Wednesday, August 09, 2006

Why that Tax-Deductible Student Loan Interest is Wasting Money!

You might love the debt you have on your student loans. Financial Planners generally like it too. It's for a good cause. It's cheap. And it's usually tax deductible. Now here's the kicker: many students don't actually get to deduct their student loan interest. Now you are probably screaming at the computer! What am I talking about? When many people file taxes, they are not actually taking advantage of the student loan interest deduction.

What do I mean? Well in many cases, people pay their student loans on-time frequently and are not able to deduct them as part of their taxes. This is because when deductions are calculated for tax purposes, many people (especially young, recent graduates) do not itemize their deductions. And this is smart; here's why:

In general, each year there is a generic amount of money as a standard set by the government in order to make life easier on taxpayers. So, instead of tracking deductible expenses throughout the year, most people simply choose to take the standard deduction. Sometimes, even people who track expenses end up taking the standard deduction because it works out better for them. H+R Block tends to allow you to do a nice comparison between the standard and itemized deductions.

People who do not have enough deductible expenses often do not have any of the common expenses that can be deducted on taxes like a home mortgage, a deductible set of moving expenses, business expenses, a child etc. And therefore, the standard deduction is best. In fact, in the case of people who are not able to deduct these additional expenses, the standard deduction is usually higher than the only deduction they have: their student loan interest.

What this means, is that for calculation purposes, often-times, unless you really itemize your deductions at tax-time, you must consider that student loan interest to be no different than other interest in terms of evaluating how and when to pay it off. Therefore, much like a mortgage or other debt with 'tax-deductible' interest. When deciding which debt matters more in terms of paying-it-off first, don't be too quick to rule out your student loan. If you aren't getting a genuine benefit from the tax-deductible interest, it might actually be worth considering it for early and/or additional payments, just like any other debt you might have.

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