Many people graduate college with debt and struggle to keep up with their student loan payments once they have a degree in hand. But what if you find yourself in the opposite position? What if you’re able to pay off your student loans early? Is doing so a smart idea, or will you incur penalties for knocking out that debt sooner?
Paying your student debt early
Let’s start with the good news: There are no penalties associated with paying off student debt early. This applies whether you took out federal loans or private loans. Either way, you have the option to pay off your debts ahead of schedule with one lump sum, or to put extra money into your monthly loan payments.
Should you pay off your student loans early?
Although you won’t be penalized for getting rid of your student debt early, whether it makes sense to go that route will depend on your bigger financial picture. Your primary financial goal, regardless of how much debt you have, should be to build an emergency fund with enough money to cover three to six months of essential living expenses. Without that cash tucked away in a savings account, you could face serious consequences if you get laid off at work, fall ill to the point that you need a leave of absence from your job, or need to pay for a major home or vehicle repair.
Once your emergency fund is fully loaded, you can then feel free to tackle other financial objectives, which may include paying off your student loans ahead of schedule. But before you do, take a look at your total debt. Are you carrying a credit card balance? More than one credit card balance? If so, you’re generally better off paying off that credit card debt before moving on to student debt. This is because credit card companies typically charge higher interest rates than student loan issuers (even private ones, whose interest rates are notoriously high). And, having too high a credit card balance could damage your credit score.
Provided you make your monthly payments on time, a high student loan balance won’t actually hurt your credit. On the contrary — those timely payments will be factored into your payment history, thereby bringing up your credit score. And, depending on your income, your student loan interest may be tax-deductible, which can never be said for credit card interest.
Now, what if you’re good on emergency savings and have no credit card debt? Should you go ahead and pay off your student loans early?
Well, there’s one more factor to consider — your retirement savings. If you’re able to put more money toward your debt while simultaneously funding an IRA or 401(k), then go for it. If not, then you might consider putting some extra money into your loans, as well as simultaneously contributing to a retirement plan. You need to give your nest egg as many years to grow as possible. Delaying retirement savings to knock out your student debt generally isn’t a great idea unless you’re really young — say, in your early 20s — and have time to dedicate a couple of years to shedding that debt before focusing on your IRA or 401(k).
The upside of paying off student loans early is clear: The sooner you knock out that debt, the less interest you pay on it. But before you rush to pay off those loans, think about what the rest of your finances look like, and make sure you don’t need that money for other important purposes.