What to Know About Paying Off Student Loans Early

Before asking yourself if you should pay off student loans early, make sure you’ve looked at the math between paying your loans down to zero and loan forgiveness alternatives.

It might cost less to work toward loan forgiveness through an income-driven repayment (IDR) plan, stretch your loan payments to 20- or 25-years based on your income, and save for a lump-sum tax bill on the forgiven balance afterward.

But if an income-driven repayment approach doesn’t make sense for your situation, then getting a private lender to pay off your federal loans and extending you a lower-rate private student loan is probably a good path to follow.

From there, though, it can be tricky to decide whether to pay the loans off ASAP or stretch payments out over a longer term. Keep reading to learn the top considerations to make before paying off student loans early, as well as other alternative early-repayment strategies.

What to do before paying off student loans early

Before you start throwing thousands of dollars at your student loans, there are a couple of items to tackle first:

• Consumer debt. For borrowers who recently finished graduate school, it’s not unusual to go three to six months before full-time work begins. This gap might come up if your profession requires licensing or exams after graduation. Whatever your student debt balance, addressing consumer debt should be high (if not the highest) on your list of debt to pay down to zero.
• Workplace benefits. Many employers will match employee contributions to their 401(k) or 403(b). There are other types of employer-provided, tax-advantaged accounts, like TSP, 457, 401(a), Health Savings Account, Flexible Spending Account, and Dependent Care FSA. Make sure you understand how your participation in each account type benefits you from a tax or employer-subsidized standpoint.
• Cash cushion. Once any and all consumer debt is paid down, create a cash cushion. Pay yourself first each paycheck and put that payment toward cash savings. One option is putting the amount you were paying toward your credit cards toward your emergency savings fund.
• Loans from family and/or friends. If you owe a family member money for your higher education, chip away at the debt you owe them. This way, you won’t have the debt hanging over your head and it won’t cause a wedge between relationships (which can happen!).

When to pay down student loans early

Generally speaking, if you owe more than 1.25x your annual compensation, it makes sense to see how much less you’ll pay on an IDR plan with your federal loans.

If that’s not you and you earn more than $50,000, you can probably afford to pay your loans down sooner than 10 years.

How to pay off student loans early

Let’s say you’re a CRNA working for a private practice and earning $175,000 annually. You owe $200,000 in federal loans at an effective 5.50% interest rate, and based on your lifestyle, you can put away up to $4,000 per month toward your loans for the next 10 years.

See Table 1 for different payment periods and assumptions.

Table 1.

Term	Interest rate	Monthly payment	Total cost (future dollars)
10 years	5.50%	$2,171	$260,463
10 years	3.25%	$1,954	$234,526
5 years	2.75%	$3,572	$214,294

If you paid your loans down in 10 years on the Standard Plan, your monthly payment would be $2,171 and $260,463 in total.

If you found a private lender to extend you a 3.25% interest rate over the same time period, you’d pay $217 less per month and almost $26,000 less overall.

Benefits of making extra payments

With the 3.25% loan, if you decided to make an extra payment, utilizing all of the available $4,000 each month toward your loans (i.e. an extra payment of about $3,000), two things would happen:

1. You’d pay a total of about $215,000.
2. You’d finish repayment almost 5 ½ years sooner!

Keep reading: Top Strategies to Pay Off Student Loans in 5 Years

Usually, with a shorter term, a private lender will offer you a lower interest rate. If we refer back to Table 1, we’re showing a 2.75% interest rate for a five-year term.

And if you decided to pay the loan down in that time period, you could save a little bit more than the $4,000 per-month scenario. Paying $4,000 per month on a five-year loan means that your total cost would be about $212,660.

But here’s the deal: with the five-year loan, you have a higher “floor” of $3,572 per month. With the 10-year loan at 3.25%, you have a floor of $1,954. While you could make $4,000 extra payments in both scenarios, with the longer-term loan you have a much lower floor if you need to take your foot off the gas pedal along your “pay-it-down-to-zero” plan.

There’s a cost of a few thousand dollars spread out over 4 ½ years, but that might be a cost you’re willing to pay for the option to slow down extra payments.

Alternatives to paying off loans early

Earlier, we ran with the assumption that you had $4,000 per month to allocate toward paying down student debt. Technically, the surplus dollars above the required monthly loan payment could be used for anything.

If you have a mortgage, you could funnel the surplus dollars toward your mortgage balance. If you itemize your taxes, the interest payments on your mortgage are deductible and if you’ve recently refinanced, it’s possible (even likely) that your mortgage interest rate is lower than your student loan interest rate(s).

If that’s the case, then paying down your mortgage instead of paying down your student loans is what I would call a “personal” decision rather than a “financial” decision. On paper, it wouldn’t make sense to pay down your mortgage. But it might feel good to not have a mortgage or have a much smaller mortgage balance.

Another option is opening an investment account and setting aside the difference each month (between your allotted $4,000 and your required monthly payment). In Table 2, see how the investment account balance would look if it earned 5% compound interest over the Table 1 time periods.

Table 2.

Term	Interest rate	Monthly payment	Total cost (future dollars)	Investment account starting balance	Monthly amount invested	Investment Account Ending Balance**
10 years	5.50%	$2,171	$260,463	$0	$1,829	$284,011
10 years	3.25%	$1,954	$234,526	$0	$2,046	$317,707
5 years	2.75%	$3,572	$214,294	$0	$428*	$309,377

There are quite a few conclusions to be drawn from the above results. Instead of trying to identify them all, here’s what I’ll say: there is no right answer.

On paper, holding investment return and loan interest rate assumptions steady, the clear winner is the five-year loan with $4,000 per month investment account contributions after year five.

But you can’t control the stock market, nor can you control when investment profits accrue to your investments or when a market crash cuts your investment account in half. You also don’t know exactly how the next five to 10 years will pan out in terms of lifestyle expenses.

The bottom line

When it comes to paying off student loans early, what you can do is pick a path and plan on being OK with the plan not going according to plan. Pay yourself by putting extra funds toward your student loans. Pay yourself by paying surplus dollars into your investment account or toward your mortgage. All of these paths are good uses for surplus dollars.

If you’re still wondering whether you should pay down your loans or invest instead, remember that it doesn’t have to be a binary choice. Do a little bit of both! Either way, you’re increasing your net worth and getting on a good path toward financial independence.

Learn how to go from six-figure debt to six-figure net worth.