Should You Pay Off Your Student Loan? The Pros and Cons of Paying Back a Student Loan as Soon as Possible

Generally, individuals are advised to be debt-free if possible. In most cases this is a good idea, since the interest rate one pays on any debt is far higher than that gained from savings accounts. Therefore, in the majority of instances it is better not to have any savings until all debts are paid. However, student loans are an exception to this rule.

The Low Interest Rate of Student Loans

Student loans are one of the cheapest forms of long term debt possible. There is no ‘real’ interest rate, because the highest rate is always no more than the rate of inflation.

Therefore paying off the loan early could be counter-productive, since many people will later need to borrow from elsewhere to fund large purchases such as houses and cars, and any other debt is certain to have a higher interest rate than a student loan. The only time it makes sense to pay back the loan is if one is quite certain that there will be no need to borrow money again in the foreseeable future.

What Should One Do With the Money From the Student Loan?

If the money is not needed immediately, the best thing is to save it in a savings account, ideally earning more interest than is paid on the loan. Even in these times of low interest rates, this is still possible if the individual shops around. Sometimes the best rates are for those who can keep the money in the account for a long period of time, or for those who can save a certain amount each month. These should be the savings accounts to go for.

Why Not Just Pay Of the Loan as Soon as Possible?

In financial terms this does not make good sense. For those who can save, the top savings accounts currently have rates of around 3.6%, while this year’s student loan rate is 2.5%. Therefore non-taxpayers will make more by savings the money than by paying it back. Even basic rate tax payers will still be slightly better off. It is only higher rate tax payers who may lose slightly – and this will not apply to many recent students.

For those with debts there is a golden rule – pay off those with the highest interest rates first. Pretty much every kind of debt is more expensive than student loans, so they are the last thing that should be paid off. Even mortgage rates, low as they are now, are higher than student loan interest rates.

As with all other financial decisions, individual circumstances may affect what a person does. However, in general student loans are almost free money – so take advantage of it for as long as possible.