How to Decide Which Student Loans to Pay Off First

Make the best choice, and you can save yourself thousands of dollars in interest and finance charges.Image source: Getty Images.

Student loans have become one of the most common types of personal loans for borrowers to have, especially among young Americans. With about 45 million people collectively owing more than $1.5 trillion in student loans, it's not uncommon for students to have to resort to tapping many different student loan funding options in order to be able to afford their college education.

If you have several different student loans outstanding, it's important to be smart about which ones you should prioritize paying off over others. The answer is partially common sense, but there are other factors that are special to student loans that you should consider in making the best choice for your own financial situation.

The 5 factors to consider

In general, you should pay attention to these five factors in deciding which student loans you should pay off first:

  • The interest rate on the loan.
  • The size of each loan.
  • Whether the loan offers forgiveness or discharge in certain cases.
  • Whether you have a cosigner on the loan.
  • Other special provisions that apply to the student loan.

We'll look at each of these factors in turn below.

1. Interest rate

The most important factor in deciding which loan to pay off first is what the interest rate on the loan is. The faster you pay off higher-interest debt, the less you'll pay in finance charges. By paying down your highest-interest student loans early, you can dramatically reduce both the total interest you pay and the amount of time it takes to pay the loans off in full.

As a quick example, say you got a tax refund of $2,500 and have two student loans outstanding. You owe $2,500 on each and have five years to go before they're paid off, but one has a rate of 4% while the other has a 10% rate. If you pay off the 10% rate loan first, then your remaining loan will have monthly payments of $46, and you'll pay just $262 in interest over the next five years. But if you pay off the 4% loan, then the 10% will cost you $53 per month, and you'll pay $687 in interest -- $425 more.

2. Amount outstanding

One factor many borrowers look at closely is how much is left to repay on a loan. There's a psychological satisfaction involved in having a smaller number of student loans left outstanding, so paying off a lender in full is sometimes worth it even if it doesn't necessarily have the lowest interest rate. It can also give you more flexibility with your payments, because you'll have fewer minimum payments to make.

One common tactic to make your debt go down faster involves what's known as snowballing. Say you have three loans with rates of 4%, 8%, and 9%. Each has monthly payments of $100, and the 8% loan is close to getting paid off. From a pure financial standpoint, taking any extra money to pay down the 9% loan makes the most sense. However, if you get that 8% loan paid off first, then you'd be able to take the $100 you had been paying on the 8% loan and divert it toward the 9% loan. Moreover, you get the satisfaction of making concrete progress toward reaching your goal of being debt-free. Meanwhile, if something happens and you're in a temporary pinch, then with only two remaining loans outstanding, it'll only cost $200 a month to cover both payments rather than the $300 you had to pay when all three loans were still outstanding.

3. Forgiveness and discharge provisions

Certain types of student loans have different favorable provisions that you might want to take advantage of. For instance, some loans offer deferment of interest in certain instances, which means that the lender will take care of covering the interest. Others offer forbearance, in which you can stop making payments even though interest continues to accrue. In addition, different loans have a variety of provisions relating to forgiveness and discharge. Some loans let some or all of your debt go away if you work a certain period of time in certain occupations, and various loans have differing provisions when it comes to discharge of debt in the event of your death. Paying down loans that don't have those favorable provisions first makes sense, as it maximizes your chances of taking advantage of them later on.

4. Cosigners

If you have a cosigner on your student loan, then it's generally a good idea to get that loan paid down first. If you stop paying a loan that doesn't have a cosigner, then your lender generally can only go after you to try to collect the debt. But if you're unable to pay a cosigned loan, then the lender has the option of going after your cosigner's assets as well. By paying down cosigned loans first, you'll at least avoid hurting your cosigner's finances if you get into a tough financial situation.

5. Other special provisions

Finally, some student loans offer additional perks that others don't. For instance, some lenders give you a lower interest rate if you agree to have payments automatically taken from your bank account, while others don't. If the perks are worth keeping, then you'll often want to keep that loan as long as possible while paying others off.

The general rule for paying off student loans

In practical terms, what all these factors usually mean is that you'll want to prioritize private student loans over federal student loans. Federal student loans usually have lower rates than private loans, and they typically come with more favorable provisions that you'll want to hang onto rather than giving up. By contrast, private loans are more likely to have higher rates, lack favorable benefits, and require you to have a cosigner.

Paying down your student loans is a difficult task, and it can take years to get all your loans paid off. However, if you're smart about choosing which loans to repay first, it can save you a lot of time and money in the long run.