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Is Your Student Ready for a Credit Card?Erica Sandberg
Graduating from college without having some amount of student loan debt feels like the lap of luxury for many Americans. It is estimated that 45 million Americans currently have student loan debt and 70% of college graduates have student loan debt after graduation.
The day you pay that debt down is a day to celebrate. Paying off student loans early is a great goal to work towards and there are many benefits that come with it. Let’s explore them.
One of the major reasons you should encourage your student to pay off their loans early is that they will potentially end up saving hundreds if not thousands of dollars. How so? Student loan, like any other debt, accrues interest over time which means the more time you take to pay off the debt, the more you pay in interest.
This means that trimming some time from their student loan debt — even just a few months or years — gives the debt less time to accrue interest and consequently your student will pay less money in the long run. In other words, it’s cheaper if they make early repayments.
Let’s do the math. Let’s say for instance your student received $28,000 in student loans at 5% interest for an 8-year repayment term. The total cost they should pay is $34,030 with $354 per month. This means that the interest charges will cost $6,030.
But if your student decides to pay the loan in just four years, the total cost of their student loan would be $30,951 and they would end up saving $3,079 in interest charges.
Paying off the loan early is a sure way to save money but some loans will subject your student to specific penalties and added fees if they make early repayments. So it’s best to check the details before making a move or consult with a financial aid office. They will help your student calculate interest rates and understand any penalties for prepayment.
Another reason paying your student loan ahead of schedule is a wise choice is that your student will improve their credit score and lower their debt-to-income ratio (DTI).
DTI compares how much debt a person has in comparison to how much they earn on a monthly basis. This is an important measure as most lenders use it to assess whether someone is a good candidate for other types of loans such as when buying a house or car. They look at historical data to see if the individual can really afford to take on a new responsibility and repay the new loan.
Typically, creditors want to see a DTI ratio of 40% or less but it can go up to 50% depending on your credit score and income. However, you want this percentage to be as low as possible. Therefore, paying off student loans early not only decreases your student's DTI ratio and makes them more attractive to lenders but they will also be able to keep their debt at a manageable level and reach other financial goals more easily.
The financial perks aren't the only benefits of paying student loans early. Student debt can be a great source of stress for young adults getting started in life. Reducing the amount of money owed can bring peace of mind as your student will have more confidence in their financial security and their ability to meet their personal and professional goals.
Paying their student loans earlier also helps your student begin thinking about other financial goals much sooner. Once their student loan is over, they'll be in a much better position to use their budget for any fun items or a dream trip they've been putting off.
In addition, we never know when the next financial crisis might be. Your student could face a medical emergency or find that it takes longer than expected to find a job after graduation.
Whatever their personal circumstances, they are still required to pay off their loan. Delaying the pay time will result in penalties, taking them even further into debt, or worse, pushing them to the verge of bankruptcy. That’s why trimming their student loan timeline will not only give them more money and breathing room in their budget but it will also reduce the risk that any potential crisis might derail them completely.
As you can see, there are many advantages to paying off student loans early.
Not only will your student save thousands of dollars on interest, they will also decrease their DTI which in turn helps to secure larger loans for better interest rates on mortgages and credit cards. Additionally, after graduation they want to start fresh. With their loan paid off, they have fewer obligations that can cause both financial and mental stress.
So, should your student pay their student loans early? Absolutely yes. After all, nobody has ever become debt-free and regretted it.
It’s time to celebrate with the perfect gift for your new grad!