Saturday, February 03, 2007

Never pay off student loans early!

There are many good reasons not to pay off student loans any earlier than you have to. If you refinanced or consolidated your loans during the golden age of student loan interest rates, then you can easily make free money by investing in money market accounts(MMAs), CDs and/or savings accounts with higher returns than the loan interest rate. In addition, interest paid on student loans are tax deductible.

Both of those ideas are pretty well known, but I came across an interesting piece of information. According to the Higher Education Act of 1965 Section 437 (a):
If a student borrower who has received a loan described in subparagraph (A) or (B) of section 428(a)(1) dies or becomes permanently and totally disabled (as determined in accordance with regulations of the Secretary), then the Secretary shall discharge the borrower’s liability on the loan by repaying the amount owed on the loan.
What this means is that, if the unfortunate should ever happen, you are not responsible for paying your loans back. Of course the ethical implications of such a plan are a little sticky, but seriously, who plans on dying or becoming permanently disabled? Consider it more of a life insurance policy.

Let's say you have an extra $500 each month from frugal living and conscious budgeting. What do you do with it? Let's look at two examples.

Bob puts his towards his student loans, managing to pay off his student loan in 10 years after graduation. Unfortunately, the day after he pays off his student loans, he accidentally falls into an uncovered manhole on his way to his job and breaks his neck, making him a quadriplegic for the rest of his life. He doesn't have any student loans to pay off, but he has nothing saved up.

Rob, on the other hand, puts his money in some MMAs, CDs and/or savings accounts. It's 10 years post-graduation, and he still has 20 years of loan payments left. He goes off on a hiking expedition through the Himalayas, but unfortunately, he encounters a female Yeti who hasn't seen her male counterpart for over 5 years. He gets brutally ravaged, but survives to tell about it, sans genitalia and various other body parts. When he returns to the states, Uncle Sam deems him disabled, so his student loan is paid off, and the $500 a month he had been saving for 10 years has turned into a modest sum.

While these stories are obviously fictitious and very unlikely, it's to prove a point.

Never pay off your student loans early!

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9 Comments:

Blogger Matthew Paulson said...

I just wrote an article in response to this post, take a read at

http://getting-green.blogspot.com/2007/02/why-you-should-pay-off-your-student.html

February 7, 2007 at 12:22 PM  
Anonymous Anonymous said...

There are actually 2 VERY important facts that MUST be included in your information.

1) If you refinance your student loans and it increases the total amount for repayment by ONE RED CENT, you can no longer claim the interest as a tax deduction. Even if you refinance at a lower interest rate, with combining the loans, it will be increased. So, combine your loans in a refinancing situation and lose your tax deduction.

2) Regarding your loans being erased in the event of your demise: ONLY if no one else's name is on the loan. That means that if you took the loan out with your parents, they will then be responsible. If you refinanced your loans and put your spouse's name on the new loan as well, your spouse will be responsible. NEVER, EVER add anyone else to your student loan if it can be avoided.

February 9, 2007 at 10:06 AM  
Anonymous Anonymous said...

This article is ridiculous because it doesn't consider many alternative situations. For example:
-One's income could be too high to claim student loan interest
-Interest rates paid on savings, MM, etc. accounts is far less than the rate paid on the student loan (in most cases).

There's more, but those are the main issues...

March 29, 2009 at 3:21 PM  
Anonymous Anonymous said...

Yes, this is a rediculous article. Essentially what the article is saying is that you should always keep your debt because you never know when you could become disabled or even die. Yes, if you die, then you do not have to pay it back. If you are disabled....who cares, you are now disabled for life and are now going to struggle for the remainder whether or not you have an $80/month bill.

Stop living for today! Think about the future and pay off your debts. The people who are living for today owe a ton of money, are upside down on their unbelievably huge houses and mortgages, and cannot retire due to the mentality they have had over the years. The mentality of the writer is why we are in the economic conditions that we are in today!

July 7, 2009 at 10:15 AM  
Blogger Stingy Student said...

I'll have to agree and disagree with the previous poster. Yes - we are in this economic situation because of people who buy things they can't afford hoping to pay them off in the future. However, I am not advocating spending away all the extra money - I explicitly state that the money should be saved up, in case such an unfortunate event such as death or disability may occur.

July 26, 2009 at 8:32 AM  
Anonymous student loan calculator said...

I am a Social Worker for the State of Alabama. I graduated in 1995. I have made my payments on time and refinanced my loans with Nelnet. Can I recieve relief through any program?

March 15, 2010 at 12:29 PM  
Anonymous Anonymous said...

I am dealing with this particular situation right now and fully agree with the author.

I was recently diagnosed with a terminal disease. I was carrying over $80k worth of MBA student loans (part fed, part private). My private loans, in the amount of $53K, were forgiven given my disability and my federal loans were put on a three-year probation period.

The private loan dismissal came with a sneaky little IRS rule. They consider that other income (sort of like a gift). That means I have to consider that other income (1099-C) on my taxes; and pay income taxes on that amount. This pushed me in to a different tax bracket and I'm left paying 35% on all my income. BIG hit, but I'm not going to leave my wife with the entire loan obligation even though she didn't sign for it. The IRS would have taken it out of our savings, life insurance, pension fund, IRA's, assets, pretty much anything they could get their hands on. Remember...you always have a sit down with the IRS before you get to the pearly gates.
Not sure what will happen to the federal loans -- I'm sure they will send me a 1099-C for that as well. I'm not really focusing on it...
I liked the article and would support that strategy. You never know when your ticket is up...Good luck...

March 18, 2010 at 8:42 PM  
Anonymous Anonymous said...

I am dealing with this particular situation right now and fully agree with the author.

I was recently diagnosed with a terminal disease. I was carrying over $80k worth of MBA student loans (part fed, part private). My private loans, in the amount of $53K, were forgiven given my disability and my federal loans were put on a three-year probation period.

The private loan dismissal came with a sneaky little IRS rule. They consider that other income (sort of like a gift). That means I have to consider that other income (1099-C) on my taxes; and pay income taxes on that amount. This pushed me in to a different tax bracket and I'm left paying 35% on all my income. BIG hit, but I'm not going to leave my wife with the entire loan obligation even though she didn't sign for it. The IRS would have taken it out of our savings, life insurance, pension fund, IRA's, assets, pretty much anything they could get their hands on. Remember...you always have a sit down with the IRS before you get to the pearly gates.
Not sure what will happen to the federal loans -- I'm sure they will send me a 1099-C for that as well. I'm not really focusing on it...
I liked the article and would support that strategy. You never know when your ticket is up...Good luck...

March 18, 2010 at 8:44 PM  
Anonymous Anonymous said...

And if you're thinking of buying a house, even better reason not to pay off student loans. Better to put any spare cash toward the down payment and lower your (higher interest rate) mortgage.

August 14, 2010 at 5:20 PM  

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