Paying Extra on Student Loans: Is It Worth It?

Many student loan borrowers pay off their loans after around 10 years of regular monthly payments. However, paying extra on those loans could help if your repayment term is longer than a decade or if you want to wipe out your student loan debt a little faster. By making a larger monthly payment or an extra payment every now and then, you could save money over the life of the loan. The more you pay toward your loans, the less you’re likely to pay in interest charges. That could mean you’re out of debt sooner and closer to reaching your financial goals.

Although paying extra on your student loan payments sounds like a good plan, it’s not always easy. For some, making the minimum payment each month is challenging enough. Each borrower is unique and will have to consider their specific financial situation before making the decision to pay extra toward student loans. Here are some things to consider before making that decision.

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Breaking down how it works

Let’s look at an example. Sam just graduated and has $40,000 in student loans at an interest rate of 6.5%. The minimum monthly payment on Sam’s loan is $454, and the balance would be repaid in 10 years. By making the minimum monthly payments, Sam would end up paying $54,503, with $14,503 having gone toward interest. By increasing his monthly payment to $600, the extra $146 that would go toward the loan means it could be paid off in just under 7 years. Saving Sam $4,750 in interest charges.

As illustrated above, making extra student loan payments could lead to paying the loan off ahead of schedule. Those funds could then be put toward other debt or into savings.

Paying off debt also improves your debt-to-income (DTI) ratio. Your DTI ratio compares how much debt you have relative to your earnings. Lenders use it to assess how much you can comfortably afford for a mortgage payment. Once your student debt is satisfied, your DTI ratio will be lower. However, paying off your federal student loans (or private student loans) could actually decrease your credit score. Why? Because it can result in less diversity in the types of debt you have. A wider variety or “mix” of debt types can slightly raise your credit score. It’s up to each individual to determine if being out of debt with a higher DTI ratio is more beneficial than a slightly higher credit score based on debt diversity.

How much additional money should I pay on student loans?

If you want to pay extra toward your monthly student loan payments, you’ll need to figure out how much you can comfortably afford and decide if you’re ready. Here are a few things to consider:

• Do you have other debts with higher interest rates? If so, consider paying off those balances before sending extra cash to your student loan servicer.
• Are you putting enough into a 401(k) at work to get the full match from your employer? If you aren’t, consider doing so. It’s a great way to invest in your future, especially if your contribution is pre-tax.
• Do you have an emergency fund? It’s important to set aside an emergency fund for any unexpected financial setbacks. Many financial experts suggest having anywhere from 3-6 months’ worth of expenses in your bank account.

By keeping these considerations in mind, you’ll have a clearer picture of how much extra money you could afford to put toward the remaining amount on your student loans.

Paying off your student loans faster

Once you’ve determined what your budget allows, it’s time to figure out the best strategy to pay off those loans before their due date.

Here are a few tips that could help:

• Make interest-only payments before you graduate. Although you’re not required to make payments while still in school, direct unsubsidized loans will accrue interest. If you’re able to cover just the interest, you could save money over time since it won’t build up while you’re in school.

• Refinance student loans. If you aren’t planning to use an income-driven repayment plan or apply for Public Service Loan Forgiveness, you may want to refinance your student loans. Refinancing to change your loan terms could help you pay off your loans faster. If you have multiple student loans, you could refinance them by combining them into one loan, ideally at a lower interest rate. If you refinance and opt for a shorter repayment term, your monthly payment might be higher. However, you could save on interest over the loan life and pay it off faster.

• Pay more than the minimum each month. Making a small extra payment each month could make a big difference. Before you begin, it’s important to ask your lender how to make sure your additional payments are applied the way you intend. Some lenders will automatically apply it to your next monthly payment, but they could also put it toward outstanding fees, interest, and principal balance. Explain to your student loan servicer, by calling or writing them, on how you’d like the payment applied.

• Apply a lump sum payment. If you have excess cash, you could make a one-time extra payment on your loan or even pay off the entire loan. For the former scenario, instruct your loan servicer to apply the payment to your unpaid balance. If you’re fortunate enough for the latter scenario, talk to your servicer and get a payoff quote.

Is there a downside to paying off student loans early?

Depending on your circumstances, there could be. Paying off your loans could disqualify you from forbearance, deferment, or other alternative payment plans. Putting too much money toward your monthly payments could hurt your current financial situation and make it more difficult to stay on track. Make sure you understand all the implications of paying off your loans early and make an informed decision that is best for your financial situation.

This article is for educational purposes only and is not intended to provide financial, tax or legal advice. You should consult a professional for specific advice. Best Egg is not responsible for the information contained in third-party sites cited or hyperlinked in this article. Best Egg is not responsible for, and does not provide or endorse third party products, services or other third-party content.