final student loan payment

Strategies on Paying Back Small Loan Balances

Michael Lux Blog, Strategy, Student Loans 0 Comments

The end is in sight!  After years of hard work and dedication your student loan is nearly paid off.  You may have a few thousand dollars left or maybe just a few hundred dollars.  When faced with this situation, many borrowers may wonder, is it better to just pay it off in full?  Should I stick with my regular schedule?  Are there tax advantages to stretching repayment in the next year?

The last few loan payments matter the least

Paying off your student loan in full may be huge from your perspective, but from a strategy standpoint, the last payments on your student loan don’t matter much.

If you have a total student loan balance of $50,000, your debt is generating large sums of interest on a daily basis.  By the time you are down to the last $500, you are likely left with your lowest interest loan.  In other words, at the beginning your debt was growing 100 times faster than what it currently is.

From a fiscal perspective, paying off your debt in full as soon as possible will save the most money on interest.  However, with a small balance, you may be talking only $10 or $20.  Financial flexibility may be more important than that last $20.

Tax Considerations

There is a deduction that borrowers get from having student loans.  Unfortunately, it is a limited deduction that only applies to student loan interest.

That means if you extend your student loan payments so that your final payment is made in January of next year, you may only end up paying a few dollars on the year in student loan interest.  A few dollars in student loan payments means you are taxed on a few dollars less of income.

Thus, you can stretch things out for a lower tax bill, but the potential benefit is so small that it really isn’t worth the effort.

Advantages of a quick payoff

If you are looking at buying a house, you know the significance of your debt-to-income ratio (DTI).  Paying off 90% of a student loan doesn’t change the monthly payment, so it doesn’t help your debt-to-income ratio.  However, once the loan is paid off in full, you have one less monthly obligation on your credit report.  That improves your DTI and enhances your ability to qualify for a mortgage.

Disadvantages of a quick payoff

The big danger here is if you dump your entire savings account into paying off your student loan in full.  Having the debt eliminated feels great, but if you have an emergency and you need the money, it is gone forever.  You can’t ask for a refund on your large student loan payment.

It may be tempting to knock out a loan the second it is conceivably possible, but if it means depleting your emergency funds, it could be a huge mistake.

Bottom Line

The final payments on your student loan are the least significant from a financial perspective.  They matter far more from a personal satisfaction perspective.

In the absence of a financial consideration, think about making your final payment on a date of significance or on a day you can celebrate your achievement.  Paying off your student loans is a huge deal and you should enjoy the moment you reach this big achievement.