Saturday, April 27, 2013

Student Loans Pay Off, Is Sooner Really the Better?

The buzz out there is that it was a hectic tax season for everyone- tax payers & tax preparers alike. So, it is now back to blogging about taxes after the long, but necessary, break and I have lots of interesting tidbits I want to share!

A couple of clients (and friends!) had this happen to them this year. They had the good fortune to be able to pay off their dependents' student loans. But not a lot of people are lucky enough to have their parents help them pay off their student loans. And I get asked this all the time-should I pay off my student loans early? What are the benefits to keeping them? After digging through a lot of literature on this, this is what I came up with.

Tax Break A common misconception is that you should keep your student loans to get a tax break from the  interest. One has to remember, the maximum tax break for student loan interest is $2,500 and it starts to phase out at $75,000 when filing single ($155,000 filing jointly). If your income is less than the phase-out amount and you can make use of the deduction, you will still be paying on the student loans. Think of what the student loans cost you in terms of how the money could be used if it was paid off/ paid down.

Debt to Income Ratio This is the ratio of how much debt you have against what you are earning. Paying
down your debt would free up your income for bigger expenses like a house or car or a wedding! Most students who come out of college with huge student loans (think medical doctors and lawyers) advice extending their payment period, having a lower monthly payment & paying more towards principle. This would apply to anyone with student loan debt. Paying it down is key!

Credit Score Paying off student loans early does not necessarily increase your credit score. This may not be  a huge factor in the overall scheme of things but something to keep in mind.

There's No Escaping Student Loan Debt People who are overwhelmed with debt may think of filing for bankruptcy as an option. However, declaring bankruptcy does not allow you to cancel your student loan debt. A better option would be put your student loan under deferment if you have a Stafford or a federally subsidized loan. This deferment allows you to temporarily stop making payments on your student loans. You may be required to continue making interest payments or you may be able to choose whether or not you pay the interest each month. This option is not available to you if your lender is a private lender. Always follow lender guidelines & communicate with them to avoid fees & penalties.

One could take two largely extreme positions to determine how much to pay on student loans. One position when thinking of paying off student loans, is to pay off as much as one can every month, cut into principal & minimize the amount to pay over the life of the loan. When you think about being unable to save at a rate higher than the interest on the student loan, this would be a good path to follow. The other position would be to pay the minimum every month. This is true if you have just started working & have a modest salary, your paycheck today has to go a longer way than you anticipate your paycheck will in the future.

No matter how much you decide on paying on your student loans, always put a little aside for emergencies. Life always has little surprises and having an overdraft fee is no fun in addition to what you already are paying to lenders. Small amounts build up over time, decide what is the best buffer for you. Don't play with your emergency stash!!

Can I dare say that your education is your own "Human Capital". Your student loan is your investment in it. Make the best of your education to pay off the loan. Only you can decide how aggressively you want to pay it down, and what you have to gain from it. Hopefully these pointers came in handy.

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