Should You Pay Off Student Loan Interest While In School?
Posted on June 12, 2006 by Her and tagged student_loan
Today we got a question from Anne, who asks,
My daughter is beginning her first year of college, and we are those awful parents who were not able to set aside anything to pay for her education. She has received a few scholarships. Only eligible for $600 in financial aid. Anyway, she will be securing a loan that we will help her with. Should we pay the interest on these loans while she is in school or just wait until she is out and start then?
Anne's question is a good one, as there are many tax laws and loan rules to consider. Here's what I suggest:
Since it sounds like you are financially able to help while your daughter is in school, give her cash gifts that equal the interest accrued and have her use them to pay off the interest early. This will allow her to take an annual interest tax deduction (you can't, unless you are the holder on the loan). If you are the holder of the loan, then you can just pay the interest yourself and take the tax deduction. In this scenario, she will graduate owing only the principal of her loan.
Alternatively, you could decide not to pay the accrued interest. After she graduates, any accrued unpaid interest will be capitalized and added to the principal of her loan. This changes the status of that money from interest to principal. This is important because this means that she cannot get the tax deduction on it anymore (the deduction is only for interest, not principal) AND she'll be paying interest on her interest. There is nothing good about this scenario.
If she is responsible for paying the accruing interest all along then she will avoid the double-interest-no-tax-break mess. In addition, paying the interest now will make the loan feel "real" to her while she's in school, so it won't be a surprise when it comes due after graduation.
Finally, Anne, there's no reason to feel awful about your decision. Children need love and support and it sounds like you are giving your daughter plenty. You did some important things right:
-You clearly defined to your daughter exactly how you can and cannot help financially, so she can plan accordingly.
-You are advocating for her and using your experience to help guide her financial decisions.
-You are being careful with your own and your daughter's finances, setting a good example for her.
Good luck to you and your daughter - she's lucky to have parents who can help her make good financial choices and advocate for her!
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Jason Stanhope | Jun 19, 2006
Unfortuneatly student loan interest cannot be claimed as a deduction if the person with the loan is being claimed as a dependent. I just graduated and was in the same shape as Anne's daughter. My parents paid the interest on the loans while I was in school so at least now I am not paying interest on interest. I was worth more to my parents as a deduction than the student loan interest deduction would have gotten me.
anon | Jul 14, 2006
You are wrong about capitalized interest not being duductable. From IRS form 970:
Capitalized interest. This is unpaid interest on a student loan that is added by the lender to the outstanding principal balance of the loan. Capitalized interest is treated as interest for tax purposes and is deductible as payments of principal are made on the loan.
tracy | Aug 26, 2006
You CAN deduct student loan interest. Line 33 on the 1040 long form is specifically for that.
Anne | Jun 13, 2006
Thanks so much for the advice. You are opening my eyes to issues I haven't even begun to think/know about. But, I am learning!!
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