So you just graduated from college and have a fancy new degree and tens of thousands of dollars in student loans. Welcome to the club!
Those loans could be an albatross around your neck for years, but there are many reasons to work hard to pay them off early. For starters, the long-run cost-savings could be huge, and it will become easier to save for the future. And your overall financial picture can improve immensely by eliminating that debt as soon as you can. Here's why.
1. You'll Save Big Bucks in Interest
Paying loans off early may require you to pay more now, but the overall amount you will pay will decrease because you'll save on interest payments. If you're paying 4.5% interest on a $10,000 student loan over five years, you're on the hook for as much as $37 in interest per month before you even make a dent in the principal. Over time, interest can add up to thousands of dollars that most people would love to have back in their bank accounts.
2. It's Easier to Begin Investing for the Future
There is an argument to be made that it's okay to invest money even when you have student loans, as long as the return on investment is higher than the interest rate on the loan. There's validity to this, but for many people it's not easy to invest and pay down debt at the same time. So, if you're finding that it's hard to do both, focus on paying down the debt. Freeing yourself from student loans means you can start to save for retirement and other long-term goals. The earlier you start investing, the better, so get rid of those loans now, if you can.
3. It May Become Easier to Get a Mortgage
When lenders examine your finances to see if you're worthy of a loan, they look at the price of the home and your income, but they also examine your overall debt-to-income ratio. This is often referred to as your "back-end ratio." Generally speaking, if your debt-to-income ratio with expenses is higher than 40%, you may find it harder to get a loan. If you can pay off your student loans early, lenders may be more kind, because your ratio will be lower. Moreover, if you are free from student loan debt, you may find it easier to make a larger down payment on the house you choose to buy. In turn, this could result in lower monthly payments and you might also avoid any requirements to buy mortgage insurance.
4. Your Last-Ditch Option Becomes a Better One
If there's one thing that's worse than declaring bankruptcy, it's declaring bankruptcy when you have student loans. That's because while debt from credit cards, auto, or home loans can be discharged in bankruptcy, student loans usually can't. Student loans can continue to haunt you even when you've done your best to wipe your slate clean. If you can find a way to pay off the loans, at least you'll have a better chance of truly starting over financially if disaster later strikes.
5. You Can Take the Long View With Your Career
When I was a senior in college, I accepted an unpaid internship at an organization that eventually led to a full-time job. Fortunately, I had no student loans to contend with — there's no way I could have accepted work for no pay. If you're debt-free, it might mean that you can afford to enter internship or apprenticeship programs. You can accept entry-level positions that offer the promise of growth within a company. This may seem counterintuitive, but a lack of debt can give you financial freedom to choose the career path you really want. And that can pay off in the long term.
6. You Can Be More Entrepreneurial
Small businesses often get started when founders invest their own personal money. It's hard to do that when you're paying off big loans. A study from the University of Pennsylvania in 2014 concluded that the rate of student debt in America was having an impact on formation of businesses with one to four employees. Perhaps it's time to unload your student debt and launch that potentially lucrative enterprise.
7. Your Mental Health Will Improve
A study from researchers at the University of South Carolina found that of more than 4,000 people born between 1980 and 1984, those with higher student loans, had poorer mental health. And while the researchers did not examine the impact on earnings, there's plenty of research suggesting that feelings of depression and anxiety can impact job performance, and in turn, income.
Are you paying off your student loans early?