What is the best way to pay off student loans?
By Eva Norlyk Smith Ph.D.
August 11, 2014
I just graduated from college, and I have about $25,000 in student loans at an interest rate of 4.6 percent. What is the best way to pay off the loans? Should I pay a lot upfront and get it paid off as soon as possible? Or should I pace myself and do the 10-year plan? What are the different advantages? –Barb
The long answer, however, is that it depends on your situation. You need to consider other factors, such as how much income you have coming in after your fixed expenses, what your general financial situation is and what your financial priorities are.
A first priority before paying down a loan quickly should be having an emergency savings account. If your car breaks down, your job situation changes or life throws you some other type of curveball, it won't help if you've spent all your extra income to pay down the student loan faster.
A general rule of thumb is to keep at least six months of living expenses in a dedicated emergency savings account.
That being said, if you can swing it, you can save considerably in interest costs if you pay more than the minimum monthly payment.
So, which way is the best way to go about paying down your loan faster? To estimate savings, it can be useful to play with a couple of different scenarios with an online calculator.
Running your loan numbers through this student loan calculator, it looks like your current monthly student loan payments are around $260 a month. If you pay an extra $200 a month, according to the calculator, you'd be able to pay back the loan in approximately five years. In addition, you'd save about $3,100 in interest.
Another option is to make one large payment early on, and still pay the same minimum monthly payment. So, let's say you make a $2,500 payment early on. This will reduce the principal balance to $22,500, which means that a larger proportion of the monthly payment gets applied to paying down principal, rather than interest. So that one-time payment, according to the calculator, will shorten the repayment term to about nine years, and you will save about $1,300 in interest costs.
As you can tell, increasing your monthly payments on the student loan is a powerful way to reduce the time it will take to pay off the loan, and you'll save on interest. And, of course, if you were to combine an extra monthly payment with a one-time large payment, the savings would be even bigger.
With savings rates on CDs and savings accounts under 1 percent, if you do have extra money at the end of the month, making extra payments on your student loan offers a great return on investment.
Ready to get started? This article offers more tips on paying back your student loans faster.
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