I refuse to pay off my student loans early.
Plenty of people judge me for this decision. The standard financial advice regarding all debt is to pay it off, and pay it off as quickly as possible.
Rapid student debt reduction isn’t the only path to financial freedom, though. The reality is that paying off student loans early isn’t always the best bet — at least when it comes to the numbers.
Here’s why I won’t pay off my student loans early.
1. My low, low interest rate
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 so big. Starting with higher-rate debt, though, often makes more sense mathematically.
The more you pay in interest, the less you have for yourself. Get rid of the high-rate debt first and tackle the student loans once that’s out of the way.
2. Milk that tax deduction
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.
If you’re looking for a little extra tax efficiency in your life, turn to your student loan interest. Paying off student loans early means you won’t 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.
Student loan interest is deducted above the line, so you don’t have to itemize in order 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.
That’s a pretty decent sum, and that reduction is enough to save you some money come tax time.
3. Invest instead
Because my 1.9% rate 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 any 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.
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.
4. I like my cash flow where it is
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 that way each month, which restricts your cash flow.
If you are willing to sacrifice to make it happen, that’s no problem. I’m not willing to sacrifice, especially since my low rate and 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 with low real returns.
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.
Think about other ways to use that cash flow. What could you do with that money if you weren’t putting so much toward student loan debt early repayment?
Avoid the pitfalls
Just because paying off student loans early isn’t my thing, it doesn’t mean you have to stop aggressively tackling your own debt. You need to be comfortable with the idea of carrying this debt for 20 or 25 years if you don’t want to pay off your student loans early.
Not everyone likes the idea of having these types of long-term obligations. 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. Don’t force it if that’s the case for you.
Another consideration is the fact that you might not have the same interest rate I do. If your rate is higher, you can look into student loan refinancing to see if it’s possible for you to find a low rate that reduces the cost of your student loans.
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.
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