Most federal student loans have a 0% interest rate through at least September 30th, 2021. During this time, borrowers are not required to make payments. However, many borrowers have chosen to make extra payments during the Covid-19 interest freeze.
The borrowers making extra payments see it as an opportunity to knock down the principal balance and get the debt eliminated much sooner than initially planned.
I think that this is a reasonable strategy that will lead to positive outcomes for many borrowers. However, it isn’t the best strategy.
A better approach would take full advantage of the 0% interest rate and provide borrowers more flexibility. A better approach would leave borrowers more prepared for financial hardships.
The Plan to Take Advantage of 0% Federal Loan Interest
Instead of making payments, federal borrowers with a 0% interest rate should set aside cash in a high-yield savings account. The interest rates on these accounts are not huge, but most should be able to earn some money.
Once the 0% interest period ends, borrowers can empty their high-yield savings account and apply the proceeds to their student loans.
Under normal circumstances, this approach is a bad idea. Student loan interest rates will almost certainly be higher than the best available savings rate. Zero percent interest provides a rare opportunity to earn some money before making student loan payments.
Maximizing Flexibility in Uncertain Times
This strategy is about far more than just earning a few extra bucks on the interest.
Surging unemployment numbers and a bleak economic outlook should worry many borrowers. One of the significant dangers of aggressively repaying student loans is that the large payments are gone forever. It is the reason borrowers are advised to build up an emergency fund before getting serious about debt elimination.
By putting monthly payments in a savings account, borrowers retain control over the money. Those that lose their job or face huge unexpected costs, such as medical bills, will be glad they held on to the cash.
Someone who loses a job can get $0 payments as long as they are unemployed. What they cannot have is a refund on payments they already made.
In the face of so many unknowns, small steps to increase financial flexibility can pay off handsomely.
Best of all, setting aside the extra payments during the Covid-19 interest freeze costs the borrower nothing. As the forbearance comes to an end, borrowers can use the money set aside to reduce their loan balance if necessary.
Talk of Student Loan Forgiveness
The House of Representatives has already passed legislation that would forgive up to $10,000 of student loan debt for “economically distressed” borrowers.
Though the HEROES Act stands little chance of surviving the Senate, there is no denying that there is growing support for student loan forgiveness.
Borrowers who put their federal loan payments in a savings account may be in a better position to maximize any potential forgiveness provision that becomes a reality during the rate freeze.
It is worth noting that such an event at this point is still considered highly unlikely. However, it is a conceivable possibility, and with a 0% interest rate, borrowers lose nothing by waiting a bit to see what the future may hold.
Who Should Make Extra Payments During the Covid Forbearance?
As with most student loan issues, this strategy is not one size fits all. Some borrowers will be better off sticking with the more traditional approach of making payments as planned to knock out their student loans.
Some might see the growing balance in a savings account and be tempted to use the money on something unnecessary. These borrowers may benefit from forcing themselves to make payments.
Final Thought: Get Creative
A 0% interest loan is highly unusual.
The zero-interest period may end in September, but the politicians in DC may decide that raising interest rates right before an election is a mistake.
This strange circumstance provides student loan borrowers a unique opportunity. Those that are willing to get creative and take an extra step or two may find that they do much better in the long run.
If you have already made payments, and wish you didn’t, getting a refund should be easy. Don’t be afraid to ask!