I have to pay back my student loan. When is the best time to do it?

Question

Today, I received the news that my "Payback phase" for my student loan has begun. I was afraid this day would come soon, but it came quicker than I anticipated. However, I got the news that I don't have to pay back yet. I have 2 years until my mandatory payments start, but if I wanted to, I could pay off the loan already. They informed me, however, that the interest rate from now on is already set at 0.46%.

I have 420 months (± 35 years) to pay back my student loans, and every 5 years, the new interest rate will be decided and fixed for the next 5 years repeatedly until the last payment. It could go to 0%, or it could go to 10%. I simply do not know.

Some more context on why I am bringing this up in the first place: My girlfriend and I would like to buy our first house. The housing market right now is really tough, but we do have a chance. However, that chance is extremely restricted due to my student loans. Let's say we could get a mortgage of $250,000, and I inform them that I have a student loan. That mortgage would be lowered by twice the amount of my student loan. So, if my loan is $10,000, then my mortgage would be lowered by 2 * $10,000 = $20,000.

The big problem is that my student loan is $32,288.02, and there is no single way we could buy a "livable" house here for ±$186,000. But we can't live in this crappy apartment for years, and we would like to move on at some point too. At this moment, I have around $6,000 in savings, so that is a start.

I am now trying to figure out the best way to handle this situation. I have a couple of options:

Save extremely hard for the next ±2-3 years (around $600-800 a month) and try to get the entire amount to pay it back in one go. Do nothing and wait until the mandatory payment starts, which will be set at around $90 a month, and pay that for the upcoming 420 months. (Basically, pay it back until I am 59 years old.) Something else?

I really need some advice here to see the best way to go around this. What should I do?

Answer 1

That mortgage would be lowered by twice the amount of my student loan.

doesn't sound too bad, since the other place you can put the money is into "down payment" and that has between 1:1.5 to 1:4 ratio with mortgage (for 40% and 20% down payment, respectively).

Trying to pay off your student loans aggressively will mean you have no down payment, which hurts your mortgage application a whole lot more.

0.46%, if that is per year, is a very favorable interest rate. You would lose both money and opportunity by paying it down ahead of schedule.

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The question you didn't ask, related your situation, is whether buying a house together with your girlfriend is a good idea. The rule of thumb is that that sort of financial entanglement should only be entered into by spouses. Without the commitment of marriage co-ownership is a recipe for trouble.

Answer 2

Anytime you can borrow money for less than 1% APR interest, the perfect time to pay that off is "upon your death". You will never be able to borrow money more cheaply in your whole life.

Therefore the only question is "what about these every-five-year APR adjustments?" What is the basis for their adjustment? That should be in your loan paperwork. If <1% is a "teaser rate" that could snap up to 28%, then I'd be thinking about paying that off. But if it's likely to snap up to 3% or 4%, that's still the cheapest money you'll ever borrow. Paying it off early makes no sense, except for "feel-good" emotions - and emotions are notoriously bad at making financial decisions. An educated person shouldn't have that problem, unless colleges are giving diplomas to people with no financial education.

and pay that for the upcoming 420 months. (Basically, pay it back until I am 59 years old.)

I get where that seems intimidating and frustrating and like a "life sentence", but this is emotional reasoning. From a fiscal POV, being at such low interest rates makes it the bargain of the century.

And the idea of taking til age 59 to pay it off is nonsense. You can pay off the loan at any rate you want. However, if you do, you'll never be able to re-borrow at that kind of interest rate ever again.

Still not getting it? OK. Long-term, the stock market pays 5-7% over and above inflation. There's short-term volatility (what people call 'risk'), but on average, it grows solidly. For every 20% crash there's a 30% gain the next year or three. This is gold-standard, and is the basis for how university endowments manage themselves. So any potential loan payment beyond minimum could be put in index funds instead, where in the long term it would grow faster than the loan does.

I completely agree with Ben that having the cash banked for a home down-payment will be much more helpful toward your home ownership goal than having the student loan paid down.

Answer 3

OP is using the wrong (outdated) calculation.

The "twice study loan" rule of thumb was based on the old study loans which have to be repaid in 15 years. Since the duration has more than doubled, the factor has decreased from 2x to 0.7x (approximately). Even if repaying would help (which it doesn't), your maximum mortgage would only increase by 70% of what you repaid. Even ignoring interest, that's just a plain bad deal.

Source.

Also note that under Dutch rules, partial repayment isn't credited. The repayment is assumed to shorten the duration of the study load, but OP will be constrained by their current income.

Answer 4

Look up Mortgage Rates

It seems likely to me that your current loan rate is well below the current mortgage rate. In the US, a mortgage at 3% was considered historic lows, and in early 2023 Americans with excellent credit are looking at 6.75% mortgages.

Your country may be different, but in the US, with a student loan at 0.5% APR, you'd do much better in the long term to save up for a larger down-payment - you'd be paying much less interest over the long run.

Variable Rates

The variable rate is the tough part. As long as the rate is low, paying off the student loan slowly is fine. But you don't know how the rate will change over time, which is difficult.

Potentially, you could save hard for the next 5 years, then make a decision when the first rate change happen. Pay off the student loan if the rates escalated significantly, or use the money as a down payment if they did not.

Short Term Pain

I don't know that I see a clear path to home-ownership in the next 3-4 years. From Googling, it looks like the transaction costs in the Netherlands for buying a home are about 5% of the value, but down payments aren't required. So for a 250k home, you'd need about 45,000 to pay off the student loans and cover closing costs. At $800 a month, that's over 4 years (even if you use all your 6k in savings, which I wouldn't recommend.)

If your current situation is not tenable for the next 4-5 years, I might look for a different apartment (further out of the city but larger, perhaps.) Save hard for the next 5 years, making the minimum payments, and then make a call when the rate change happens about what is best for you.

Answer 5

The best time to pay off a loan is ALWAYS NOW, UNLESS there are penalties for paying off the loan.

Call me old fashioned, but living debt free is the best way to live.

That new car and television can wait, save up for them while you can. Don't buy yourself deeper in debt by paying off one loan (your mortgage) with money you should have used to pay off your student loans.

That rental apartment might be small, but it's cheap. When you buy that house, you're also going to have to take into account maintenance cost, higher property taxes, you have to pay for renovations and repairs yourself. Is it worth it? Hell yes. When you have the income and savings for it. If you have to borrow yourself deeper into debt, HECK NO. And if the only way you can afford to buy that house now is by not paying off your student loans, you're not going to have the money to pay for the upkeep of your house. Wait until you get a better paying job first, and save up some money, THEN buy a house.

I lived in a small rental apartment for 10 years after I graduated before I bought the house I live in now, I never regretted it. And if the rent of that place hadn't got higher and higher until it topped the mortgage payments I'm now making, I'd not have moved for another few years (and would have paid less for my house as I ended up buying just before the mortgage crash of 2007/8).