A lump sum or additional payments?
Borrowers can repay their student loans in several ways, from refinancing to using popular repayment strategies such as snowball or avalanche. Two additional methods are to make a lump sum payment or to make additional payments.
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Is either method the best way to pay off student debt? GOBankingRates takes a closer look at some of the pros and cons associated with using a lump sum or additional payments to pay off student loans.
Lump sum and additional payments: what’s the difference?
Don’t know the difference between paying a student loan with a lump sum and additional payments? Here’s what each term means.
A lump sum payment is a one-time payment. It can be any amount of money. If you receive a bonus at work, for example, this one-time payment can be used to pay off a loan with a high interest rate. Depending on the size of the premium, the lump sum payment may even have the ability to completely pay off student loan debt. A person who receives a corporate bonus of $5,000 and has a student loan with a balance of $5,000 would be able to repay the loan in full.
Additional payments mean the debt will be paid off faster, but not all at once. For example, if you make 12 monthly payments a year on your student loans, you could budget for an additional $100 payment every three months. That means you’ll make 16 loan payments each year and pay an extra $300 for the balance. You can pay off your debts faster by using additional installments.
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Lump sum and additional payments: pros and cons
Lump sum payments and additional payments share the same advantages and disadvantages.
Both offer borrowers the ability to pay off their loans quickly and save money in accrued interest. On the other hand, there is an argument to be made that this money could be used for other purposes. Some argue that using excess cash to pay loans instead of applying it to another area of your life, such as paying off credit card debt or saving for a down payment on a house , can restrict your personal cash flow.
Christine Nguyen is a product manager at Highway Benefits, a company that helps make it easier for employers to repay student loans tax-free as an employee benefit. Nguyen said any extra payment above your minimum monthly payment helps you pay off student loans faster. Depending on the payment amount, borrowers can save hundreds to thousands of dollars in accrued interest over time.
Make sure that additional payments are explicitly applied to your current loan principal, as opposed to future payments. (That’s not so much a “con” for making a lump sum or extra payments as a caveat.)
“Some loan servicers will automatically advance your next payment due date when they receive an additional payment, unless they are explicitly told to apply it in a certain way,” Nguyen said. “When this happens, additional payments will be credited to your future monthly minimums instead of decreasing your outstanding loan principal. Principal is what accrues interest over time.
Is it better to pay student debt using a lump sum or additional payments?
The answer to this question ultimately depends on your situation.
Professionals who receive year-end bonuses might decide to use that lump sum to pay off high-interest student debt. Extra payments might make sense for someone who recently received a raise and plans to contribute an extra $50 each month to student loans.
If you decide to start making additional payments, remember that these are less of a one-time financial commitment and more of lump-sum payments. Although there is a bit of flexibility in deciding how much extra you want to pay, Nguyen recommends paying attention to other factors such as the interest rate on your loans, refinanced interest rates, deductions taxes you wish to claim on your interest payments and any other future financial goals.
Those who are unsure whether to make a lump sum payment or focus on additional payments are advised to consult a financial advisor or tax professional for advice.
Some borrowers may not even need to consider these options.
“If you’re lucky enough to work in an industry that qualifies for student loan forgiveness programs or work for a company that offers student loan repayment benefits,” Nguyen said, “take advantage of one or the other might be a better way to pay off your student debt while still being able to invest in other areas of your life.
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This article originally appeared on GOBankingRates.com: Paying Off Student Loan Debt: Lump Sum or Extra Payments?