Many college students graduate with several thousands of dollars in student loan debt. While this can seem intimidating to new graduates, employing some financial savvy makes it very possible to save money while paying off this debt.
Below is some food for thought.
What Should New Graduates Know About Student Loans?
New graduates often think that the best financial move they can make is to pay off their student loans as fast as they can. After all, the sooner those loans are paid off, the sooner they can start saving, right?
You essentially have two options at your disposal:
A) Make extra principle payments on your loans monthly, or
B) Pay the minimum and save/invest the difference
The answer, of course, depends. As a general rule, the lower the interest rate is on student loans, the better off the graduate will be paying the minimum payment and nothing more, while investing the “extra” money that they would have paid on the loan. The lower the interest on the loan and the higher the average market return, the more this concept applies.
In fact, when the loan interest rate is low, it frequently makes sense to invest “extra” funds rather than directing them to the loan principle. This allows the money to be invested for a longer period of time to capture the power of compounding interest. Early saving frequently outperforms large monthly investments at a later date. However, the smaller the difference between the loan interest rate and the average market return, the less helpful this strategy becomes.
The Benefits of Student Loan Debt
Nearly any debt is bad debt, but there are student loans and home mortgages that do not fall into this category. In fact, these types of debt can often be used as an advantage. Both student loan interest and home mortgage interest are tax deductible. You can deduct up to $2,500 for student loan interest each year, which helps to subsidize the cost of the loan. The faster the principle is paid, the sooner the tax deduction is lost, meaning that paying just the minimum may be the best option for some individuals. Savings from the tax deduction can then be invested at higher rates of return.
Saving Money is Important
In order to utilize this strategy, it’s important to save the money rather than spending it. Before deciding how to proceed, it’s important to learn about your loans. Is there a grace period prior to repayment? If so, the loans may be charged a lower rate of interest, meaning that it may make sense to consolidate the loans to lock in the lower interest rate. This might help lower the cost of borrowing and will mean you only have to make one payment each month.
The team at Baker Retirement & Wealth Management have been serving the greater Evansville area for nearly thirty years. We are well-equipped to help new graduates create a plan that works for their unique needs. If you’re interested in learning how to save money while paying off student loans, give us a call at 1-866-244-3517 today.Talk to a CPA for Free