This blog post is part of the Student Loan Debt Movement, which is encouraging and inspiring people to take action on their student loans. In this post, we’ll play the “devil’s advocate” by looking at a few reasons to consider making only the minimum student loan payments (before hopefully increasing your payments later!).
If you are a recent college graduate who wants to start building a good financial foundation, you’ve probably asked yourself, “Should maximizing my student loan payments be my number one priority?”
While paying down your student loan debt as quickly as possible is a great goal, going “all-in” isn’t necessarily the most impactful way to improve your personal finances over the long run.
Before committing to paying off your student loans as quickly as possible, it is important to consider your entire financial situation as a whole. There are financially-smart reasons to pay only your minimum student loan payments – at least early on in your financial journey.
While paying down your student loan debt as quickly as possible is a great goal, going “all-in” isn’t necessarily the most impactful way to improve your personal finances over the long run.”
Cover your other necessary expenses
“Pay yourself first” is commonly accepted as one of the best money habits you can develop.
As soon as you receive your paycheck, you should immediately set aside money toward your long-term financial goals before you have a chance to spend it all on clothing, avocado toast, and coffee.
What might this look like if paying your student loans as quickly as possible is your #1 financial goal?
On payday, you’ll immediately (and hopefully automatically) make student loan payments regardless of when your payment is actually due. If you have paid twice a month, you’ll be making payments twice as frequently as technically required.
This all sounds pretty good, right?
The “pay yourself first” mantra is perfect advice as long as you create a budget you are able to stick with. Without a budget? You may quickly find yourself with a cash flow issue.
Let’s say you decide to pay an extra $200 toward your student loans as soon as your paycheck clears. This makes you a personal finance superhero, right?
But what if the $200 you thought was “extra” was actually needed to cover your groceries or a car insurance payment? While you may have paid down your student loans by $200, be careful not to rack up $200 of credit card debt later in the process.
The secret is creating a realistic budget. Leave the guesswork behind. Know how your monthly take-home pay compares with your typical monthly expenses. If this means paying the minimum student loan payment until you increase your income or decrease your expenses, so be it.
Build an emergency fund
While both of these statistics are alarming in their own right, one of these items takes priority: the emergency fund.
If you don’t have an emergency fund yet, would you be able to financially “survive” if you:
- Suddenly lost your job?
- Needed to make costly repairs to your car?
- Found yourself with medical bills?
Without an emergency fund to cover these expenses, you may end up with thousands of dollars in credit card debt overnight (and possibly without income to make the minimum payment). This is why building an emergency fund is an absolute necessity.
If you find yourself in one of the emergency situation listed above, student loan providers will often work with you to reduce or pause your student loan payments. Utilize your emergency fund to cover unexpected expenses and lost income until you get back on your feet.
Before increasing your student loan payments above the minimum payment, make sure you have an emergency fund. For most individuals, setting aside three to six months of personal expenses will require $5,000 to $10,000 depending on the cost of living in your area.
It may take 12-18 months to establish a comfortable emergency fund, but paying only the minimum on your student loan payments will help you reach your target amount as quickly as possible.
Building an emergency fund takes patience, but you will have greater security and peace of mind when you want to start increasing your student loan payment or focusing on other financial goals.
Take advantage of the employer match
Before you start paying more than your minimum student loan payments, make sure you are contributing enough to receive the full employer match on your 401k if your company offers this benefit.
Assuming a 7% annual return on your investments, it typically takes about 10 years to double your money. When you contribute to your 401k account and your employer matches your contribution, you have instead doubled that initial money immediately.
Failing to take advantage of your employer match is leaving free money on the table.
Even if your student loan interest rates are 10%, the value of this “free money” from your employer will outweigh the cost of your debt. Utilizing the employer match will add hundreds of thousands to your retirement savings over your lifetime.
If you’ve built an emergency fund and budgeted enough to cover your expenses, be sure to contribute to your retirement accounts to the full employer match before increasing your student loan payments.
(This advice may also apply to your Health Savings Account (HSA) if you’re on a high-deductible insurance plan. Your company’s HR team should be able to provide more information on if HSA contribution matching is available.)
Pay off your high-interest debt
To minimize the amount of interest you pay on your debts, make sure your #1 priority is paying down the loan with the highest interest rate (commonly called the “avalanche method”) – regardless of how much you owe on each loan.
Student loans typically carry an interest rate of 5-10% depending on the lender and your creditworthiness when the loan was issued. On the other hand, the interest rate on credit cards is typically between 15-30%. Every dollar you owe in credit card debt will cost you roughly three times as much in interest charges as your student loans!
Credit cards are a revolving type of debt, which means there is no specific payoff schedule that gives you a specific date when you are debt-free. Just making the minimum payment on a credit card will likely take years to pay the debt off – even if you stop adding new purchases to the card!
Before increasing your student loan payments, focus on completely paying off any credit cards with a balance (and any debt with a higher interest rate than your highest-interest rate loan).
Consider your investment returns
If you are learning more about personal finance and have some “extra” money in your budget, you’ve probably asked yourself, “Should I use my money pay off my debt or invest instead?”
From a purely mathematical perspective, it’s best to put your money where you get the highest return. If your student loans are accruing interest at 5% and you can earn 8% through investing, you may want to contribute your money to an investment account, let it grow, and then use that invested money to pay down even more of the debt later.
That being said, there are two alternative points to consider:
- Paying off debt is a guaranteed return
- Paying off debt improves your cash flow
There are no guarantees when it comes to investing your money. If you choose to invest $10,000, your money could grow enough to someday pay off a much higher balance of student loans… or it could decrease in value when it could have immediately gone toward your student loan balance. You may decide to take the guaranteed return and peace of mind that comes from watching your debt shrink or disappear.
Paying off debt also improves your cash flow situation. By completely paying off a loan, you are able to eliminate a required payment from your monthly expenses so you can instead use that money elsewhere.
Do you have a relatively low-interest rate on your student loans? Consider continuing with the minimum monthly payment and enjoy higher returns on your money by investing any additional money instead.
There you have it: five valid reasons to pay only your minimum student loan payments. (Sorry that international travel didn’t make the list!)
Even if you are interested in paying off your student loans as quickly as possible, remember that student loan debt is just part of the picture with your personal finances.
Before increasing your student loan payments, make sure you choose a reasonable amount to pay each month, creating an emergency fund, and pay off your credit card debt. Consider your student loan interest rates before deciding to increase your payments or invest your money elsewhere.
After covering these baselines, you will have a solid foundation for your personal finances. With a healthy emergency fund and minimal credit card debt, you’ll be prepared to go “all-in” and wipe out your student loan debt once and for all!
Do you pay more than the minimum payment on your student loans? Why or why not?