Written By Travis Hornsby, CFA®, CFP®
I’m seeing tons of advice from “experts” telling you to pay extra on your student loans to take advantage of the 0% interest through the end of September. I think that’s terrible advice.
But paying nothing on your student loans is probably the best idea.
With interest rates so low, you might even consider borrowing the maximum amount you possibly can for school.
It’s a strange time right now. Congress has made many changes to try to rescue borrowers amid the coronavirus outbreak, and there will be unintended consequences from all of the changes. Plus, the recession could have a significant impact on the future of student loan policy in America.
The short-term payment and interest freeze under the CARES Act shouldn’t change your long-term student loan repayment strategy. However, policy changes could come down the pipe as a result of what Congress did to help borrowers during these hard times.
Why you should pay nothing on your student loans
Usually, you’d want to take advantage of 0% interest and throw as much cash as you can toward your debt. Without interest fees, more of your payment goes to the principal balance, and you pay off your debt faster.
Under normal circumstances, that would make sense. But the state of the economy is anything but normal.
Anyone who tells you to pay extra on your student loans right now is giving you bad advice.
The latest release shows that 30 million people are unemployed. That number is expected to climb, especially since employers have started to lay people off strategically.
For example, our hospital system here in St. Louis is laying people off because they realized that some people are better off on unemployment than on their payroll.
What if you’re one of those strategic layoffs? Wouldn’t you rather have extra cash in the bank that you could spend on groceries and rent than have a lower balance on your student loan?
As state governments open things back up, the economy can go one of two ways. One option is the coronavirus situation will have improved enough that the economy can grow without an increased risk of death from the virus.
If that’s the case, then maybe paying student loans during this time was an okay idea. But if you take the other side, what happens if reopening restaurants and businesses leads to an even higher spike in deaths?
Then the economy will get even worse because businesses will increase their layoffs, and more people will be out of work.
Mainstream media would have you believe that paying off your student loans is the answer to all of your problems. Instead, I encourage you to put what you’d usually pay on your student loan in a savings account.
If the economy recovers, that money is available to put toward your loan when the 0% interest expires. And if not, you’ll be glad to have control of that cash in case things get worse and you lose your job.
Lowering your payment with private student loans
The CARES Act only applies to federal student loans. Private student loans aren’t eligible for the interest and pay freeze. But you have options.
Most private lenders are offering up to 90 days of forbearance if you ask for it. The interest will continue to accrue, but it can free up some cash each month.
Refinancing your private loans is another option to lower your monthly payment. Lenders have gotten more conservative – I was seeing rates in the 1% to 2% range in early March – but I’ve heard from some readers who are refinancing with an interest rate below 5% for 20-year fixed-rate loans.
Let’s say you have 4.5% interest on a 10-year loan with a $2,000 monthly payment on a $200,000 balance. If you refinance to a 20-year loan at 4.9%, you could lower your payment to $1,300 per month.
The interest rate is a little higher, but you can always refinance again when the economy recovers to lower your rate and get a shorter term. In the meantime, you free up cash flow that you can save or use for living expenses if you’ve lost your job.
Don’t worry about the amount you borrow
It sounds ridiculous to say, but you shouldn’t worry about the amount of debt that you have. That’s especially true if you have federal student loans. A balance of $1 million is okay if it’s all federal debt because there is a strategic way to approach those loans that can open up a lot of options.
Your student loan debt shouldn’t hold you back. You’ll see that you have more freedom than you think if you book a student loan consult with us to explore repayment options.
Should you worry about the amount that you borrow with private student loans? Maybe.
Assuming you have a good income and a good overall financial picture, a 20-year repayment term can lower your required payment. Then you could focus on other things to increase your income and give you more power and a bigger shovel, as they say, to pay back your balance.
The worst-case scenario is that you’d have to relocate to earn higher pay because the need isn’t as big where you are now.
Unintended consequences of the recession
In reaction to the swift economic downturn caused by the pandemic, Congress paused student loan payments and interest for six months. Many borrowers needed the relief and, overall, it was a smart move.
As generous as it was, it’s going to create the expectation that Congress will do the same thing the next time we have a terrible recession.
But it’s redundant because the ability to pause your student loan payment is already built into the federal student loan repayment system. If you’re on an income-driven repayment (IDR) plan, you can put your payments on hold if you lose your job or your income drops.
The idea behind IDR is to give payment relief to the people that need it. The borrowers who don’t need it are still paying their loans, subsidizing the system for people that need help.
The actions of Congress also make me believe that the tax bomb will be less likely in the future. The passing of the CARES Act makes me think that, when push comes to shove, politicians care more about getting their votes than being careful about spending the government’s money.
What does this mean for your student loans?
With all of the changes in student loan repayment that happened because of the CARES Act, keeping up with the details is complicated.
Specifically, the changes emphasize the need for you to have a plan in place to repay your student loans. Your savings rate matters the most. Even if you do everything else wrong, you’re on the right track if you have a high savings rate.
The consultants at Student Loan Planner® are here to help you make the most out of your finances. I encourage you to book a consult with one of us if you’re not confident in your repayment plan.
Not sure what to do with your student loans?
Take our 11 question quiz to get a personalized recommendation for 2024 on whether you should pursue PSLF, Biden’s New IDR plan, or refinancing (including the one lender we think could give you the best rate).
Great article Travis,
As far as paying down loans with 0% interest, there is almost no scenario where this would be anyone’s best option. Even if you have no other debt, putting that money in a high interest savings account would put you more money ahead by the end of September. I know some banks that still have interest rates well above 1%. Otherwise, paying down any debt with an actual interest rate would be a far better option. Additionally, federal student loans are generally much more gracious regarding times of financial hardship. Almost all other forms of debt would be better options to pay down before federal student loan debt.
Not worrying about the amount borrowed is sound as well. I’ve previously written that I wish I had taken out MORE in student loans when I was in pharmacy school. Unless your student loan balance is well below your projected gross annual salary, then income-driven repayment (IDR) with forgiveness after 20 years will likely be the best option. Now that I fall into that same bucket, the sacrifices of eating ramen noodles and driving a $400 car seem ridiculous. An extra $5,000 would have gone a long way back then.