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4 Reasons I Refuse to Pay Off My Student Loans Early
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This report was originally published September 30, 2016.
While the standard financial advice is to pay off debt as quickly as possible, I believe there are both pros and cons to paying off student loans early. For me, the downsides outweigh the benefits, which is why I refuse to pay my student loans ahead of schedule.
While your goals might be different, here’s why I decided against paying off my student loans as fast as possible.
4 reasons I refuse to pay my student loans early
There are four specific reasons I won’t be rushing to pay my student loans off early:
Years ago, when I was tackling credit card debt on top of my student loans, it made sense to ignore my student loans. After consolidating my student loans in 2005, I had a 1.9% interest rate. Rather than focusing on such low-rate loans, I turned my attention to the higher-rate credit card debt I’d amassed.
When deciding which debt to demolish first, it’s tempting to pay off student loans early because they are often so big. But starting with higher-rate debt often makes more sense mathematically.
The more you pay in interest, the more you may end up paying throughout the lifetime of the loan. Get rid of the high-rate debt first and tackle the student loans once it’s out of the way.
The interest you pay on student loans is tax deductible. Between my low interest rate and the tax deduction, my student loans don’t cost very much at all. Paying off student loans early means you may not receive that tax deduction down the road.
You shouldn’t keep your loans around just for the tax deduction, but if you have other things to do with your money, it’s nice to know that your student loans aren’t such a huge resource drain.
You won’t even have to itemize your deductions to take advantage. You can reduce your taxable income by up to $2,500 when you meet the eligibility requirements for a student loan tax deduction, which include being legally obligated to pay interest on a qualifying student loan and your modified adjusted gross income being less than the amount determined by the IRS. That’s a pretty decent sum, and that reduction may be enough to save you some money come tax time.
Because the 1.9% rate on my student loans is so low, I prefer to invest the money I would have used to pay off student loans early. We talk about debt repayment as a guaranteed return, but is the 1.9% really worth it? With a long-term approach to investing, you could see annualized returns of more than 7%.
Putting extra money toward my retirement has helped me build my portfolio and prepare for my future. It’s been much more profitable than putting that money toward paying down low-rate student loan debt since my returns are much higher than what I’m paying in student loan interest.
Even with hiccups in the stock market, the overall gains have been worth it. My returns so far and my potential returns for the future are much better than I would see if I spent five years diverting that money to student loan payoff.
Putting the money to work with the help of compound interest over time has been a much better investment than paying off low-rate student loans early. Combine that with the tax efficiency boost from my loan interest tax deductions each year, and my student loans aren’t worth paying off early.
If your employer offers you a 401(k), you may be able to get an even greater return on your retirement savings. That’s because your employer could match what you contribute to this type of retirement account up to a certain percentage of your paycheck. Why wouldn’t you want to take advantage of that?
One of the most important aspects of your finances is your cash flow. Paying off student loans early means devoting more of your financial resources, which can restrict your cash flow.
If you are willing to give up part of your budget to make it happen, that’s no problem. I’m not willing to do so, especially since my low rate and being able to take advantage of the tax deduction mean I’m not paying very much for my student loans.
I like having the freedom to use my monthly disposable income how I want without it going toward paying down loans.
While you might want to pay off student loans early, you don’t want to put other areas of your finances at risk. Before you stretch your budget for rapid student loan reduction, it might make more sense to shore up your finances with an emergency fund.
Having an emergency fund can help you with more immediate crises, such as a job loss, an unplanned medical procedure or car repairs. This money can prevent you from falling into more debt if you need to take out an additional loan to pay for these unplanned expenses.
Think about other ways to use that — what else could you do with that money if you weren’t putting so much toward student loan debt early repayment?
Just because paying off student loans early isn’t my thing, it doesn’t mean you have to stop aggressively tackling your own debt. Some repayment plans span 20 or 25 years, and not everyone likes the idea of having these types of long-term obligations.
And sometimes it doesn’t matter what the math says — if you can’t sleep at night because of the student loan debt hanging over your head, then it could make sense to pay it off ASAP, regardless of other pros and cons of paying off student loans early.
Another consideration is that you might not have the same interest rate I do, which is extremely low. If your rate is higher, you can look into student loan refinancing to see if it’s possible for you to find a lower rate that reduces the cost of your student loans.
Otherwise, if you are paying 8% on your student loans and are worried that you will only see 7% annualized returns on your investments, paying down your student loans as fast as possible makes sense.
But if you can refinance, maintain your cash flow and invest in assets that provide a better return, you might not need to pay off your student loans early. There are real pros and cons of paying off student loans early, so consider student loan refinancing and all other avenues before making a decision.