Editors' pick: Originally published Feb. 27.
If you're one of the 44 million Americans owing a total of $1.3 trillion in student loans, you may be zealous about trying to get it paid off early. But that may be a mistake. Sometimes it can be smarter to pay minimums on student loans and put your disposable income elsewhere.
When it comes to retiring debt early, student loans are a lot like mortgage loans, says Joseph Roseman, managing director of Charlotte-based retirement planning firm O'Dell, Winkfield, Roseman and Shipp. "I will show people how to accelerate and pay off their credit card debt every time somebody asks me to," Roseman says. "But when somebody asks about paying off student loans or mortgage debt early it needs to be a much deeper conversation."
In a conversation about a student loan payment, monthly cash flow will be a central topic. The average payment in 2015 for 20- to 30-year-old borrowers was a hefty $351, according to the Federal Reserve of Cleveland. Many borrowers find it too much. About 11% of student loan borrowers are more than 90 days past due, making student debt by far the most likely to be in default of the major categories including mortgages, home equity loans, car loans and credit cards.
While it's rarely a good idea to ignore a debt completely, there are good reasons for not trying to pay off a student loan early. One is that it could be smarter to retire a debt with a higher interest rate, such as a credit card. Credit cards generally carry interest rates of 15% or higher, while many student loans are 5% to 7%. Paying the credit card off first will usually save you money.
Even if you don't have other debt, consider comparing what your student loan costs with what you could earn by saving and investing elsewhere. "The top two factors to keep in mind are how much interest you pay on your loan, and how much you can earn on what you save," says Sean Stein Smith, a member of the financial literacy commission of the New York-based Association of International Certified Professional Accountants.
Few investments guarantee returns superior to the 5% to 7% a typical student loan charges, of course. However, you may be able to beat that by putting money into a tax-advantaged 401(k) or similar retirement plan, especially if your employer matches contributions. "That's as close to getting money for free as possible," Stein Smith notes.
You may also want pay off a student loan early to improve your debt-to-income ratio, which may help if you're trying to qualify for a mortgage. Finally, some people just don't like owing money, so they want to retire all loans, education or otherwise.
However, for many borrowers, making no more than minimum payments on a student loan makes good sense. Education loan rates are relatively low, and interest may be tax-deductible, Roseman notes. Also, unlike most other debts, federal student loan borrowers may be able to defer paying off the loans, suspend payment or even have part of the loan forgiven.
Your overall financial situation also comes into play. For instance, if you don't have emergency savings, you may want to consider at least temporarily making minimum payments and concentrating on building up three to six months' worth of essential expenses in a savings account, Stein Smith says.
One final example of when it might be wiser to defer paying off a student loan is if you are an older borrower. Federal loans generally are discharged by the death of the borrower, Roseman points out. So he sometimes counsels people who take on student loans as a result of going back to school late in their careers to simply pay the minimums.
In this case, letting nature take its course can be a financial tactic. "You could die," Roseman explains. Student loans may have 25-year payback periods, and if a borrower doesn't expect to live that long, death may be an effective way to discharge the loan. However, not all loans are discharged by death, he warns. State and private student loans may have to be repaid by heirs from the proceeds of the estate. In that case, your only choices are to pay now or pay later.