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I've heard from several people that they only make the minimum payments on their student loans because they have tax advantages.
Basically, the interest you pay on a student loan is tax deductible, so it lowers the amount of money you can be taxed on, therefore lowering your tax burden. Shouldn’t I just keep making the minimum payments so I can claim the interest on my taxes every year? Short answer: no. Long Answer…
Sallie Mae, a leading provider of student loans, usually requires their student loans to be repaid in 10 years. The interest rate varies for each loan, but thanks to the Servicemembers Civil Relief Act, all credit obligations incurred before entering active duty MUST be no greater than 6% per year, including credit cart debts and student loans. So let’s say for arguments sake that your interest rate is 6%.
If you just make the minimum payments on these loans, you’ll end up paying $12,000 in interest over the 10 years! Now, the first year, when you’re paying the most interest with each payment, you’ll be able to claim $2200 of interest payments. Not bad right? Well, this $2200 is an adjustment on your tax return, so it lowers your adjustment gross income, which is turn lowers your tax due.
Many servicemembers fall into the 15% bracket, so we’ll use that. A $2200 adjustment only reduces your taxes owed by $330. And this amount will decrease every year you pay off the loan, as the interest becomes less and the principle becomes a greater proportion of the payment. So over the 10 years, you’ll possibly have $1800 of taxes removed.
Now, if instead of just making minimum payments you added $200 a month to your payments, you’d pay the loan off 4 years earlier and save $5000 in interest payments! And, you’ll still be able to claim the $7200 in interest, for a $1080 tax break.
|Minimum Payments ($397.42)||+$200 per month|
|Time to Loan Payoff||10 years||5 years, 10 months|
|Interest Paid over 10 Years||-$12,690||-$7219|
|Tax Break at 15% over 10 years||$1903||$1082|