Generally speaking, paying extra on your student loan is a smart move. It is one of the most efficient methods of debt elimination.
Unfortuantely, it isn’t always the best decision.
Today I’ll first explain why borrowers should be in a rush to make extra payments.
Then, I’ll highlight the four situations where delaying extra payments is the smart move.
Student loan bills make it appear as though interest is added monthly.
In a certain sense, this is accurate. Student loan interest does get added to your principal balance every month. However, interest accrues daily.
That means that the more debt you have, the more interest it generates each day. By making an extra payment, the daily interest that is accrued is reduced. Thus, the sooner the payment is made, the more it will save on interest.
Having said all that, the daily accumulation of debt isn’t so substantial that one day will make a huge difference. A $20,000 student loan with an 8% interest rate will generate about $4.38 in interest each day. A day or two of extra interest won’t make a huge difference, but the interest can quickly pile up.
There are at least four exceptions to the “pay now” rule of thumb.
Concerns about future payments
The first exception would be if making your extra payment now might jeopardize a future payment.
If you have the money now but you are not sure that you will be able to make the minimum payment over the next few months, it might be a better idea to hold on to your cash.
However, some lenders will take the extra payment and count it towards the minimum for future months. If your lender engages in this practice, you can consider going ahead with the additional payment — just be sure to call your lender to verify their policy.
Better opportunities elsewhere
Aggressive repayment is highly encouraged as it can save borrowers a bundle on interest. However, a singular focus on student debt could be a mistake.
If you have high-interest credit card debt, it might be better to pay that off first. Similarly, if your employer matches retirement contributions, you could be better off in the long run if you set that money aside for retirement.
Before making the extra payment, be sure to consider how your student debt fits in with your other financial goals.
You are about to refinance your debt at a lower interest rate
Refinancing student loans can change your calculations.
If your loan with an 8% interest rate becomes a loan with a 3% interest rate, the urgency to pay it off may drop. This goes back to our previous point.
Lower interest rates could mean an opportunity to save for a home down payment, put money aside for retirement, or eliminate other debt. At present, student loan refinance companies offer rates starting at about 2%.
You might need the money for something else
This one should be pretty obvious, but it is worth highlighting.
Once that money goes to the lender, you cannot get it back under any circumstance. If the money could be necessary for something else, keep the cash on hand.
Sherpa Tip: Most borrowers can find a justifiable reason to delay making student loan payments, such as saving for retirement or buying a house.
This mindset becomes dangerous if you delay attacking your debt but don’t divert the funds towards another justifiable priority. Don’t make the mistake of justifying a delay on your student loans to pay off credit card debt but then using the money to buy something else instead.
If temptation is an issue, knock out the debt when you can.
If you are considering making an extra payment and worried about making a mistake, it is always good to think twice before cutting a check.
There are certainly times when paying extra isn’t the best course of action.
However, it is worth remembering that student loan lenders are experts at extracting every penny they can out of borrowers. By making an extra payment, you not only reduce your monthly spending on interest, but you take a massive step towards getting your loan paid off faster and paying less over the life of the loan.
When you do make your extra payment, just be sure to be smart about it.