Janice Lozano
Paying off student loans can be a confusing and overwhelming process, especially when you have multiple types of loans to consider. The average student borrower takes 20 years to pay off their loans, but there are ways to speed up this process. When deciding which loan to pay off first, it's important to consider the interest rate, the loan type, and your financial goals. Federal loans typically have more benefits and lower interest rates than private loans, so it often makes sense to prioritize paying off private loans first. However, if you have variable interest rates, you may want to pay off those loans before your fixed-rate loans to limit the window in which rates can increase.
| Characteristics | Values |
|---|---|
| Interest rates | Choose to pay the loan with the highest interest rate first to pay less interest in the long run. |
| Loan type | Private loans typically have higher interest rates and fewer benefits, so they should be prioritized. |
| Loan terms | Federal loans often have better terms, such as loan forgiveness and forbearance options. |
| Loan repayment strategy | Make more than the minimum payment, pay every two weeks instead of once a month, or create a student loan spreadsheet to keep track of your loans. |
| Interest capitalization | Unpaid interest on your loan can be added to the principal balance, increasing the overall loan debt. |
| Interest accrual | Interest on subsidized loans doesn't start accruing until after a six-month grace period, while unsubsidized loans accrue interest while you're in school and during the grace period. |
| Loan balance | Pay off loans with higher balances first to reduce the overall debt. |
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What You'll Learn
Private loans first
If you have multiple student loans, it can be confusing to decide which one to pay off first. However, in many cases, it makes the most sense to pay off private student loans before federal loans. Private student loans usually have less favourable terms, higher interest rates, and fewer benefits such as deferment, forbearance, and forgiveness. Federal loans, on the other hand, have stronger borrower protections and fixed interest rates. Therefore, it is advisable to focus on paying off private loans first.
Private student loans are loans given by a bank or other financial institution to help pay for your education. They make up most of their rules, and you will need to figure out if your interest is fixed or variable. Variable interest rates can be risky during times of economic uncertainty or when inflation is high, so you may want to pay these off before your fixed-rate loans. Private loans also do not have as many benefits as federal loans. For instance, federal loans offer pathways to loan forgiveness and forbearance options, which private loans usually lack.
Before deciding which loan to pay off first, you should gather your paperwork and check which types of student loans you have. You can find your federal loan details via your loan servicer, but they won't have information on non-federal debt. You can find your private student loans by checking your credit report from the three main credit reporting agencies: Experian, TransUnion, and Equifax.
After gathering all the information, you can create a student loan spreadsheet. Include the name of each loan, its balance, its interest rate, and your minimum monthly payment. This will help you decide which loan to pay off first. If you have both federal and private loans, you may want to prioritise the private loan with the highest interest rate to save money in the long run.
While paying off private loans first makes sense in most cases, there is no universal solution. The best strategy for paying off student loans depends on your situation and goals. For example, if your federal student loans have higher interest rates than your private ones, you may want to prioritise paying them off first to take advantage of their benefits sooner.
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Federal loans have benefits
Federal loans are standardized by the government and offer several benefits over private loans. Firstly, they typically have lower interest rates than private loans, which usually have the highest interest rates. Federal loans also offer stronger borrower protections, such as deferment, forbearance, and forgiveness. Federal loans from after 2006 all have fixed rates, whereas private loans can be either fixed or variable. The variable interest rates of private loans can be risky during times of economic uncertainty or high inflation, making it prudent to pay them off before fixed-rate loans.
Federal loans also offer better repayment terms and more flexibility, such as pathways to loan forgiveness and forbearance options. This flexibility is especially beneficial if your circumstances change in the future. For example, if you have a Direct PLUS loan, which is a type of federal loan for parents of undergraduates or graduate and professional students, you may want to prioritize paying it off before other direct loans due to its higher interest rates.
Another advantage of federal loans is that they provide interest subsidies for certain borrowers. For instance, the federal government covers the interest on Direct Subsidized Loans while the borrower is in school and for a six-month grace period afterward. This results in lower repayment amounts compared to unsubsidized loans of the same size. Therefore, it might be strategic to tackle unsubsidized loans first to reduce the overall balance across your loans.
While the specific approach to repaying student loans depends on individual circumstances and goals, the benefits associated with federal loans make a compelling case for prioritizing private loan repayment first.
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Interest rates vary
Within federal loans, there are also different types to consider, with varying terms that can affect your choices. Direct subsidized loans are those where the federal government covers the interest while you’re in school and for a six-month grace period afterward, resulting in a lower repayment amount. Direct unsubsidized loans, on the other hand, accrue interest while you’re in school and during this grace period, leading to a higher balance. Direct PLUS loans are for parents of undergraduates, or graduate and professional students, and interest accrues as soon as the loan is disbursed. Due to the higher interest rates, it often makes sense to pay these off before other direct loans.
In the UK, there are five student loan repayment plans, with varying interest rates. The interest rates are generally set on 1 September each year, using the Retail Prices Index (RPI) of the previous March. RPI is a measure of inflation that tracks changes to the cost of living in the UK. Plan 1 loans are those taken out between August 1998 and September 2012 by borrowers in England, Wales, and Northern Ireland. The interest rate for these loans is RPI or the Bank Base Rate + 1%, whichever is lower. Plan 2 loans are for undergraduate courses and Postgraduate Certificates of Education (PGCE) taken out since 1 September 2012 in Wales and between 1 September 2012 and 31 July 2023 in England. The interest rates for these loans vary between RPI and RPI +3% depending on the borrower's circumstances. Postgraduate/Plan 3 loans are for master's or doctoral courses in England and Wales, while Plan 5 loans are for undergraduate loans from the 2023 academic year. The interest rate for Plan 5 loans is RPI +0%. Mortgage-style loans have a fixed interest rate of 4.3% for the period 1 September 2024 to 31 August 2025.
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Loan forgiveness
When it comes to paying off student loans, there are a few strategies you can consider to make the process more manageable. Firstly, it's important to understand the different types of loans you have. Gather your paperwork to check which student loans you have; federal or private, subsidized or unsubsidized, Direct Loans, Federal Family Education Loans (FFEL), Perkins loans, or Direct PLUS loans. Federal student loans typically have more benefits, such as fixed interest rates, lower interest rates, and stronger borrower protections. On the other hand, private student loans often have higher interest rates and fewer benefits like deferment, forbearance, and forgiveness.
Given these differences, it usually makes sense to prioritize paying off private student loans first. By tackling the loans with less favourable terms and higher interest rates first, you can reduce uncertainty and minimize the overall interest you pay. However, it's important to note that there is no one-size-fits-all solution. Your repayment strategy should align with your financial goals and circumstances. For example, if you prioritize minimizing interest, you may opt to pay off the loan with the highest interest rate first. Alternatively, you might choose to start with the loan with the lowest balance to build momentum towards becoming debt-free.
Another factor to consider is the interest rate type. Federal student loans have fixed interest rates, while private student loans can have either fixed or variable interest rates. Variable interest rates carry the risk of increasing during times of economic uncertainty or high inflation. Therefore, if you have a private loan with a variable interest rate, you may want to prioritize paying it off first to limit your exposure to potential rate hikes.
Lastly, it's worth mentioning that federal student loans offer pathways to loan forgiveness. This means that under certain conditions, the federal government may forgive or cancel part or all of your federal student loan debt. This benefit is not typically available with private student loans, further emphasizing the importance of prioritizing private loan repayment. By understanding the nuances of your loan types and considering your financial goals, you can make informed decisions about which student loans to pay off first and work towards achieving financial freedom.
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Variable rates are risky
When it comes to repaying student loans, it is generally recommended to prioritize paying off private loans first, as they typically have higher interest rates and less favourable terms. Federal loans often provide better benefits, such as lower interest rates, deferment, forbearance, and forgiveness options.
However, when considering private loans, it is essential to understand the difference between fixed and variable interest rates. Variable rates are riskier than fixed rates because they can fluctuate over time in response to economic conditions and market changes. Fixed rates, on the other hand, remain constant for the duration of the loan, making them a safer and more predictable option.
Variable interest rates may offer a lower rate initially, but there is a possibility that the rate will increase during the repayment period. This uncertainty makes it challenging to calculate your exact monthly payments and can lead to higher overall costs if interest rates rise. Variable rates are especially risky during times of economic uncertainty or high inflation, as it becomes challenging to predict future interest rate movements.
In contrast, fixed-rate student loans provide stability and peace of mind. With fixed rates, you know exactly how much you will pay each month and can plan your finances accordingly. Additionally, in a high-interest rate environment or when rates are increasing, fixed rates protect you from paying higher interest charges.
While variable rates can sometimes work in your favour, especially if market rates are low and you plan to repay your loan quickly, they are generally a gamble. No one can predict future interest rate movements accurately, and the potential savings may not outweigh the anxiety and financial strain of dealing with unexpected rate hikes. Therefore, if you are unsure, it is usually advisable to choose a fixed-rate loan for your student debt.
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Frequently asked questions
It is recommended to pay off private student loans first, as they usually have higher interest rates and less favourable terms. Federal loans often have benefits such as deferment, forbearance and forgiveness, so it makes sense to reserve these benefits in case your circumstances change.
If you took out a federal student loan on or after July 1, 2010, then you likely have a Direct Loan. Federal loans taken out before this date could be a Federal Family Education Loan (FFEL) or a Perkins loan. Private loans are usually issued by a variety of different companies. You can find federal loan details via your loan servicer, and private loan details by checking your credit report.
One strategy is to make payments every two weeks instead of once a month. By doing this, you make 13 full monthly payments per year, which is the equivalent of making an extra payment on the debt each year.
