenders are not pausing interest.
While some private student loans come with reasonable interest rates, many others come with high interest rates than can devastate a borrower’s finances.
Borrowers facing high interest rates have two choices for dealing with their private loans:
- Refinance at a lower interest rate.
- Pay down the balance as quickly as possible to get rid of the loan.
A third choice might conceivably be to continue to pay the minimum at the high interest rate, but that option is objectively terrible.
Receiving a large check from the government might lend itself to option two, but borrowers should first consider the refinance route.
Like so many other aspects of life in 2020, student loan refinancing is in a weird place. Due to the current economic uncertainty and valuable protections on federal loans, this site has suggested that most borrowers should not be refinancing their student loans. Borrowers who want to refinance their private loans would be the key exception.
The refinance marketplace has been somewhat unpredictable. Some lenders have raised rates and gotten more strict in the approval process, while others have been able to offer historically low-interest rates. As a result, borrowers may need to check rates with several different lenders to find the best option.
Those that are able to find a favorable refinance opportunity can free up cash each month, reduce their monthly spending on interest, and better equip themselves for whatever the future may hold.
Don’t Forget About the People who Really Need Help
For many Americans, how to spend their stimulus check will be an easy decision. They will need the money to put food on the table. Those of us who have the luxury of considering other uses should be mindful of that fact.
It may not be easy for most student loan borrowers to give desperately needed money to a charity, but a little bit could make a huge difference.
As an example, a contribution to a local food bank could feed many in your community. Many food banks claim that for every dollar contributed, they can provide five meals to local families. If you give yourself $1,000 from the stimulus check, the remaining $200 could be used to provide 1,000 meals to your neighbors.
Final Thought: Consider all possible options for your stimulus check
If you are considering using a stimulus check to pay down student debt, you are thinking responsibly. Using the money to help eliminate student loans may ultimately prove to be a smart move.
However, reducing student debt might not be the best possible decision. Borrowers should carefully consider all alternatives before making any final choice.