Student debt. Yes, you’ve heard all of the stories, and are probably living some version of it, or know someone who is. My sister-in-law, for one, will be an example of someone who has a lot of student debt ($100k+) when she finally finishes her graduate degree.
Recently, I was introduced to Personal Capital, an online investing and personal finance app. They're trying to help students be smart with student loan repayment by syncing assets and liabilities. We’ll all heard the stories - crushing levels of debt preventing an entire generation of buying houses, cars, etc. If you’re living this situation, what can you do?
(By the way, I do not work for them, nor am I getting paid to write this.)
There are stories of people who lived like hermits, took on 15 side jobs a week and paid down their million dollars in debt in 3 months. Yes, I’m exaggerating but those types of stories are out there. The common theme in many articles is simple - pay down student debt as fast as possible!
While many say that student debt is the priority, you may want to consider 3 other factors:
1. It’s about CASH FLOW, not just interest cost.
You hear many people talk about how much interest they’ll pay over the life of the loan(s) and how it takes forever to pay down. Those may be true, but you need to be able to survive day to day. One way to do this is to consolidate students loans and take advantage of the longer repayment plans.
Consider this example of a $35,000 loan at 5% interest.
At the typical 10 year repayment period, your monthly payment is $371 per month.
Instead, using a 25 year repayment period, your payment drops to just under $205 per month. That’s a difference of $166 per month!
Yes, you pay more interest - almost $17,000 more!
Why would someone want to do this?
You can use the difference to build up savings.
You can pay down other debt.
What is important is that if you do this, you cannot just spend the difference in monthly payment if you’re serious about getting out of debt.
Repeat after me - YOU CANNOT JUST SPEND THE DIFFERENCE. Do one of the 2 things listed just above to improve your overall financial situation.
The interest isn’t as bad as it seems. Student loan interest may be deductible on your income tax return. It’s not much, but every little bit helps. And the rate is low compared with many other types of debt you might have, such as credit cards, which brings me to my next point…
2. Focus on other debt
Chances are if your monthly cash flow is tight, you’re probably using credit cards. And if all of the stories are to be believed, many recent grads don’t have much savings nor are they paying down their credit card balances each month.
If every last dollar is going towards student loan payments, but then you have to use the credit card to buy groceries, you are effectively trading student loan debt for credit card debt. Put it another way, you are trading 5% tax deductible interest for 18% non-tax deductible interest. And that is very bad for your long term financial health.
Just think, an extra $100 balance on a credit card, the annual interest is $18. Versus an extra $100 on the student loan at 5% is only $5 in interest. In this scenario, you would be throwing away $13 per year in interest by focusing on the wrong debt. Now, just think of how much you have in credit card debt - thousands? Tens of thousands? That interest cost gets really high!
3. Improve your credit score
You might not be able to pay off all of your student debt at once, but understanding the key drivers of credit can help you with other major purchases. Two of the biggest factors in your score and ability to get loans are credit utilization ratio and debt to income ratio.
Paying down your credit cards can greatly impact your credit score. Utilization refers to your balance as compared with the credit limit. The lower the utilization, the higher your score, on average. This also means that closing unused cards can hurt your score because the combined limit of all of your cards would be lower. Consider this carefully before you just close cards - unless those cards carry annual fees - in which case, close them if you’re not using them!
Since you are paying down debt, your required debt payments may be lower, which will lower your debt to income ratio. That means the total amount of loan payments as compared to your gross monthly income. A good rule of thumb is that your loan payments should be no more than ⅓ of your income. That is, for every $100/mo in income, you should have no more than $33/mo in loan payments. Some banks will allow a higher ratio (more in debt payments) and others will require lower. This is just a guideline.
And a better credit score will allow you to borrow at lower interest rates when you need to make that next major purchase.
Student debt is a major problem. And yes, if you have a mountain of debt, it will take you a while to pay it off. Following these tips will help make that journey a little easier.
Do you agree with these? What are your thoughts? I am interested in seeing your comments below.
