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It’s not always smart to pay off your student loans early

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Q. How do I know whether it is a good deal to pay off a student loan early? More than nine years ago, I owed $10,000 in student loans to one provider who offered a $2,000 discount if I paid it off immediately. The loan from a local community organization had a zero percent interest rate at the time. Should I have taken the deal?

A. Zero percent student loans are rare. But other people might face similar questions if they have low rates on auto loans, credit cards and other debt: Is it smart to pay the loan off early, even though it isn’t accruing much interest — or any interest at all? Should the cash be used for something else?

The answer depends on a number of factors, including how much a person has in savings, if he or she has any other debt and if the money can help them meet some of their other goals, financial advisers say.

Generally speaking, there are few benefits to paying off a zero-percent loan early, says Beth V. Walker, a financial planner who specializes in helping families figure out how to pay for college. Instead, it may be smarter to use the money to pay off more expensive debt, pad savings or invest in other goals, she says.

For instance, think of someone who also has credit card debt, which can often grow at an annual percentage rate of 20 percent or more. Instead of putting any extra cash toward the zero-interest-rate student loan that isn’t growing, it may make more sense to put those extra payments toward the credit card debt as a way to reduce interest charges, says Betsy Mayotte, director of consumer outreach and compliance for American Student Assistance, a nonprofit organization that offers guidance to families paying for college.

Most student loan borrowers won’t see this kind of offer to reduce what they owe unless they are struggling to keep up with their payments, Mayotte says.

On a purely financial basis, it could be more cost-efficient to pay off the loan early in exchange for the smaller debt load, Mayotte says. The discount could be viewed as a return of 20 percent or a windfall of $2,000. Consumers may struggle to find that kind of return anywhere else at a time when savings accounts aren’t paying much and stocks are looking expensive.

But even with that discount in mind, consumers should ask themselves how much money they would have left in the bank after the student loan is paid off, Mayotte says. If paying off the loan is going to wipe out a person’s savings, then maybe it is best for him to hold off, she says. Otherwise, he might have to turn to credit cards when emergencies happen, which could lead to interest charges that would eat into any savings earned by paying off the loan early.

Consumers also need to think about whether the money could help them meet some other long-term goals, Walker says. For example, if the cash could be used to pay for a higher education course that could help a person land a higher-paying job, the payoff could be much larger than the $2,000 that would be saved by paying the loan off immediately, she says.

Some people might want to use the cash to help them afford the equipment or classes they need for a career change. Other people may consider using the cash to go toward a down payment for a house or to pay for a home improvement that could improve their quality of life, Walker says. “Sometimes you invest in things that don’t show up on a financial balance sheet, but they show up on a personal balance sheet,” she says.

This is a feature in which we talk to experts about the personal finance questions that stump readers.

Read more:

Why now’s the time for investors to hold a little more cash

How to tell if a balance transfer is a good idea

How millionaires under 40 manage their money

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