What Should You Do with The Money You Save with Student Loan Forgiveness?November 4, 2022
In August, the Biden Administration announced financial relief for millions of people with student loans.
Specifically, up to $20,000 in student loan debt will be forgiven for eligible borrowers. The Department of Education website has a link that enables borrowers to apply for this forgiveness, and applications must be submitted by December 31, 2023.
The Biden Administration is also reducing payments for undergraduate loans by creating a new income-driven repayment program and improving the existing Public Service Loan Forgiveness program.
The White House has estimated the change to income-driven plans will lower the average student loan payment by more than $1,000 for both current and future borrowers. And for those whose debts are forgiven, federal student loan payments could disappear altogether, freeing up an estimated $150 to $300 per month for borrowers.
This is a lot of extra money, and it’s important to use it wisely. So, the big question is, what exactly should you do with the cash you are saving once your student loans have been forgiven or your payments lowered?
Here are a few possible options.
Repay other debts
If you have other debts besides your federal student loans, you may want to consider using the money freed up by student loan forgiveness to help pay them down.
Making extra monthly payments to your credit cards, car loan, or other creditors could save you a fortune on interest and help you to become debt-free faster. The sooner you pay off these other debts, the sooner you can do more to accomplish other financial goals since you won’t be wasting money paying financing charges.
It’s also important to remember that the Biden Administration’s loan forgiveness plans only apply to federal student loans. You will still have to repay private loans as promised. You may wish to use some of the money freed up from federal loan forgiveness to make extra payments to your private loans to eliminate your student loan debt for good.
Refinancing could make this process easier if your private student loans are currently at a high-interest rate. Refinancing would involve getting a new loan and paying back existing debt with the proceeds. If you can reduce the rate you’re paying by refinancing; your extra payments will do even more to reduce the principal balance on your loans quickly.
Save for emergencies
Dealing with high-interest debt is most likely the first priority, but if you don’t owe a lot of money to credit cards or have other loans with high rates, then you may want to prioritize saving for an emergency fund with your extra money made available due to loan forgiveness.
Most experts recommend that you have enough saved to cover three to six months of living expenses. If you have less than this amount, you could bulk up your account quickly with the money freed up by Biden’s plan.
Saving for emergencies with money can give you more peace of mind and enable you to avoid debts when surprise expenses happen or if you experience a decline in income.
Save for retirement
You’ll likely want to have a fully funded emergency fund before beginning to invest too much. Otherwise, when something goes wrong, you could be forced to sell your investments at a bad time to cover the bills.
But once you have enough money to be prepared for surprises, retirement savings is another top priority to work on. Saving for retirement is crucial because you cannot live on Social Security benefits alone. These benefits are designed to replace 40% of pre-retirement income, not the 80% to 90% most experts say you need. They simply aren’t meant to be your sole income source.
The sooner you begin investing for retirement, the easier it will be to save up enough money to supplement your retirement benefits and provide a comfortable life when you are a senior. And the more you invest, the more your money can work for you. As your investment returns are reinvested, you’ll benefit from compound growth once those returns earn returns of their own.
Putting the extra money available thanks to loan forgiveness into a retirement account can not only help you to reap the advantages of compounding, but you may also qualify for tax breaks for retirement investing as well. Both 401(k) and IRA accounts come with generous tax advantages that will make your contributions go further.
Save for other major financial goals
Finally, if you are saving enough for retirement, have an emergency fund, and have paid down high-interest debt, you may want to redirect your former federal student loan payments to other financial goals.
These could differ depending on your situation. For example, many people want to buy a house, but student loans may have been standing in their way. Thanks to loan forgiveness, it should hopefully be easier to save a down payment and easier to qualify for a mortgage since you won’t have to worry about your federal student debt affecting your debt-to-income ratio.
Each of these options could potentially help you to get ahead financially, so be sure to choose wisely. And if you want to get proactive about dealing with the rest of your student loan debt after federal loans are forgiven, you should think about refinancing your private loans to reduce the cost of repayment on those as well.
If you move forward with reducing private loans while the federal government is helping with federal student loan debt, you can put yourself in a great financial position to thrive in your future.