A version of this article was released on October 29, 2020.
On January 20, President Joe Biden made it official: No student loan repayments due before September 2021.
The stay on federal loan repayments began in March 2020 as a feature of the CARES Act. He temporarily set interest rates at 0% and suspended payments and collections on all federal student loans until September 30, 2020. (This Faq on the website explains how the current, automatically granted payment suspension works and which loans are eligible.)
As the pandemic intensified and the number of unemployed increased, the education ministry extended the student loan payment until the end of 2020 and then again until January 31. Now the DOE says it will extend relief for “at least” eight more months, until September 30, 2021.
DOE’s action brings much needed relief to those who have lost their income in the current pandemic. But if you’re lucky enough to still be power to make regular loan payments, what should you do with the money? Should you continue to pay off your student loans even though no payment is due?
The advantages of continuing your payments
If you continue to make your regular payments while interest is not accruing, your payments will be applied directly to the principal balance. (Tip: Be sure to clarify your intention to apply full principal payment with your loan manager.)
This will give you a great head start when it comes to paying off that loan – not only will you eventually be able to withdraw the loan sooner than you expected, but you will end up paying a lot less interest over the life of the loan. (Also, according to the Studentaid.gov website, any loan repayments made during the suspension of payments period can likely be repaid if applicable; contact your loan officer for more information.)
But while there are some obvious benefits to continuing to pay off your student loan, that might not be the best use of the extra money in your budget. It’s a concept in finance called return on investment: Carefully consider all the things you could do with that money in your budget right now.
Is there a better use of money?
Let’s go over some ideas for getting the most out of those student loan payment dollars, based on your own financial situation.
1. Save an emergency fund
If you don’t have an emergency fund, set aside a few months of potential student loans to create one.
As my colleague Christine Benz explains, emergency funds are crucial, whatever the stage of life or the situation. If there’s one thing 2020 has taught us, it’s to expect the unexpected. Whether it’s home repairs, out-of-pocket medical bills, or work, having a large cash cushion will save you from having to finance big expenses with out-of-pocket credit cards. high interest or loans on retirement accounts. And, as Benz advises, keep in mind that the higher your fixed expenses and the harder your job would be to replace (because it is specialized and / or better paid), the larger your emergency fund must be.
2. Start a debt repayment plan
There are two well known debt repayment strategies, the “snowball” and the “avalanche”. They both require that you pay at least the minimum owed on all of your debts each month, as missing payments can wreak havoc on your credit score. On top of that, you focus the extra money on paying off the principal of one loan at a time.
- The “snowball” method. You prioritize paying off the loan with the smallest balance first, regardless of the interest rate. You then proceed to the loan with the next smallest balance.
- The “avalanche” method. You focus on paying off the loan with the highest interest rate first, then the loan with the next highest interest rate, and so on. There are advantages and disadvantages to each. The avalanche method ensures that you pay as little interest as possible. It’s the cheapest way to pay off your debt, but it’s not necessarily a slam dunk for everyone.
If the early gains you get from paying off your smaller balances first provide you with the motivation to carry out your debt repayment program, then the snowball method is the best choice for you.
While I understand the allure of the snowball, I personally am #TeamAvalanche when it comes to high interest credit cards. The average rate charged by credit cards in the United States is 15%, according to Federal Reserve data; balances compounded at this rate have the potential to grow like weeds. If you have really high interest loans (with APRs in the 1920s and 20s), I would prioritize paying them off first.
3. Make the most of your retirement plan
Some people might find it counterintuitive to invest money when you owe money. Shouldn’t you pay everything first, then invest? Again, the answer is, it depends on where you can get the most bang for your buck.
Once you’ve settled any high-interest debt, think about what rate of return you could get by investing in the market. Over the past 100 years, stocks (on average) have risen 7% per year on an annualized basis, after inflation. If you start investing small portions of your paycheck on a regular basis at a rate of 7% per annum for decades, this is an extremely powerful wealth building tool.
Also note that if your employer offers to match a portion of your contribution to the pension plan, you should get this free money back. The image below shows how much of a difference the game makes.
The light blue line shows the growth of $ 100 invested in stocks at the end of each month. The dark blue line represents the same investment with a 50% match with the employer. (In other words, $ 150 invested each month instead of $ 100.) Since investment returns increase exponentially and not linearly, fund your retirement account with as much money as soon as possible. offers you the best growth potential.
In short, paying off your student loans is a good idea, but you could gain an even greater long-term financial benefit by applying additional cash to consolidate an emergency fund, servicing an interest rate loan. even higher interest or by saving more. for retirement.