Getting a college degree that will lead to a great job is the goal of every college student. But one of the cold realities of college is that it usually comes with a lot of debt. Debt that takes years to pay off.
Since a college grad's student debt is usually quite large and also long term, it's important to take advantage of every money saving opportunity that's available to you.
For instance, employers often have programs that will help you pay back some of your student debt. There are also programs that will forgive a portion of your debt if you remain in that career field in a specific location for a minimum amount of time.
Another option is the student loan interest deduction that you can claim on your tax return.
Although this sounds like a simple method of getting back some money, the student loan interest deduction doesn’t apply to every loan, which means not every person with a student loan can take advantage of it.
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The Nitty Gritty of the Student Loan Interest Deduction
A college grad that can deduct student loan interest can do so even without itemizing deductions. This is perfect for the recent graduate that isn’t a homeowner and has no need to itemize deductions.
You can deduct up to $2,500 of the student loan interest that you have paid during the tax year as long as you aren’t “married filing separately.”
A college graduate using this status can only deduct $2,500 total, even if both spouses are repaying student loans.
- If you’re single, you can’t make more than $80,000 annually.
- If you’re married, your combined income can’t exceed $160,000.
- If you’re single and earn more than $65,000 per year ($160,000 if you’re married), the amount you can deduct is reduced.
You can deduct loan interest only if a qualified lender granted the loan. If a family friend gives $20,000 to put toward your college education, you can’t deduct the interest they may charge in the repayment of that loan.
If your employer has a program in which it lends you the money to pay back student debt, you can’t deduct any interest charged to you.
As long as a qualified lender made the loan and not a good-willed person, you can deduct the interest.
The interest can be deducted on the minimum payments you have made, as well as extra payments toward the loan.
There is also a question as to whether it is the parent or the student who can take the deduction. The IRS says the person who can take the deduction is the one whose name is on the loan.
Another catch is that the institution the education was obtained from must be an eligible institution.
Pay Off Student Loans Early
There are some other factors to consider.
For instance, don’t delay paying off your student loans as fast as you can just because you want to claim a tax deduction. Deductions aren’t tax credits, so the overall benefit isn’t as high. A deduction simply reduces your taxable income.
It's almost always in your best interest to pay off your student loans as fast as possible so you don't have that debt looming over your head.
Student debt is why a college grad may not be able to buy a home anytime soon.
If you have $40,000 in student loan debt, that $40,000 is being considered in your debt-to-income ratio. Lenders won’t lend on a car, home, or much of anything when the debt-to-income is too high.
They see a high debt-to-income ratio as a possible inability to pay.
Even a student with loans in deferment will find that student loans still affect the debt-to-income ratio.
Here is an idea to pay off those loans sooner: use the money you save from the student loan interest deduction to pay down your debts even faster.
Using your tax refund to pay down debt is a really smart money move. Prolonging a student loan just because of tax benefits costs more in the long term, which means it’s a longer wait to achieve some of life’s basic achievements, like home ownership.
David Chen, Contributor to and Founder of Millennial Personal Finance
Resources that may help you:
- LendEdu: Compare Student Loan Refinance Companies for Free without Hurting Your Credit
- LibertyTax Service: A Simple Way to Do Your Taxes Online & Save Money
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