This week I’m super excited to be sharing a guest post all about paying off student loans early, from Katie, the founder of Agape Investing. I have often received questions about student loans and as someone who never had them, I thought it would be best to seek out someone who did.
Katie writes on topics surrounding real estate, entrepreneurship, and finances all from a faith-based perspective. She currently lives in Denver, Colorado where she enjoys drinking coffee and playing board games, as well as exploring the Rocky Mountains with her husband.
I will let Katie take it away from here.
By the end of 2020, we will have paid off all of our student loans.
Wow. Whenever I say that (or write it) it gives me chills! I haven’t been paying off my student loans for a very long time, but just knowing that they will be a thing in the past by the end of this year feels so great.
If you are one of the millions of people in the world with student loan debt and you are considering paying it off early, this article will help you to decide if it is the right path.
How to Student Loans Work?
Student loans are very helpful for those who want to get a college education but can’t afford to pay for it out of pocket. They help give millions of people the opportunity to obtain a degree.
When you are issued a student loan, you sign a promissory note agreeing to the terms of the loan. The terms include these important pieces of information:
- Amount Borrowed
- Disbursement Date
- Interest Rate
- How Interest Accrues
- First Payment Date
- Payment Schedule
If you end up going to a 4-year college or university you will most likely have at least one loan for each academic year. The terms of each loan will be different due to changing interest rates, the lender you use, etc.
Be sure to check the promissory note for each of your loans to verify the terms. The terms of your loan will look different. Make sure to look for any extra fees you may have on top of your interest.
How Is Student Loan Interest Calculated?
Your monthly loan payment will be the same every month and this will depend on the kind of payment plan you have. However, each time you make a payment, the interest is paid before any money goes toward reducing your principal. The remainder of your payment is applied to your principal balance.
Steps to Calculating Student Loan Interest:
- Divide your interest rate by the number of days in the year. This gives you your “interest rate factor.”
- Multiply your interest rate factor by your loan balance.
- Multiply that number by the number of days since your last payment.
This will give you the amount you owe in interest that period.
If you make an overpayment, that extra money will go towards reducing the principle which will then reduce your future interest payments.
Reasons to Pay off Student Loans Early
To Save Money On Interest
Student loans are expensive. The money you borrow to pay for your education is not free. They come with interest and the rate you have will most likely be different each year. Meaning that some loans are more expensive than others.
Student loans will either incur interest daily or monthly. So if you pay extra towards the principal loan amount, the interest you incur will be less as the principal amount drops.
We will be paying off our student loans about 6 years early. After doing the math, we will save close to $5,000!
It will also clear up our budget from the monthly payments we have been making. We can now reallocate those to something else.
Debt To Income Ratio
The debt to income ratio is used when applying for other loans. We invest in real estate so our debt to income ratio is important to us. When being qualified for a mortgage (or really any loan), the lender will look at how much debt you have compared to your income. The lower your debt to income ratio is, the better your chances are to be qualified for a loan with a good interest rate.
The debt to income ratio is determined by taking your monthly debt payments and dividing it by your monthly income.
Peace of Mind
Besides being able to save thousands of dollars, this was another huge reason for us to pay off our student loans. These are our only forms of personal debt and we would love the peace of mind that comes with paying them off.
It already feels so great knowing that they will no longer exist after 2020. I cannot wait for the freedom to wash over me when I hit the button to pay off the last bit of those loans!
Strategy for Paying Off Student Loans Early
There are different ideas on what the best strategy is for paying off student loans. You will most likely have multiple loans that are all different. Some will have a larger borrowed amount than others, and some will have higher interest rates than others.
This debt payment strategy is to take the loan with the highest interest rate and pay that one off first. Then moving on to the next highest interest rate.
The debt avalanche strategy is great for those we are looking to save as much money as possible.
The debt snowball strategy is to focus on the loan with the smallest amount owned and working towards the largest.
This strategy is a good option for those who need little wins along the way to help keep them motivated.
Choosing a Debt Payment Strategy
Choosing a debt payment strategy will depend on your personal long term goals, as well as your mindset.
As we have been paying off our student loans, we have focused on allocating our overpayments to the loan with the highest interest rate. The reason for this is mainly because we decided we wanted to save as much as possible.
How to Pay Off Student Loans Early
In order to pay off your student loans early here are some tips on how you can get started.
Analyze Your Budget. Find out how much extra you are able to pay towards your student loans.
Stop Paying for Things. There are plenty of things you can stop paying for and instead get for free.
Pick up a Side Hustle. If you’re needing to make more money, a side hustle might be the right avenue for you.
Refinance Your Student Loan. You may be able to qualify for a lower interest rate which would help save you money in the long term.
Use Raises Towards Loans. If you get a raise or a bonus, consider putting that new money towards your student loans right away.
Before Paying Off Your Student Loans Early Ask Yourself These Questions
Deciding to pay off student loans early is a very personal choice. Our situation will be different from yours, so paying off your loans early may not be the right decision. Before you make a choice either way, ask yourself these questions.
Does my income allow me to pay extra towards my student loans?
Do you have income that you are currently saving that could go towards paying off your student loans? If your monthly income is already stretched to cover your necessities it may not be the best choice to pay extra towards your student loans.
Do I have an emergency fund built up?
Before deciding to pay off your student loans early, it would be wise to build up an emergency fund. That way you have a safety net if a major emergency comes up.
Do I have other higher interest debt that could be paid off first?
If you have any credit card debt, it may be advantageous to focus on that first. Maybe you have a car loan or mortgage with a higher interest rate than your student loans. If you are going to pay off any debt early it may be a wise strategy to focus on those that are costing you more money.
What are my long term goals?
Paying off your student loans early can help save you hundreds if not thousands of dollars down the road. But it will prevent you from using that money now for something else. The best use of your money will be up to you and your long term goals.
Paying off student loans early is not for everyone. In fact, many people choose to stick with the payment plan instead of paying them off early. The decision is personal and will ultimately be determined by your long term goals.
Are you paying off your student loans early?