Dear Penny: Should I Use Student Loan Forbearance to Pay Off Other Debt?

Dear S.,

For scores of people who are struggling right now, forbearance offers much-needed relief. But for people like you who haven’t been affected financially by COVID-19, this is a welcome chance to get ahead.

Real quick, here’s what’s going on with student loans: All student loans owned by the federal government were automatically placed in forbearance on March 13. Payments are suspended through Sept. 30. No interest is accruing. If you made a payment after March 13, you can even request a refund from your servicer.

So that means that you can take advantage of this time to make more headway on debts that are still accruing interest, or keep paying your student loans so that your entire payment will go toward the principal, not interest.

But I’m not convinced you should do either of these things. You say you’re able to work from home and haven’t lost any income. I sincerely hope your situation stays this way.

Still, before you put this money toward debt, I have to ask: How long could you stay afloat if you lost your job tomorrow?

The crisis we’re in has taught us just how essential it is to have an emergency fund. More than 30 million jobs have been lost, and many of those people are still waiting on unemployment benefits to arrive.

If you don’t have an emergency fund that could get you through three to six months without a paycheck, I’d urge you to consider putting what you usually pay toward your student loans into a savings account instead. An emergency fund helps you avoid debt because you won’t need to put expenses on a credit card if your income drops suddenly.

But if you have healthy savings and your job is secure, I’m all for using the forbearance period to tackle debt.

If you have credit cards, I’d suggest starting there, because for most people, debt on a credit card has the highest interest rate. Try putting your usual payment toward the highest-interest balances you have. If you pay off the highest-interest balance, move onto the one with the next-highest interest rate. In debt payoff circles, this is known as the debt avalanche method. 

An added benefit to paying off credit cards is that it lowers your credit utilization ratio, provided that you don’t run up the balance again, which boosts your credit score.

Of course, private student loans aren’t covered by the automatic forbearance. So if you have them, you might consider using this reprieve to chip away at those balances that are still accruing interest.

I do think it makes sense to keep paying down your federal loans so you can tackle as much of the principal as possible if you don’t have high-interest debt — with two exceptions.

If you’re on an income-driven repayment plan, your suspended payments will count toward forgiveness. If you’re working toward Public Service Loan Forgiveness and you have a Direct Loan, your suspended payments will also count toward forgiveness, so long as you’re still working for a qualifying employer, like the government or a nonprofit. 

Translation: If you made your payments through the forbearance period and ultimately qualified for forgiveness through either option, you would have thrown six months’ worth of payments away. So for those enrolled in either program, a better option may be to put the money in a savings account. If you left either program, you could then apply the money you saved toward your loans.

Student loans are an already complex topic, but the temporary forbearance makes it even more confusing. The Department of Education has a frequently updated Coronavirus and Forbearance Info for Students, Borrowers and Parents FAQ on its website, studentaid.gov, that’s pretty informative and easy to understand.

Regardless of what you choose, it sounds like you’re in a good position to use this time to improve your finances. Whether you put your freed-up cash toward savings or debt, you’ll be making a wise decision.

Robin Hartill is a certified financial planner and a senior editor at The Penny Hoarder. Send your tricky money questions to [email protected].