How do you decide which student loan to pay off first? A smart plan can lead to financial freedom instead of disaster. Don’t miss the all-important first step. Then consider these 9 key factors before finalizing your decision. You’ll save a bundle and move toward financial freedom.
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Most of today’s college grads have a pile of student loans. Not just one. They can be a beast to manage. And the question of the hour becomes, “Which student loan do I pay off first?”
At least in theory, paying off one student loan is relatively simple and straightforward. Paying off a stack of loans with due dates scattered all over the calendar is an entirely different beast.
You can save a bundle by prepaying your student loans. And be rid of the debt much faster. But in order to do that, you’ll have to decide which student loan to pay off first, second, third, and so on.
This guide will walk you through the factors you should consider and help you decide which student loan to pay off first.
The All-Important Step 1: Compile All Your Student Loan Info in One Place
Don’t miss this very important step or you’ll doom yourself to failure.
Before deciding which student loan to pay off first, you need an inventory. A master list of all your student loans, interest rates, outstanding balances, payment due dates, and repayment terms (if you make your regular payment, will it be paid off in 10 years or 20?).
You’ll also want all your login info for each account, so you can easily check your statements, track your progress, and make extra payments to lower your balance faster.
Taking this inventory is an essential step in making your student loan repayment plan. It gets everything in one place and gives you the 30,000-foot view of your project. Without it, it’s impossible to develop a comprehensive plan. You’ll doom yourself to failure before you even begin.
Incidentally, if you have other debt to pay off, the same first step applies. You have to know your total debt and have the big picture in mind. No matter how scary it is.
If you’re familiar with Excel, that’s probably the easiest way to compile all your info in one place and be able to easily compare apples to oranges.
Step 2: Decide between Debt Snowball and Debt Avalanche Methods
The two most popular methods for paying off debt are the debt snowball and the debt avalanche. They’ll both help you get out of debt. But like most things in life, each option has its pros and cons. Here’s what to know before you decide…
Debt Snowball Method
How debt snowball works: With the debt snowball plan, you aggressively pay off your smallest (lowest balance) loan first, while paying the minimum on all your other student loans. Once the smallest debt is paid in full, you re-allocate the funds you’ve been using for that loan towards paying off the next smallest student loan.
The goal: Quickly knock off the smallest student loan in your loan portfolio and earn a small win. Then you’ll be motivated to keep going, build momentum, and repay the rest of your student loans till they’re all gone.
Debt snowball pros:
- Creates small wins with each loan repaid.
- You gain momentum after seeing quick results.
Now for the debt snowball cons:
- Disregards interest rates, types of student loans (subsidized/non-subsidized, etc.), and other key money-saving factors that should be part of your repayment plan.
- Higher overall cost, due to not paying off high-interest loans first.
- May take longer to repay all student loans.
Who should use the debt snowball: The debt snowball is best for those who struggle to stay motivated during the repayment process. But the debt avalanche method will save you more money over the long term. And we can all use extra cash in our pockets to fund other dreams, right?
Debt Avalanche Method
How debt avalanche works: You repay the student loan(s) with the highest interest rates first. Your savings on interest can quickly add thousands of dollars to your bottom line. Which lets you repay other student loans faster, or reach other financial goals such as saving for a down payment for a home.
The goal: You tackle the loan with the highest interest rate first. Once that’s paid off, you re-allocate those payment amounts to the loan with the next highest rate. And so on, until they’re all repaid.
Debt avalanche pros:
- You save a lot of money on interest over the life of your student loans.
- Student loans are paid off faster and you can meet other financial goals more quickly.
And the debt avalanche cons:
- Disregards student loan balances or types of loans, even if you’re nearly finished repaying a particular student loan.
- May be less motivating, depending on your personality and level of discipline.
Who should use the debt avalanche: If you’re disciplined, and have student loans with higher interest rates, the debt avalanche can save you thousands of dollars in interest. And help you achieve other goals faster.
So which is right for you – debt snowball or debt avalanche?
Whichever method you use, you should always keep making your monthly minimum payment on each student loan.
Missing payments can mess up your credit rating and your life for years. It affects all kinds of things in your life – like buying a home, renting an apartment, purchasing insurance, and more…
9 Other Factors for Which Student Loan to Pay Off First
Now that you’ve chosen your preferred method, you need to factor in a few other issues, discussed below. They’ll help determine your final priority list… which student loan to repay first, second, third, and so on…
- Prepayment penalties
- Private student loans vs. federal student loans
- Subsidized student loans vs. unsubsidized student loans
- Interest rates
- Balance of loans
- Any missed payments or defaults to address
- Fixed rate vs. variable rate loans
- Discharge or forgiveness provisions
1. Does your student loan have prepayment penalties?
It’s against the law for lenders to charge prepayment penalties on student loans. Federal law prohibits prepayment penalties on both federal and private student loans. However, if any of your “student loans” are in the form of a private loan, there may be prepayment penalties attached. Otherwise, prepayment penalties shouldn’t be in the picture.
2. Is your loan a private or federal student loan?
If you have both private student loans and federal student loans, you should generally prioritize the private loans for earlier payoff. That’s because private loans typically come with higher interest rates, and offer less flexibility should you fall on hard times. They’re also not eligible for income-driven repayment, extended repayment, forbearance, and forgiveness that may be available with federal student loans.
Plus, while defaulting on a federal student loan can damage you for years, defaulting on a private student loan may have even worse consequences legally and financially.
What’s more, your private loan may have a cosigner. (See below.)
But, if you’re able to refinance your private student loans to a lower interest rate than your federal student loans have, it might make sense to pay off the federal loans first.
Remember to keep making the monthly minimum payments, even on your lower-priority student loans.
3. Is your loan a subsidized or unsubsidized student loan?
Subsidized federal student loans are offered by the federal government to students demonstrating need. The federal government pays the interest on subsidized loans as long as you’re at least a half-time student, during a six-month grace period after graduation, and during any deferment periods thereafter.[i]
Check with your student loan servicer(s) to find out which of your loans are currently accruing interest. If they’re not already, when will they start accruing?
Unsubsidized student loans start accruing interest the day you get the loan, and all that accrued interest is then added to the principal.
Of course, if you take out a subsidized loan and are able to repay it before interest starts accruing, you just scored an interest-free student loan!
4. What’s the interest rate?
If you opt for the debt avalanche, this is the primary deciding factor impacting which student loan to pay off first. The faster you knock off high-interest debt, the less interest you’ll pay. You radically reduce both the total interest and the time it takes to repay the loan.
This can be liberating and enable you to pursue other financial goals.
5. Do you have a cosigner?
Do some of your student loans have cosigners? If so, it’s a good idea to repay the one(s) with a cosigner first.
Let’s say you stop making payments on a loan with no cosigner. Your lender will go after you to collect the debt. But if you’re unable to repay a cosigned student loan, the lender can go after both you and your cosigner. For this reason, many people won’t even consider cosigning a loan.
By repaying the cosigned loan first, you’ll avoid damaging your relationship with the cosigner should you get in a tough financial situation. And trust me, your cosigner will breathe a sigh of relief when it’s paid off.
Some student loans allow the removal of the cosigner once a certain number of payments have been made. Find out. Then try to facilitate this as soon as possible.
6. What’s the balance of the loan?
How much do you have left on each student loan? There’s a definite psychological relief in knocking off a couple of smaller loans. It’s gratifying, lets you see progress, and simplifies keeping track of your remaining loans.
Say you have two loans for $2,500 each, and you get a $5,000 bonus or tax return. Repaying both those loans can be rewarding and help you gain momentum towards reaching the rest of your goals… even if they’re not the highest interest loans. Then you can attack the high interest ones with a vengeance.
Barring low balances that you can potentially pay off quickly, you’re better off attacking your high-interest student loans first. That’ll give you the most bang for your buck, financially speaking.
7. Are there any missed payments or defaults to address?
If you’ve missed payments, you owe it to yourself to make fixing that situation your highest priority. Ignoring it will damage you for years. Plus, the added interest and penalties can be the kiss of death for your finances.
If you’ve missed a payment or two or three, make them up as soon as possible. Get a side hustle. Work some overtime. Take a weekend job. The sooner you repay missed payments, the better.
On the other hand, if your loan has already gone into default (which takes nine months or more), find out how to get it out of default and move forward with your life.
8. Is your loan fixed rate or variable rate?
This is a less obvious part of the interest rate question. If you have a fixed rate, you can predict the future payments. With a variable rate, you can’t.
If you have a low variable rate right now, repay the higher-rate loans first. Then hope you can repay the lower variable-rate loans before their rate goes up.
9. Are there any discharge or forgiveness provisions?
Some federal loans qualify for special forgiveness status after making payments for a specified amount of time, such as ten years. These are often the result of working in a field that the government deems necessary (like teaching, nursing, etc.).
If you’re working toward such forgiveness, make that federal loan low priority for early repayment. Make all your payments on time so you don’t disqualify yourself. But pay off the rest of your student loans first. Not the one with potential forgiveness provisions.
Now That You Know Which Student Loan to Pay Off First, Here’s How to Prepay Them
Federal regulations require that an early payment be counted as your next installment payment, unless you specify otherwise.
So it’s very important that you provide specific instructions to the lender to make sure your prepayment or extra payment is applied the way you want.
Your instructions should specify that the prepayment is an extra payment toward the principal balance. Additionally, it should not be treated as an early payment of your next installment. And the lender should not advance the due date of the loans.
Be sure to include the loan ID for the specific loan to which your prepayment is to be applied. This is especially important if you have multiple loans with the same lender. Otherwise, they may apply the extra payment to any of your loans based on their criteria or even randomly.
Your instructions should also dictate that the lender should not re-amortize the loan based on your lower loan balance. Otherwise, your plan to pay it off early will fail.
Final Considerations in Deciding Which Student Loan to Pay Off First
The benefits of prepaying your student loans are clear. You pay less interest and get rid of your monthly loan payments much sooner. Out of debt and on your way to financial freedom.
But here are a couple of caveats.
If you’re carrying a balance on your credit cards, pay off that debt first. Credit card debt is almost always more expensive (higher interest) than student loan debt. Repay the loans with the highest interest rates first.
You should also strive to set aside money for a six-month emergency fund before accelerating your prepayment plan.
To be sure, that’s a door that can swing both ways. By ousting your debts, you require a lot less moolah to stay solvent on a monthly basis. So you could make a case for a smaller emergency fund and fast-tracking your debt repayment before building a larger emergency fund.
When I had student debt and was first married, we decided that we’d live off my husband’s income and throw my entire income at my student debt. We were able to pay it off in about a year, while also saving for a down payment for our first home. (At the time, I’d never heard of an emergency fund. Today I’d modify that plan to include one.)
It’s much less stressful to live without debt, no matter how challenging it is to pay it off. So it’s worth the journey. Being debt-free adds margin to your life. It generally means that an emergency won’t sink your ship. You can sleep at night.
Besides, it lets you attack your other financial goals and lifestyle dreams.
What would you do next, if all your student debt were gone in the next one to five years? Share your dreams below!