How to Pay off Student Loans Fast
For someone with a bevy
of student loans outstanding, I can understand the desire to get them paid off
as quickly as possible. It's one thing when you're paying a car note, because
you at least have the car out in the driveway that you can see out the window
and understand why you're making those payments each month. With student loans,
the education is over and done with by the time you are required to start making
payments on the loans, so even though you received a valuable education from the
experience and another notch on your resume, there's nothing tangible to show
for the check that you have to write each month. It almost feels like you are
paying money for nothing.
But hold on there, not so fast. If you come into
a large amount of money, it doesn't always make sense to pay off student loans
all at once. Believe it or not, paying down student loans may actually wind up
costing you money.
The principle is this: depending on your interest rate,
you may be able to invest the money you were going to put toward the extra principal
on the educational loans at a higher interest rate than you are currently paying
on the loans. Sound crazy? Say you have a student loan that you are currently
paying 4 and a half percent on. If you pay off student loans, it is like earning
four percent on that money had you invested it. But here's the kicker: the amount
of money on which you would be earning four percent actually declines each month,
as the imaginary principal would have gone down with each payment that you would
have been required to make had you not paid off the entire loan.
you invest the extra money at the same four and a half percent annual rate of
return, you are still ahead of the game after the first month, since you will
be earning that rate of return on the entire amount for as long as you commit
to the investment vehicle. However, it is often possible to find investments that
exceed the interest rate of the student loan. For example, many mutual funds have
a history of earning far more than the hypothetical four and a half percent used
in this example. Some bonds can be found that exceed this rate of return as well,
along with stocks that pay dividends greater than this rate.
affecting the calculations is that interest on student loans is often tax deductible.
This can work to bring the interest rate down another few points, increasing the
likelihood that an investment will pay off better than paying down the loan.
there are many different types of investments that can pay better than the interest
rate on a student loan, which would make it prudent in some cases to invest the
extra money. However, many would argue that the peace of mind that comes with
being debt free is worth the additional money that could be earned by investing
the money. It's just a matter of personal preference, and which is more important
to the individual.