Why you should Pay Off Student Loans Early

Apr 13, 2022

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Many college graduates finish with student loan debt and carry it into adulthood. However, that student loan debt could be putting you in more trouble than you realize.

Why you should Pay Off Student Loans Early

You might be contemplating whether it is appropriate to include your student loans into your debt repayment plan or if you should be concerned about repaying your student loans in the early stages. If you’re in this position, there are various excellent reasons to concentrate on your student loan repayment in the earliest time possible.

1. Your Debt-to-Income Ratio.

Another reason to pay off student loans is that it can reduce your debt-to-income (DTI) proportion. This measure is how high your monthly debt repayments are compared to your monthly earnings. If you can pay back your student loan, you’ll be free from these monthly installments and be able to achieve other financial goals faster.

A lower debt-to-income ratio is essential if you intend to apply for credit, specifically for a mortgage. Most lenders will consider having a lower DTI ratio as a sign that you can carry on and pay off new credit. Lower DTIs that range from 30% to 35% are sufficient to prove that your debt is in an acceptable amount. It is generally required to have a DTI below 43% to qualify for a mortgage.

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The process of paying off student loans can lower your DTI and, in turn, increase your chances of being approved for loans or credit and being eligible for lower rates and deals soon.

2. Tax Break

A common misconception regarding students’ loans is that they need to save them for the tax breaks, which might be why you should put the student loans at the final stage of your repayment plan.

However, it is essential to realize that tax deduction comes with its limits. Tax deductions are limited to $2,500 for the student loan interest you have to pay. The deduction also starts to decrease when your income is $70,000. It will be eliminated when you reach the adjusted gross amount (AGI) of $85,000 (or $140,000 or $170,000 for those who have a joint return).

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Finally, this deduction will only lower the tax burden by reducing your adjusted gross earnings.

The amount is not significant, and you could pay more in interest than what you’d benefit from the tax break for the duration of your loan. It’s best to get rid of your student loans instead of retaining them as a way to receive a tax deduction.

3. It’s Costing You

If you take advantage of the tax deduction, you must be aware of how much you’re losing every month due to the payment for your student loan and interest.

Interest on student loans is calculated in the form of a percentage proportion of your outstanding balance. If you make additional payments and reduce your total balance, the charge amount will decrease. Making your student loan payments early will also mean that you’ll be paying less interest than the loan cost. Suppose you adhere to the same payment schedule.

In the event of student debt, the amount of your loan could make up a substantial portion of your spending budget. If you can pay your student loan debts, you can eliminate the payment and have cash flow. In addition, you’ll be able to achieve your financial goals quicker, like saving to put down a down payment for your first home, making trips, building an investment portfolio, or even starting the business of your dreams.

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4. Let go of Financial Stress.

Student loans can be an enormous source of stress, preventing people from achieving financial stability. According to the Pew Research Center, a third of college graduates between the ages of 25 to 39 are living financially well, in contrast to 51% of those of the same age who do not have outstanding student loans.

If you are looking to lessen your financial burden, you should focus on getting rid of your student loans. Even if you are close to the end of your repayment plan, you could profit by clearing the debt and lessening the amount you have to pay.

Making a budget and debt payment plan must be the first thing you do when you leave college because these steps will help you clean the debt you owe and allow you to forget about the cost of living.

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5. It’s almost indefinable.

Many who are weighed down by debt from student loans hope that bankruptcy can provide an answer to their problems. But, if you file bankruptcy, it’s unlikely that student loans can be forgiven through this process. Borrowers must make a separate claim to have student loans discharged during bankruptcy and demonstrate that repayment will cause “undue hardship. “

Beyond declaring bankruptcy are a few options to remove the student loan. Federal student loans and certain private student loans can be released upon the death of the borrower or complete disability.

Students’ federal loans could be forgiven by qualifying for specific student loan forgiveness programs like public service loan forgiveness.

Debt paid off is considered tax-deductible income to the Internal Revenue Service. However, if the student loan is paid off within the 2021-2025 timeframe, then the Recovery Plan Act from 2021 stipulates no tax obligation on loan.

However, the reality is that for most borrowers, the best option to eliminate student debt is to pay it.

The idea of getting out of debt quickly is a dream. However, it’s not feasible before you begin an action plan to eliminate your student loan debt assess your financial situation.

  • Ensure you have a savings fund that is three to six months’ worth of essential expenses before focusing on taking care of student loans. If you’re not saving enough to cover your costs, a solid emergency fund will help avoid debt when life throws you a pricey unexpected expense. 
  • If you’re in debt elsewhere, Students loans are a good option as they have low rates of interest when compared to other types of credit such as credit cards and personal loans. It is important to consider comparing the interest rates when you decide which is the first debt to address. For instance, student loans may not be your priority to rid yourself of when your primary goal is to save money through eliminating the deficit.

Frequently Answered Questions (FAQs)

Do you have a penalty to pay off student loans earlier?

There aren’t any penalties to pay off student loans earlier, and you will be able to make repayments in full at any point. Review your loan contract for further details on the prepayment.

Do I need to pay off my student loan to help my credit score?

At first, paying off your student loan may result in your credit score dipping. It pulls one account from your credit profile and may make it more important to other accounts, such as those on your credit card. But, your credit score will recover after a couple of months and might even improve in the future, so long as you continue to maintain excellent credit behavior.

When should you begin making payments on student loans?

When should you begin making payments on student loans?

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