There are several ways borrowers can pay off student loans, from refinancing to using popular repayment strategies such as snowball or avalanche. Two additional methods include making a lump sum payment or making extra payments.
Is either method the best way to pay off student debt? GOBankingRates takes a closer look at some of the pros and cons associated with using lump sum or extra payments to repay student loans.
Lump Sum and Extra Payments: What’s the Difference?
Not familiar with the difference between paying student loans using a lump sum versus extra payments? Here’s what each term means.
A lump sum payment is a one-time payment. This can be any amount of money. If you receive a bonus at work, for example, this one-time payment may be put toward paying off a loan with a high interest rate. Depending on the size of the bonus, the lump sum payment may even have the ability to completely pay off a piece of student loan debt. A person who receives a $5,000 company bonus and has a student loan with a $5,000 balance would be able to pay off the loan in full.
Extra payments mean the debt will be paid off more quickly, but not all at once. For example, if you make 12 monthly payments a year on your student loans, you might budget to make an extra payment of $100 every three months. This means you’ll make 16 payments toward your loans each year and pay an additional $300 toward the balance. You can pay down debt faster using extra payments.
Lump Sum and Extra Payments: Pros and Cons
Lump sum and extra payments share similar pros and cons.
Both offer borrowers the opportunity to pay off loans quickly and save money in accumulated interest. On the other hand, there’s an argument to be made that this money could be put toward other uses. Some argue that using excess cash to pay for loans instead of applying it to another area of your life, such as paying off credit card debt or saving for a down payment on a house, may restrict your personal cash flow.
Christine Nguyen is a product manager at Highway Benefits, a company that helps facilitate tax-free employer student loan repayments as an employee benefit. Nguyen said any additional payments above your monthly minimum payment helps you pay off student loans faster. Depending on the payment amount, borrowers can save hundreds to thousands of dollars in accumulated interest over time.
Make sure extra payments are explicitly applied to your outstanding loan principal, as opposed to future payments. (This is not so much a “con” for making lump sum or extra payments as it is a caveat.)
“Some loan servicers will automatically advance your next payment due date when they receive extra payment unless told explicitly to apply it a certain way,” Nguyen said. “When this happens, extra payments will be credited towards your future monthly minimums instead of decreasing your outstanding loan principal. The principal is what accumulates interest over time.”
Is It Better To Pay Student Debt Using Lump Sum or Extra Payments?
The answer to this question ultimately depends on your situation.
Working professionals who receive year-end bonuses might decide to put this lump sum toward paying off high-interest student debt. Extra payments may make sense for someone who recently received a raise and plans to contribute an additional $50 each month toward student loans.
If you do decide to start making extra payments, remember this is less of a one-time financial commitment than lump sum payments. While there is a bit of flexibility in deciding how much extra you want to pay, Nguyen recommends paying attention to other factors such as the interest rate on your loans, any refinanced interest rates, tax deductions you want to claim on your interest payments and any other upcoming financial goals.
Those uncertain as to whether they should make a lump sum payment or focus on extra payments are advised to speak with a financial advisor or tax expert for guidance.
Some borrowers might not even need to consider these options.
“If you’re fortunate enough to work in an industry which qualifies for student loan forgiveness programs or work for a company offering student loan repayment benefits,” Nguyen said, “taking advantage of either could be a better way to pay off your student debt while also being able to invest in other areas of your life.”
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