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Do you have student debt that you want to get rid of as fast as possible?
Would you like to pay off your debts to free up your money so you can invest it and build your future?
There are several options for paying off your loans. And depending on your unique situation, one of these options — plus a little creativity — will help you answer what’s the best way to pay off student loans.
A few preliminary questions to ask yourself:
- Do you have lots of money in savings or investments that you can throw at your debt?
- Are you willing to sell some of your stuff?
- Do you have a side hustle that makes it easier for you to pay off your loans fast? Are you willing to start one?
- Are you living paycheck to paycheck? (If so, I really recommend you start tracking your expenses. )
The answer to these questions determines your best path going forward.
There’s an option here for you, no matter your financial situation. Even if you’re just barely making the minimum payments, you’ll learn some tips for paying off your loans and doing it as fast as possible.
Options for Paying Off College Loans
First things first: if you’re overwhelmed by federal student loans, you may qualify for income-based repayments. This gives you a smaller monthly payment based on your income. To see if you qualify, check the Federal Student Aid website.
There are 4 primary options for paying off student loans:
- Just keep making the minimum payments
- Make larger payments (and increase the payment amount over time)
- Pay off your loans in one big chunk
- Refinance your student loans
Let’s look at each option and compare the pros and cons.
1. Make the Minimum Payments
Chances are that you’re already making the minimum payments on your loans. There’s nothing wrong with this approach. I make the minimum payments on mine. (I have $15,000 in federal loans as I’m writing this.)
Why am I making minimum payments? My interest rate is “only” 4.25%, and I’d rather be able to invest as many dollars as I can into investment funds with (historically) high returns. I’m going for the benefits of having dollars with time in the market — compound interest.
If your interest amount is higher, you may be more motivated to pay off your loans faster.
Making the minimum monthly payment is the easiest option for you and your wallet, and it may even give you the chance to invest some other dollars. But the drawback is that you end up paying the most interest.
That said, it’s not a terrible option if you don’t have extra money (yet) to put towards paying off loans.
If you’re reading this, you probably aren’t interested in just making the minimum payments. So let’s look at some other options for paying down your student loans.
2. Make Larger Payments
If you’re currently making minimum payments and you want to pay off your loans faster, you can start making larger payments. This may seem like a simple solution — and it is. But “simple” good decisions add up over time.
Any time you get a raise or get money for your birthday or Christmas, increase the amount you put towards your loan payment that month.
If you’re already good about tracking your monthly income and expenses, you already have a good idea of how much more you could be putting towards your loan payments.
If you don’t know how much money you spend each month, or you don’t think you could possibly pay any more than the minimum, you may benefit from tracking your income and expenses. You can do it for free with a tool like Mint or Personal Capital. Or do it with a spreadsheet. Or with paper and a pencil if you prefer. Just do it!
The benefit of making larger payments is that you end up paying down your loan faster, so you pay less interest — which keeps more money in your pocket.
The Side Effect
The side effect of making larger loan payments is that it may cause you to do 2 things:
- Realize where you can cut some expenses
- Realize it’s possible for you to make more money
Cutting your expenses is always a good move, but it has its limits. I think those limits are worth exploring, but minimizing expenses is only part of the equation.
Maximizing your income is where real wealth is built.
Consider what you can do to earn more at your current job, and think about how you can make money on the side. In my experience, this comes down to building in-demand skills and being proactive.
3. Pay it Off In One Big Chunk
Another option for paying off your loan is to pay it off in one big chunk.
If you already have money saved and invested, you may be able to pay off your student loans right this minute. But, depending on your interest rate, you may not be willing to give up potentially great long-term returns on your investments to get rid of your student loan debt.
If the interest rate on your loan is less than the expected long-term returns from the stock market — about 7% accounting for inflation — you’re probably better off keeping your dollars growing for you in your investments.
But maybe you just want to be out of debt.
If that’s your situation, and you can afford to pay off your student loans and be done with it, go for it.
The benefit of this approach is that you pay the least possible amount of interest on your loan. You’re free and clear. You can breathe a sigh of relief and instead of making monthly payments you can invest those dollars.
The drawback to paying off your loans in one chunk is that you’ll be using money that could be invested for potentially greater gains than the money you’ll be saving in loan interest. And if you pull from your savings, you may be in a tough spot if an emergency arises.
Also, when you sell investments, you’ll have to consider the tax implications. Any realized gains would be added to your taxable income for the year.
Before you pay off your loans in one fell swoop, you should:
- See if your loan has pre-payment fees
- Make sure you have enough of a remaining emergency fund to protect you
- Investigate how selling investments to pay off a loan might affect your taxes
4. Refinance Your Loans
If you want to preserve your capital and keep your investment dollars at work for you, another option is to refinance your student loans.
Refinancing is where you replace your current loan with a new loan that comes with a new (lower) interest rate and new terms. It only makes sense to refinance if you will benefit from a lower interest rate and a lower overall interest amount.
In How to Refinance Student Loans, I compare the benefits of refinancing, and I give a few warnings about what benefits you might lose if you refinance federal loans — benefits like deferment and forbearance.
It also includes a refinance checklist.
There are 5 primary steps to find the best refinance option:
- Know your current student loan and projected interest payments
- Use the student loan payment calculator to determine the benefits of refinancing
- Know what benefits you might lose if you choose to refinance
- Compare refinance companies to find the best overall loan package
- Apply to your top choices and choose your best option
Related: How to Refinance Student Loans
What is the Best Way to Pay Off Student Loans
So what’s the best way to pay off student loans? The best way has less to do with paying and more to do with earning.
The fastest way to pay off student loans is to make larger payments. And the best way to make larger payments is to earn more.
You don’t need expensive courses. In fact, for an ultralearning experiment, Scott Young completed the entire coursework for the MIT computer science bachelor’s degree for free in one year.
You don’t need to invest lots of money. But you do need to invest time and energy. Building skills is the best way I know to earn more money and pay off a mortgage, credit card debt, or student loans.
What About You?
Do you have any ideas for paying off student loans faster? Let me know!
- IRS Publication 970 which outlines how you may qualify for $2,500 in tax deductions from your student loan interest
- Financial Student Aid site for income-based repayment application