Which Student Loans Should You Pay Off First? Interest Rate Is Only One Factor

For federal loans, the order is already set for you: servicers send extra money to your highest interest rate loan unless you tell them otherwise. What can reasonably change that order has little to do with the rate. It is whether a loan is private, whether someone co-signed it, and whether it is headed for forgiveness.

• The highest-rate method is the federal default. Paying smallest balance first is the choice that takes an instruction.

• Private and co-signed loans often move up the order. Private loans have no federal safety net, and a co-signed loan keeps someone else liable.

• A loan headed for forgiveness is where extra money earns least. Paying it down reduces a balance that may be cancelled.

• You do not have to prepay at all to follow an order. Saving the extra and paying a loan off in one payment is a third approach.

Federal loan servicers apply extra money to your highest interest rate loan first, unless you direct it somewhere else.

MOHELA, Nelnet and Edfinancial all publish the same default. Once your current amount due is paid, any excess goes to the loan with the highest rate. When two loans share the highest rate, the unsubsidized loan comes before the subsidized one. On a consolidation loan, extra money goes to the unsubsidized portion.

That default is the highest-rate method, applied automatically. A borrower who wants to pay off the smallest balance first, or to target one particular loan, has to give the servicer an instruction. Nelnet and Edfinancial call it a special payment instruction; MOHELA calls it payment directions. Either can be set for one payment or as a standing rule, and the mechanics are covered in what happens when you pay a student loan early.

The default only reaches loans at that servicer. A private loan is a separate account with a separate lender. No federal servicer can route money to it, so paying down a private loan is always a deliberate decision about where to send the payment.

A private student loan carries none of the protections built into federal loans, which is a reason it can come ahead of a federal loan with a higher rate.

No income-driven repayment. A federal loan’s payment can be recalculated from your income if it drops, in some cases to zero. A private loan’s payment is set by its contract.

No forgiveness. Federal loans can be cancelled through public service forgiveness or at the end of an income-driven plan. Private loans have no equivalent.

No federal right to pause payments. Any forbearance a private lender offers is its own program, on its own terms, not a right written into federal law.

Generally no disability discharge. Federal loans can be discharged for total and permanent disability. Federal law does not require private lenders to offer anything comparable, and most do not; a few run discretionary programs, and a small number of places, including the District of Columbia, now require it by local law.

The trade is rate against protection, and income stability decides how much the protection is worth. A private loan at a lower rate can cost less in interest than a federal loan at a higher one and still carry more risk, because nothing cushions it if your income falls. The question underneath is how likely your income next year is to look like your income this year.

When that likelihood is high, the order can flip. A borrower with a high, steady income and a low-rate private loan may reasonably put extra money toward a higher-rate federal loan instead, because the federal protections are less likely to be needed. That reasoning holds only as long as the income does, and careers differ a great deal in how steady their income is.

If a private loan has a co-signer, that person owes the full balance alongside you, and for many families that decides the order before the interest rate is even considered.

The decision is usually about the relationship, not the rate. A parent or relative who co-signed is exposed for as long as the loan exists, and getting them off it is often the goal in itself. A higher-rate federal loan in the borrower’s name alone exposes only the borrower.

Federal flexibility is what makes that order possible. When the federal loans sit on an income-driven plan, their payments stay manageable, which leaves room to send extra money to the co-signed private loan.

Paying the loan off ends the co-signer’s obligation entirely. Some lenders also offer a co-signer release after a run of on-time payments, subject to their own conditions. The routes to getting a co-signer off a loan are covered in student loan co-signer release.

Some relief for the borrower does not reach the co-signer. Federal law requires a private lender to release a co-signer when the student borrower dies. A discharge for the borrower’s disability is different: where a lender offers one, it can keep collecting from the co-signer, although the District of Columbia now requires both to be released.

A federal loan that is on track to be forgiven is the loan where extra money earns the least, because paying it down reduces a balance that may be cancelled.

Extra payments do not lower an income-driven payment. That payment is calculated from your income and family size, not your balance, so a smaller balance leaves the monthly bill unchanged. It only shrinks the amount cancelled at the end.

Extra payments do not speed up public service forgiveness either. That program counts qualifying monthly payments over time, not dollars. MOHELA says so directly on its own payment page.

So where a borrower has both, the forgiveness-track loan is the one extra money helps least. Money directed at a private loan, or at a federal loan that will be repaid in full, changes what the borrower pays; money directed at the forgiveness-track loan mostly does not.

That logic runs in both directions. A borrower on a forgiveness track with private loans alongside has a reason to keep the federal payment as low as the rules allow, including by lowering adjusted gross income, and send what that frees up to the private loans. How a pre-tax retirement contribution can lower an income-driven payment is covered in pay off student loans or invest.

This depends on actually reaching forgiveness. Most borrowers who start with small balances repay them in full before the clock runs out. Whether you are likely to reach it is covered in should you pay off student loans early, and what waiting costs overall is in pay off student loans or wait for forgiveness. On the Repayment Assistance Plan, paying ahead also suspends that plan’s interest waiver and principal match for the months paid ahead, unless you decline the due-date advance.

Paying the highest rate first costs less in total interest; paying the smallest balance first closes whole loans sooner.

Highest rate first, often called the avalanche method, puts every extra dollar where it stops the most interest. Over the life of the loans it produces the lowest total cost. For federal loans it is also what the servicer does by default.

Smallest balance first, often called the snowball method, ignores the rate and clears the smallest loan, then the next. It costs more in interest, and in exchange a loan disappears sooner and there is one fewer account to track. The sense of progress from closing a loan is a real reason people choose it, and a plan someone sticks with can outperform a cheaper one they abandon.

The difference in cost depends on how far apart the rates are. Undergraduate federal loans from the last three years carry 6.53%, 6.39% and 6.52%, which leaves little to choose between them. Loans from earlier years can differ by more than a point, and a private loan at a much higher rate widens the gap further.

Both methods above assume extra money goes to a loan the month you have it. A third approach keeps making the minimum payments, holds the extra in a savings account, and pays a loan off in one payment once the account can cover the whole balance.

The cost is some additional interest. While the money sits in savings, the loan keeps accruing at its rate and the savings earn their own, usually lower, rate. The cost is roughly the difference between the two, on the amount being held.

What it buys is the choice. Money sent to a loan is gone the moment it is paid, even if a job ends or a bill arrives the next month. Money held in savings can still cover either, and it can be committed to the loan when there is enough to close it entirely.

It also sidesteps the mechanics of paying ahead. A loan paid off in full closes, so the due-date advances and the Repayment Assistance Plan subsidy problems that come with partial prepayment never arise. The one number needed on the day is a payoff quote, since interest accrues daily. How that works is covered in paying off a student loan in a lump sum.

Once you are in repayment, a subsidized and an unsubsidized loan at the same interest rate cost exactly the same to carry.

The subsidy covers specific periods, and active repayment is not one of them. The government pays the interest on a subsidized loan while you are enrolled at least half-time, during an authorized deferment, and for most subsidized loans during the six-month grace period. An unsubsidized loan accrues interest through all of those. During ordinary repayment and during forbearance, both accrue interest the same way.

The difference is protection against a future deferment. If you later qualify for a deferment, only the subsidized loan stops accruing. That is why servicers break a rate tie toward the unsubsidized loan: it is the one that would keep accruing. How the two loan types differ when borrowing is covered in subsidized versus unsubsidized loans.

A handful of facts set each loan’s place: whether it is federal or private, whether it has a co-signer, whether it is on a forgiveness track, its interest rate, and how steady your income is likely to stay.

1. Every loan, listed. For each: the servicer or lender, whether it is federal or private, the interest rate, the balance, and whether anyone co-signed it.

2. Any federal loan on a forgiveness track you are likely to reach. Extra money helps that loan least.

3. Any loan with a co-signer. Paying it down is the one route that reliably frees that person.

4. Each private loan against the federal ones, on rate and protection together, weighted by how likely your income is to hold.

5. Rate, balance, or saving up, for what remains. Highest rate first costs least in interest; smallest balance first closes loans sooner; saving up to pay a loan off in one payment keeps the money available until it can close one.

6. Match the servicer’s instructions to the order. Unless the order matches the highest-rate default, a special payment instruction or payment direction is what puts it into effect.

The student loan payoff guide covers the other decisions in the same family.