Student Loans: Paying Off Your Debt Faster
Paying off your student loans won't happen overnight, but you can shorten your repayment period by a few months or even a year or two. How? By using one or a mixture of the methods outlined here.
Apply a trick that's used for mortgages to your student loan debt. It's well known that if you pay your mortgage off in biweekly – instead of monthly – payments, you could shave several years off your mortgage. This is because of two factors: First, you are paying less in interest because there is less time between payments for interest to accumulate. Second, you will end up making an extra month's worth of payments every year. This is because paying every other week equals 26 annual payments. It's a relatively painless way to reduce the cost of borrowing and pay off your loans faster. If you are paid biweekly, the payment feels the same on your wallet because you are taking half a payment from each paycheck.
The only con to making biweekly payments is if you are getting a discount for having automatic payments directly debited from your bank account. In this case, the lender will more than likely take out your payments once a month. If this is the case, never turn down an interest rate deduction. Instead, on the two months per year where you get three biweekly checks, you can send in an extra half payment. You can have your interest rate deduction and reduce your repayment period.
How much can biweekly payments save you, even without the direct debit discount?
Example: Your student loans upon graduation total $40,000. Your average interest rate is 4.5% and your repayment period is 20 years. Your monthly payment is $253.06.
|Payment Frequency||Number of Payments||Payment Amount||Total Payments in First Year||Total Interest Paid in First Year||Time to Pay Off Your Loans|
|Monthly Payments||12||253.06||$3,072.72||$1,774.17||20 years|
|Biweekly Payments||26||126.53||$3,372.28||$1,522.46||17 years and 7 months|
Adding Small Amounts Each Month
You may not be able to afford an extra payment a year, but you can afford to send in an extra $5 a month or $25 every other month. Every dollar you pay toward your student loans can save you up to 200% of the extra payment you sent.
Let's say you send in $5 in month six of your 10-year loan repayment schedule and your interest rate is 6%. $5 plus the 6% interest that would be charged to borrow the $5 for 10 years totals $8.70. It doesn't matter how much you borrowed because we are only calculating the interest saved on $5 for 10 years. This is because whether you borrowed $2,000 or $10,000, your last payment including principal will be over $5 and therefore you pay interest on your $5 for the entire loan. Just imagine what you could do if you paid an extra $5 per month for a year or more.
Below is a repayment tables for a $10,000 student loan repaid over a 10-year period with $5 a month added to all of your payments in year two.
|Payment Month||Payment||Remaining Balance|
|1-12 (year 1)||$111.02||$9,247.28|
|13-24 (year 2)||$116.02||$8,386.46|
|25-119(year 3 to year 9 and 11 months)||$111.02||$59.40|
|120 (final payment at 10 years)||$11.48||0|
As you can see, paying a total of $60 ($5 x 12 months) extra in year two saved you $100 on your final payment.
When to Hit the Brakes on Your Accelerated Repayment Schedule
Be careful about using all your spare dollars for student loan payments. If you have a high-interest rate credit card, you're better off using your extra cash to reduce your credit card balance. For instance, if you have $2,000 in credit card debt with a 12% interest rate, you shouldn't pay off your 6% student loan first.
Student Loan Tax Deduction
The best part of your student loan interest tax deduction is you can use the money you're getting back as a tax refund to pay off your student loan faster. How much can you save, and how do you qualify for and apply for your tax deduction?
Like any other tax deduction, the amount of your student loan interest reduces the income on which you are paying taxes. So if your marginal tax rate for your income level is 25%, multiply the interest you paid on your student loans by 25% at the end of the year. For instance, if the amount of interest shown on the 1098 form you received from your lender at the end of the year is $2,400 – which could easily be the case with a $300 payment – 25% of $2,400 means you'll owe $800 less or receive a refund for $800 of the tax you already paid. Taking your $800 refund and making an extra payment on your student loans could cut more than a year off your repayment schedule. (For other profitable ways to use your tax return, see Don't Waste Your Tax Refund.)
Speedy – but Painless – Repayment
Paying off your loans months or years faster doesn't have to make a big dent in your financial life. You can add small amounts to your monthly payments, make biweekly payments instead of monthly payments or send in the money from your tax refund from your student loan tax deduction towards getting rid of your loans once and for all.Student Loans: Federal Loan Consolidation
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