Student loan debt plagues some 40 million Americans and on average, graduates leave school with nearly $30,000 of debt that they’ll somehow have to pay off. If your checking account islooking healthy or you’ve gotten a bonus, it may be tempting to make a big dent in your debt balance at one time. But it’s importantto look at the big picture to decide if it’s the right thing for you to do.In fact, a financial advisor might be best suited to help you create a plan to pay off your student debt.
A Lump Sum Payment Reduces Your Interest Amount
As a condition of borrowing money to cover your education costs, you’re expected to pay it back with interest. Rates for Federal Direct loans currently range from 4.29 percent to 6.84percent for new borrowers, depending on the type of loan you have. If you borrowed from a private lender, you may be charged a fixed or variable rate that’s higher than 18 percent.
If a sizable part of your monthly payment is getting eaten up by interest each month, paying off a big chunk of your loans in one go will save you money in the long run. For example, let’s say you borrowed $30,000 at a rate of 5 percent. If you were to pay $320 a month toward the loans for 10 years, you could pay over $8,000 in interest before it’s all said and done. Now, if you paid down $5,000 of that debt using a lump sum and continued making your regular monthly payments, you might save over $2,500 on interest.
Paying off your loans early might be the best decision if you can save a considerable amount of interest with a large lump sum payment.
It’ll Speed Up Your Loan Payoff Time Frame
In addition to reducing what you’re handing over to the lender for interest, a lump sum payment would also get you closer to being debt-free faster. Going back to the previous example, making a $5,000 lump sum payment on a $30,000 debt could trim almost two years off your total repayment period, assuming you kept paying the same $320 a month. If you’re able to add on a few extra dollars to your payment each month, you could shorten it even more.
For many millennials, student loan debt has become a major barrier to other financial goals, such as saving for retirement or buying a home. If you’re able to get rid of your loans in less time, you can use the money you’ve been paying toward them each month to start building your nest egg or saving for a down payment for a house you can afford.
Lump Sum Payments Still Qualify for a Tax Deduction
If you’ve been making payments on your student loans all year, you can generally write off some of the interest you’ve paid at tax time. For the 2014 tax year, the limit on the deduction was set at $2,500. The deduction applies regardless of how you paid the interest so using a lump sum wouldn’t affect your ability to claim it.
There is a downside, however, if you’re paying all of your loans off at once: That’s one less deduction you’ll be eligible for going forward. Deductions reduce the amount of your income that’s subject to tax, which directly affects how much you owe orthe size of your refund if you normally get one.
Make Sure You Have a Safety Net in Place
Draining your savings account to get rid of your student loans for good can work against you if you don’t have a backup plan in case of an emergency. If your car breaks down, for example, or you lose your job, it’s a good ideato have some money set aside to cover your expenses until you can get things back on track.
Pouring every penny you have into your student loans just doesn’t make sense if it means you’ll have to turn to a credit card or personal loan to cover a last-minute payment. Establishing a separate emergency fund before you start attacking your loans ensures that you won’t come up short if you have an unexpected expense.
Tips for Financial Planning
- A financial advisor can be a huge difference maker in helping you manage your debt and help you figure out when and how to pay off your student debt. With their experience, they can help you make the right long-term financial plan so you meet your goals. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
- Consider this free student loan calculator as the tool to help you estimate what it will take to pay off your student debt.
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FAQs
A Lump Sum Payment Reduces Your Interest Amount
Is it better to pay off a student loan in lump sum? ›
Lump sum to decrease student loan debt
This is a great option, and I would recommend doing this if possible. Depending on your student loan interest rate and repayment plan, some experts recommend choosing to pay off chunks of your student loans instead of investing in the stock market.
Is it worth it to aggressively pay off student loans? ›
Paying off student loans early can benefit you financially, but it should typically come second to building your emergency fund and retirement savings. People with private student loans or without other debt tend to benefit more from paying off student loans early.
How to negotiate lump sum student loan payoff? ›
Steps to negotiating student loan settlements
- Gather required documentation. ...
- Know your options. ...
- Negotiate the terms of the settlement. ...
- Request a paid-in-full statement. ...
- Deferment or forbearance. ...
- Income-driven repayment plans. ...
- Refinancing.
A lump-sum comes with pros and cons. One advantage is that with a lump sum, you have more control up front, and once you receive it, you can invest the money however you wish. However, you may receive less money in a lump sum than you would have if you took periodic payments. Taxes are also a concern.
What happens if I pay a lump sum off my loan? ›
Paying a lump sum off your mortgage will save you money on interest. It will also help you clear your mortgage faster than if you spread your overpayments over a number of years. But this option holds risk. If you needed the money back in an emergency, such as job loss, it could be difficult.
Will my monthly payments go down if I pay a lump sum? ›
Will my mortgage payments go down if I pay a lump sum? Your recurring monthly mortgage payment will remain the same even when you submit an additional payment or lump sum unless you recast your loan.
Is $80,000 a lot of student debt? ›
Average student loan debt in America
Among all borrowers, the average student loan debt in 2023 was $38,787. 53% of federal student loan borrowers owe $20,000 or less. 47% of the total outstanding federal loan debt is held by 10% of borrowers, who owe $80,000 or more.
How long does it take to pay off $80,000 in student loans? ›
How Much Is $80K in Student Loans?
| Balance | Repayment Term | Monthly Payment |
|---|
| $80,000 | 5 years | $1,546.62 |
| $80,000 | 10 years | $888.16 |
| $80,000 | 15 years | $675.09 |
| $80,000 | 20 years | $573.14 |
Jan 25, 2024
Despite what you may think, paying off your loans as soon as possible isn't always the best thing to do. Getting ahead of your debt is, in general, a smart move; however, if it comes at the cost of avoiding other debt, or overshadowing other benefits you may be receiving, it could set you back in the long run.
The rule of thumb is based on two assumptions. One is that 10 years is a reasonable amount of time for repaying student loans. The other is that it is reasonable to expect borrowers to spend half of the increase in average after-tax income from a college degree on repaying their student loans.
What is the average student loan payoff? ›
Average Student Loan Payments
As of May 30, 2023, the average monthly payment for federal student loans was estimated to be about $500 per month when adjusted for inflation. However, the final number depends on the type of loan, loan amount, interest rates, and repayment plan.
What is the fastest way to pay off a student loan? ›
9 tips for paying off student loans fast
- Make additional payments.
- Set up automatic payments.
- Get a part-time job in college.
- Stick to a budget.
- Consider refinancing.
- Apply for loan forgiveness.
- Lower your interest rate.
- Take advantage of tax deductions.
A lump sum is good for funding long-term investments, while an annuity guarantees larger total payouts. Choose based on your financial goals and applicable rules surrounding the specific lottery. An annuity ensures a larger total payout over years.
Is it better to take a lump sum or not? ›
Taking a lump-sum payment can be very risky. Perhaps the greatest risk of cashing out a pension early is the prospect of running out of money. In contrast, a monthly payment offers a steady income for the remainder of one's life, and in some cases can also be passed on to a spouse.
Is it better to pay lump sum off loan or extra monthly? ›
Since your interest is calculated on your remaining loan balance, making additional principal payments every month will significantly reduce your interest payments over the life of the loan. By paying more principal each month, you incrementally lower the principal balance and interest charged on it.
Is it better to pay off student loans or keep money in savings? ›
If your loan interest rates are low and fixed, you may want to prioritize saving over paying off your loans. On the other hand if your loans are high-interest, or you don't have a plan to get a good return on your savings, paying off your loans may make more sense.
Is it better to pay off student loans immediately or over time? ›
Paying off your student loans ahead of schedule not only eliminates that monthly bill from your life sooner, but will also save you money on interest. The sooner you get out of debt, the sooner you can breathe a sigh of relief and turn your attention toward your other financial goals.
Is it better to take out student loans or pay out of pocket? ›
The Case for Taking Student Loans
If you're paying cash for your own education, or that of your child(ren), you're going to be investing a large sum of money upfront. Paying out of pocket means sacrificing other financial goals, such as investing. And this is a bigger problem than most students and parents realize.
