Should You Pay Student Loan Interest While Still In School?
Financial experts suggest prioritizing investments over early interest payments for federal student loans.
1The Case Against Early Payments
Financial advisors generally recommend that families avoid paying interest on federal student loans while the student remains enrolled. With roughly half of federal borrowers qualifying for some form of loan forgiveness, early payments often represent wasted capital. Redirecting these funds into investment accounts typically yields higher long-term financial growth for students.
2PSLF and Forgiveness Dynamics
Public Service Loan Forgiveness requires 120 qualifying monthly payments made during full-time employment. Payments made during in-school deferment do not count toward this total. Consequently, paying interest early simply reduces a balance that would eventually be erased by the program, providing zero tangible benefit to the borrower in the long run.
3Understanding Interest Capitalization
Federal student loans accrue interest on the principal balance rather than on unpaid interest while in school. However, this unpaid interest capitalizes once the deferment period ends, adding to the total balance. For a 6.52% rate, a freshman loan of $5,500 accrues approximately $359 annually, which becomes part of the principal later.
4Investment Versus Debt Repayment
Investing extra cash during college years leverages the power of compound interest. A hypothetical $2,000 invested by graduation and held for 40 years at a 7% return can grow to $30,000. This strategy significantly outperforms the marginal savings gained by paying off interest before the mandatory repayment period officially begins.
5The Math of Compounding Returns
Over a four-year degree, dependent students might accrue roughly $4,173 in interest at a 6.52% rate. If this amount is invested at a 7% return instead of being paid off, it could grow to over $8,700 by the end of a ten-year repayment term, assuming the borrower qualifies for forgiveness programs like PSLF.
6Private Loan Considerations
Private student loans differ significantly as they do not qualify for federal forgiveness programs. Only about 14% of employers offer repayment assistance for these loans. Borrowers should review their specific promissory notes to understand how lenders handle in-school interest, as these loans often require more careful management than federal counterparts.
7Parent PLUS Loan Exceptions
Parent PLUS loans represent a distinct category where early repayment is often advisable. These loans lack access to income-driven plans like RAP or PSLF. Since the debt burden falls on the parent, paying early prevents balance growth and protects the parent's long-term retirement savings from being depleted by high-interest debt.
8Financial Planning Strategy
From an estate planning perspective, students should not prioritize repaying Parent PLUS loans. Taking funds from a 22-year-old to pay off a 60-year-old's debt is considered poor financial planning. It is more efficient for the child to utilize their own income to fund a Roth IRA, allowing assets to compound over several decades.
9Risk Management and Savings
While stock market investments offer the highest potential returns, they carry inherent volatility. Families seeking zero risk can utilize high-yield savings accounts to store funds intended for interest payments. This approach ensures the money remains accessible to pay off accrued interest before the grace period ends, providing a safe middle ground.
10Strategic Conclusion for Borrowers
For those pursuing PSLF, the most effective strategy is to stop in-school interest payments and redirect those funds into personal investments. Borrowers retain the flexibility to clear accrued interest before capitalization if their career plans change. Waiting to pay allows families to maintain liquidity while maximizing the potential for long-term wealth accumulation.
Original article: The College Investor — Should You Pay Student Loan Interest While Still In School?