Being a first generation college student, I was not prepared for this monster. But through hard work, research, and the right support system, I have been able to figure it out and develop a repayment plan.
What keeps me focused is the fact that they will be paid off and no longer an albatross around my neck. Not everyone feels this way, though. In fact, some people even consider keeping some student loans to take advantage of the tax benefits.
While it seems logical to do that, financial advisors would strongly advise to knock those debts off as fast as possible. Not only does it free up money for other budget categories, it just makes everything less stressful to know you’re no longer paying on your education.
Beyond freeing up money and elimination some financial stress, here are three major financial benefits to paying off student loans.
Why It’s Smart to Pay Off Your Student Loans
In America, we rely heavily on our credit score heavily if we want to finance large purchases such as a home or car.
Your credit score is made up of the following components:
- Payment History – 35%
- Debt-to-Income Ratio – 30%
- Credit History Age – 15%
- Types of Credit On Report – 10%
- Number of Credit Inquiries – 10%
As you can see, the most important is paying your bills on time. Next is debt-to-income ratio (DTI).
Debt-to-income ratio is a formula comprised of two parts:
- How much debt you currently hold (student loans, credit cards, car loan, etc.), the ratio of credit utilization (credit card balances vs. credit card limits), and your total loan balances in relation to the original amount of the loan
- Your income
Those two numbers are then compared against each other to create your debt-to-income ratio.
Paying off student loans is one way to improve your DTI. However, if you only make minimum payments, your DTI will take that much longer to go down. And the higher your debt-to-income ratio is, the larger the impact on your credit score, which in turn impacts your other major purchases and financial decisions.
However, one way to improve your financial situation while also paying down your student loans is to save for a “rainy day”. But if your student loans are too large, that might not be possible
Establishing An Emergency Fund
Most experts will tell you to put away money for a rainy day – an emergency fund. Unfortunately, large student loan payments make saving for an emergency fund difficult. In fact, nearly 40% of Americans don’t have the ability to even cover a $1,000 emergency.
While student loans may not be the sole cause of this, it is a factor. The unfortunate part is that this lack of emergency fund can trickle down into even more debt.
Let’s say your car needs an emergency repair that is $500. If you don’t have available cash, that money will typically come from a credit card that will begin to accrue interest. That $500 repair now can cost closer to $1,200.
Paying off student loans means you can set aside money into an emergency fund for that unexpected car repair or medical bill.
While I do have student loans, my wife and I made it a priority to build our savings and emergency fund first. If you have the ability to do so, I recommend establishing an emergency fund of at least $500.
Knowing you have that cushion in the bank makes it easier to tackle your student loans and make extra payments with confidence
Building A Savings Account
A savings account has become wishful thinking for many people paying off student loans. While paying student loans, it is difficult to budget money aside for a savings account. While the overall American savings accounts and rates look healthy, 29% of Americans still have a savings account with less than $1,000 in it.
Again, student loans may not be entirely guilty of this, but it does play a role.
However, like an emergency fund, it’s necessary to start saving as soon as you can. Having a savings account provides several benefits.
First, it gives you security when an unexpected expense comes up. This is similar to an emergency fund, but ideally it would be for larger expenses like an unexpected home repair.
Second, it gives you asset protection. While many people may tie their money up in assets such as real estate or bonds, a savings account is liquid cash that typically can be accessed quickly.
While the potential profit from a savings account is much smaller, it is comforting to know you have immediate access to that money if you need it.
Third, it gives room for unexpected business opportunities. If a perfect opportunity to make money arises, having liquid cash can come in handy.
The Goal of Paying Off Student Loans
The ultimate goal of paying off student loans is to get your financial life into a healthier place.
While it is incredibly hard, it can be done. Andrew was able to pay his way through school and graduate nearly debt free!
The financial benefits of paying off student loans are staggering.
Getting out from under the burden of student loans is incredibly stress-relieving – I can’t wait to get there myself!
Once you can get that monkey off your back, the ability to build an emergency fund and build your savings can completely change your outlook on life, and allows the potential for further opportunities to be in your reach.
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