Taking out a personal loan to pay off student loans comes with a hefty price. Shorter repayment terms and higher interest rates, for instance, are disadvantageous. That is not to say it does not offer benefits.
Unlike other types of loans, there are few restrictions on how you use a personal loan. Even so, using a personal loan to pay off a student loan is not as easy as it sounds.
For one thing, there are additional regulations governing student loans. Furthermore, it needs to comply with standards defined in the Higher Education Act. Unfortunately, most personal loan lenders do not meet these requirements.
Can You Use a Personal Loan to Pay Student Loan Debt?
The short answer is yes, you can. For sure, there are benefits to using a personal loan to pay off student loans. Even so, there are also reasons why you are better off seeking other solutions.
Before discounting personal loans altogether, take the time to review their benefits.
1. Flexible and Versatile
As alluded to earlier, you can use a personal loan for different purposes. According to LendingTree:
- There are 19.4 million personal loan borrowers in the U.S.
- The national average for a new personal loan is $6,092.
- 27% of borrowers use the money to consolidate debts.
- 20.9% of borrowers use the money to refinance credit card debts.
Under most circumstances, you can use a personal loan on almost anything. Pay for home improvements, car, business, medical bills, sudden expenses, and others.
For student loan consolidation, keep in mind that some – not all – private lenders have restrictions.
2. High Borrowing Limits
Consumer credit data analyzed by Experian in the last two years shows that the average number of credit cards held by Americans in 2020 is 3.84. Across all accounts, the average total credit limit is $22,751, broken down as follows:
- Gen Z (18-22 years old) has an average FICO score of 667 and an average total credit limit of $8,062.
- Millennials (23-38 years old) have an average FICO score of 668 and an average total credit limit of $20,647.
Based on these data, one can surmise that the total credit limit available may not be enough for many Americans to pay off their student loans entirely.
Most personal loan lenders, on the other hand, offer from $1,000 to $50,000. Some can even lend you up to $100,000.
Compared to credit cards, personal loans have much higher borrowing limits.
3. Lower Interest Rates
Personal loans have lower interest rates compared to credit cards. For first-time borrowers, though, the diverse range of interest rates might be confusing. Some lenders, for example, offer 3% or less, while others could be as high as 35.9%. As of July 2021, the average interest rate of personal loans is 10.49%.
The average credit card interest rate, on the other hand, is 16.22% as of 18 Aug. 2021, although this figure constantly changes. Typically, new credit cards have higher interest rates. Credit score also affects the interest rate. For example, a lender could impose up to 21.77% interest rate for bad credit ratings.
On interest rates alone, personal loans are far more favorable than credit cards.
4. No Collateral
Because personal loans are “unsecured,” it offers a degree of peace of mind. There is no need to put up your assets such as a property or car as a guarantee.
Make no mistake about it, though, as failure to repay comes with consequences. If anything, you still keep your home or car.
5. Easy to Manage Financial Debts
Americans have an average of almost four credit cards and seemingly countless other bills. Dealing with different interest rates and payment due dates is cumbersome.
As long as you have an excellent credit rating, you can qualify for favorable rates on a personal loan. By consolidating credit card debts, you can then streamline the monthly payments. Even better, you may even save some money in the process.
Having highlighted the pros of personal loans, you should also consider their disadvantages.
1. Not Qualified for Lower Interest Rates
Yes, some lenders generally provide lower interest rates than others. But it does not mean that they can give you the most favorable rates compared to credit cards. If you have a poor credit score, for instance, then your interest rate will be higher.
2. High Fees and Penalties
The interest rate should not be the sole basis. A financial institution may offer a lower interest rate but charge you more with other fees.
- Application Fee. Some lenders do not have an application fee. Others, on the other hand, may charge you from $25 to $50.
- Origination Fee. Upon approval of a personal loan, the lender will charge you with an origination fee. Usually, it ranges from 1% to 6%. Some lenders, though, can charge an exorbitant 8% to 10%. The origination fee will appear on your billing as part of the balance and is subject to interest.
- Payment Protection Insurance. You may have to shoulder this insurance in the lender’s best interest, usually 1% of the loan amount.
- Late Payment Fee. Some lenders may charge you $25 to $50. Others could impose a penalty of 3% to 5% of the monthly due.
- Return Check Fee. If your check bounces, then expect to be charged $25 to $50 by the lender.
- Prepayment Penalty. If you have extra cash in the future, you may consider paying off the personal loan before the loan term ends. But be aware that most lenders usually would charge you a prepayment penalty. Typically, the rate ranges from 2% to 5% of the loan amount.
3. Higher Monthly Payment
Personal loans, compared to credit cards, require higher fixed monthly payments. With credit cards, you have more leeway on how much you repay each month.
Consolidating credit card debts makes it easier to manage your monthly expenses. But it may take some time for you to adjust to the higher lump sums. For this reason, too, you have to make sure that you are financially capable of going this route.
4. Can End Up with More Debt
Consider your attitude and tendencies on personal finance. A personal loan is a debt. If you used it to clear credit card or student loan debts, you only replaced one debt with another.
What you want is to avoid spending more than you can afford. Some people, unfortunately, spend more on top of their existing loans after clearing credit card debt.
Why Is Paying Off Student Loans Early Good and Bad?
In an ideal world, you graduate from college or university without any debt. Unfortunately, it is a pipe dream for half of all American students who need student loans.
Consider these stats:
- Student loan debts rose higher than other types of household debts since 2010. By 2019, 21% of U.S. households have existing student loan debts.
- The average student loan debt per person is $37,500 as of December 2020.
The next best thing to having no debts is paying off student loans early with the above-mentioned in mind.
There are solid reasons why getting rid of existing student loans is a good idea. Here are some of them.
1. Pay Less Over the Long Term
Federal student loans and private student loans accrue interest. The earlier you can lessen or pay off the balance, the less time it takes to accumulate interest. As such, you end up paying less money overall.
2. Allocate Funds for Other Expenses or Financial Goals
Because you paid off your student loan early, that means you can repurpose money for other expenses. Instead of student loan repayment, you could now use the funds to save for retirement, buy a house or a car, and others.
3. Better Debt-to-Income Ratio
Student loans count toward your debt-to-income (DTI) ratio. Keeping your DTI low is essential in the sense that lenders consider this as a qualification for credit.
When your DTI is low, you benefit by having lower interest rates on mortgages, credit card interest rates, and so on.
In some situations, you should refrain from paying off your student loan.
1. High Monthly Payments
Apart from paying off your student loan in its entirety, the most common way of getting rid of it early is to pay more each month.
Assume, for instance, that you have an extra $100 monthly. Before thinking about student loan payments, you should also consider other essential funds.
Having an emergency fund should be one of your top priorities. Having such funds is more vital in these uncertain times brought about by the pandemic. In the U.S., 1/3 of households, including half of the homeowners making $50,000 annually, have less than $500 for emergency home repair.
As you can see, there are other essential expenses that you have to consider. These include medical bills, mortgages, and others. If there are sudden expenses, the high monthly bills may be too much.
2. Giving Up on Student Loan Forgiveness
Check if you are eligible for student loan forgiveness if you have a federal student loan. In a nutshell, this program frees you from your obligation to repay a federal loan – in part or whole.
There are more than a few options to qualify. One is to work in public service. Another is to make monthly installments through an income-contingent payment (ICR) plan.
A disadvantage of paying too early is losing the chance to avail of federal loan protections. For example, a disability or the school closing down can get student loans forgiven. If any of the qualifying circumstances were to happen after you paid off your loans, then you would have wasted a lot of money.
Unfortunately, student loan forgiveness does not apply to a private student loan.
How Else Can You Pay Off Your Student Loan?
Aside from using a personal loan to pay, there are other clever ways to get rid of student loans faster. Here are several strategies you can use.
1. Generate More Income
Quite simply, a loan is a debt that you would have to pay – no ifs, no buts. At best, you can pay off your debts at the soonest possible time to get them out of the way. While at it, you also want to reduce total interest payments.
The only way you can achieve that is by increasing funds dedicated to paying off your student loan.
Here are some ways to do that.
- Reduce Cost of Living. Review your personal finance and see which expenses you can cut off. Anything unnecessary or luxurious, you can put the funds to better use. Although you may be sacrificing your lifestyle, you gain far more benefits in the future.
- Extra Source of Income. How much spare time do you have? Consider an additional job to earn money on the side. For instance, you could try working as an online freelancer.
- Get a Job with Student Loan Assistance Benefits. When job hunting, consider companies that offer such programs.
- Bonus, Refund, and Other Cash Windfalls. Any cash windfall or tax refund you receive, use them to pay off your student loan.
2. Pay More Monthly
There is no limit on how much monthly payment you make. Even though a loan agreement includes the number of years and monthly dues, most loan servicers do not charge extra if you were to pay off your debt early.
To illustrate how much you can save, here is a rough estimate:
- Loan amount: $38,000
- Loan term: 10 years
- Interest rate: 6%
Over ten years, your monthly due is $421.88 (before taxes and fees). The total interest paid would amount to $12,625.35.
Assume, for instance, that you could throw in an extra $100 each month.
Your monthly payment would be higher at $521.88 (before taxes and fees). However, the total student loan interest payment you made would be significantly less at $9,365.59.
In other words, you can save $3,259.76 from your student loan.
3. Use Autopay
Take advantage of automatic payments. Most likely, your loan servicer offers a 0.25% discount to ensure you do not miss paying on your due date.
Now, 0.25% may not sound so much. Still, it is worth over $100 throughout your student loan.
4. Avail of the Public Service Loan Forgiveness (PSLF)
One difference between federal and private loans is that only the former may qualify you for the PSLF. This program is one of the best ways to lessen or get rid of student loans fast. In essence, you can be eligible for up to 100% loan forgiveness by working in public service at the federal, state, or local government agency.
Student Loan Hero has an excellent list of student loan forgiveness programs that you can review.
Why Is Refinancing Student Loans a Smart Move?
Whether student loan refinancing is beneficial or otherwise depends on market circumstances. However you look at it, you are merely replacing debt with debt. The key here is to take advantage of favorable interest rates so that you end up with savings – not more debts.
The credit score is another factor you need to consider. Some students may have availed of high-interest loans due to lower credit ratings. Over time, their credit score may have improved, thus qualifying them for lower interest rates. If you are in a similar situation, then you should consider student loan refinancing.
As of August 2021, the prevailing student loan interest rates are favorable. Here are some benefits you can expect.
1. Save More from Lower Interest Rate
To revive the economy, the Federal Reserve is keeping lower interest rates steady. Although they may have to increase the interest rates in the future, it is not likely to happen before 2023.
Refinancing your student loans with a lower interest rate can save you thousands of dollars – potentially.
Here is an example of how significant the savings could be:
The total interest amount paid for $38,000 with a 10-year term at a 6% interest rate is $12,625.35.
If the interest rate goes down by 2%, the total interest amount paid would be $8,167.78.
The total amount saved would be a staggering $4,457.57.
Apart from huge savings, student loan refinancing also gives you the option of choosing variable interest rates. Bear in mind, though, that this is favorable only when the likelihood of a further decrease in interest rates in the future is high. It can be counterproductive if there is a hike soon.
Note: You would need a low DTI and an excellent credit score (usually 660 or above) to qualify for lower interest rates. As an option, you may find someone who does qualify to co-sign for you.
2. Consolidate Monthly Student Loan Payments
It is not uncommon to have multiple loan servicers – both federal and private. As such, it is a hassle to keep track of payments.
With student loan refinancing, you are effectively consolidating all loan servicers into one. Managing your monthly expenses then becomes less confusing and certainly far more convenient.
As beneficial as refinancing student loans sounds, it also has some serious drawbacks that you need to consider before making a final decision.
1. Locked Repayment Plan
With federal loans, you can change the repayment plan. For example, you can switch from a standard 10-year repayment plan to an income-based 20-year repayment plan.
Once you refinance federal loans, you lose that flexibility. The only way for you to change your repayment plan is to refinance for the second time.
2. Forego Student Loan Forgiveness
Refinancing servicers do not have student loan forgiveness options. Do take the time to think through the consequences of letting go of this opportunity.
On the plus side, refinancing companies allow you to stop making payments in case of financial setbacks. The Department of Education, for example, allows several ways in which you may qualify for up to three years of forbearance.
Unfortunately, these deferment and forbearance options do not compare to the benefits of student loan forgiveness.
One thing you can do is to consolidate all private student loans while avoiding refinancing federal loans.
Should You Use a Personal Loan for Student Loan Repayment?
You can find a personal loan servicer that allows you to use the funds to pay off student loans. That being the case, then yes. But the more important consideration is whether it is the best solution for you or not.
Before deciding, consider how paying with a personal loan compares with refinancing a student loan debt.
- The national average interest rate for U.S. personal loans is more than 10%. In comparison, you can negotiate for a 4% or lower interest rate when refinancing.
- Personal loans offer flexibility, high borrowing limits, and not requiring collateral. When used to pay off student loans, these advantages are not any better than refinancing.
- The biggest drawback of paying off federal student loans is letting go of the student loan forgiveness program while still in debt. As a consolation, you can find employers with student loan assistance programs. No company, meanwhile, will cover even a tiny amount of a personal loan.
Yes, you can use a personal loan to pay off student loans. But doing so may be disadvantageous. On interest rates alone, it is evident that refinancing is a much better option, with the difference potentially reaching several thousand dollars.