In general, financial experts recommend paying off debt as quickly as possible. Debt is a burden and something that should be eliminated in order to make room for other financial goals. However, student loans can be the exception despite the average student debt statistics indicating otherwise (they're pretty big). There are a few instances in which it makes sense not to pay off your student loans early and focus on other parts of your finances. Here are three reasons why you shouldn’t pay off your student loans early.
You Need an Emergency Fund
An emergency fund is a cash reserve set aside for unexpected expenses or for regular expenses in the event of job loss. Emergency funds are extremely important for keeping you out of debt. In the event that something like a major home repair or medical bill comes up, it’s important to be able to take care of those expenses without going into more debt.
For this reason, it’s wise to prioritize building an emergency fund over paying your student loans off early. Continue paying the minimum payments needed to avoid any late fees. Use the excess money to save three to six months of expenses in an emergency fund. Not only with this give you peace of mind, it’ll help you avoid going into more debt should you get an unexpected bill or become temporarily out of work.
The Interest Rate Is Low
The interest rate on federal student loans is currently under 4%. If you have private student loans, you can consolidate them and land a refinanced loan with an even lower interest rate. With interest rates these low, there’s no real rush to pay off student loans early.
What you can do instead is focus on other high interest debts such as credit card debt. Sometimes it can be tempting to pay off student loans first since they represent such a large amount. But paying off high interest debt first will save you money in the long run because you end up paying less in interest altogether.
Don’t forget that the interest you pay on student loans is tax deductible. You can deduct up to $2,500 per year if your annual income is less than $80,000 (single) or $160,000 (married). Between this tax deduction and the low interest rate, student loans don’t actually cost much at all. This isn’t a reason to keep them around longer than you need to. But if you have other debts, it’s definitely wise to make those a priority over student loans since you can have this tax advantage.
It’s Important to Start Investing Early
Investing helps your money keep with inflation and gives your money the opportunity to grow exponentially. You can generally expect a return of about 7% on stock market investments over time. Since student loan interest rates tend to be lower than the average rate of return from the stock market, it makes mathematical sense to invest rather than pay off student loans early.
Since compound interest works best when you start investing early, it’s best to use any extra money to fund your retirement plan or taxable investment accounts rather than pay off your student loans early. Your low interest student loans will always be there. The opportunity to grow your money with compound interest each year becomes less and less as you wait.
Other Things to Consider
In many cases, the math works out in favor of not paying off your student loans early. That doesn’t mean that it’s the right decision for everyone. If you’re someone who’s debt-averse or otherwise doesn’t like owing money, it may make sense to get rid of your student loans as fast as possible for peace of mind.
Another thing to consider is that some private student loans have higher interest rates. If your student loans are costing you more than you’d earn in the stock market, definitely pay off the student loans first. Also see if you can refinance them to get a better interest rate moving forward.
Ultimately, the decision to pay off your student loans early or not comes down to your financial situation and personal preference. If you don’t have an emergency and your student loans have a low interest rate, it’s probably better to use that extra money to invest in the stock market and take advantage of compound interest. If you have other debts with higher interest rates than that of your student loans, it makes sense to get rid of those debts first.
On the other hand, if your student loans have a high interest rate or you just prefer to aggressively tackle all of your debt, definitely pay those student loans off early.
When you take all of these factors into consideration, you’ll have a much better idea of what decision is best for you. Just remember to think about the big picture and how paying off your student loans affects the other areas of your finances.