Got extra money? Maybe don't use it for student loans
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For people paying off their student loans on a traditional 10-year plan and doing fine, paying extra to fast-track paying off your loans can be wise. But for those on other payment plans and with other debt priorities, paying extra towards your loans might not be the smart money decision. Whether it’s a bonus from work, a tax refund, small inheritance, or another cash windfall, think for a moment before you throw it at your student loans. Here's why.
#1 It can foul up your PSLF
First, when pursuing Public Service Loan Forgiveness, there are stringent requirements for payments. Mess them up, and you might not be eligible for PSLF. You must make 120 on-time payments under an approved plan to qualify.
When on this track, it makes no sense to put any extra money towards your school debt. And if it puts PSLF at risk, you’re asking for trouble. If this is your plan for loans, take that extra cash and do something else with it – put it in an IRA, pay off your credit cards, etc.
#2 It doesn’t benefit IDR plans
Debtors on Income-Driven repayment plans also don’t benefit from paying down their debt. If you want a cushion to make sure you don’t miss a payment, rather than trying to pay ahead, stash that money in a savings account and if you have a cash shortfall, you’ll have that safety net to make your IDR payment.
Second, since IDR plans forgive balances at the end of the repayment term, there’s no upside to putting a few thousand dollars towards reducing the principal. Instead, pay down other debt, put it into retirement, or savings since you’ll have a tax bill to pay when the balance is discharged.
#3 It’s better used for savings
People struggling with student loans often don’t make (and can’t make) savings a priority. But without a safety net of an emergency fund, you’re vulnerable to a financial crisis. Even something small like a busted refrigerator or a car problem can break your budget if you have no emergency savings.
Instead of trying to chip away at your student loan balance, open a savings account and stash the cash there. Alternately, you can buy a 6-12 month CD so you can earn better interest but still access the money if you need it in a crunch.
#4 It might be better spent on other debt
Another factor to consider is what your other debt costs you. Student loan debt interest is often much more reasonable than credit card interest (single versus double digits). And if you’re on a track for PSLF or IDR with balance forgiveness, the effect on interest may be minimal.
However, if you’ve got a credit card balance with a 15-20% interest rate, that’s significant. Put the cash windfall towards paying off that debt and save on interest expense. That can be a much better use of your money, so think carefully before you spend that extra cash on student loans.
If you do pay extra…
If you decide to try and pay extra on your student loans, know in advance that it can be a hassle. First, don’t pay extra regular payments. Also, don’t tack the money on with a regular payment. You want to pay it separately and specify to the lender that you want that amount to go to the principal.
It doesn’t benefit you nearly as much if it goes to interest rather than principal. If you don’t ask, loan servicers will never apply the money where it best benefits you. Plus, even if you tell them to apply it to the principal, they might not. Misapplication of funds is a common complaint against student loan servicers.
Closely examine your statement to make sure they applied it correctly. If not, you’ll have to push back and have them reapply the payment to reduce your principal. Loan servicers don’t make it easy for you to address your debt the way that you want to, so be careful and always monitor what they do.
For those North Carolina consumers struggling with student loans, bankruptcy might be a fitting solution for you. If you meet certain criteria, you could prove undue hardship and qualify for student loan reduction or discharge. To find out more, read reviews from our clients and call 1-888-234-4181.
Contact the Law Offices of John T. Orcutt today for a free student loan bankruptcy consultation at one of our locations in Raleigh, Durham, Fayetteville, Wilson, Greensboro, Garner or Wilmington.