Imagine this, you’ve signed the bottom line, you’ve earned the degree and have accumulated a hefty amount of college debt. After graduating and spending 5 years paying the minimum on your loans, you discover your balance on one of them is $5 higher than when you started, even after paying $4331.25.
It wasn’t until I decided to buy a house, that I really took a deeper look into my financial situation and realized I was making some critical mistakes in a system that was designed to keep me in debt.
According to the Institute for College Access & Success’ Project college graduates are averaging $27,000 in student loan debt. That’s just the average. I have friends with more than 150K in student loans. OUCH! Even though I didn’t have that much debt, if I had kept paying the minimum on my Signature Student Loan, I’d be pushing 40 before my loans were paid off. At that rate, my friends would be dead and buried.
So, let’s take a look and make sure you’re not being swindled and pimped.
Here’s what you need to know about your student loans:
Length: What’s the length of your loan? Remember, most loans are set up to be paid off anywhere from 10 to 25 years time. Your lender is out to make money off of you. The longer you pay means the more interest they gather.
Amount and # of loans: Seems like a no brainer, but do you know what your loan amount is at currently? Look carefully. Your lender might actually combine your separate loans into one payment making it look like you just have one loan when in reality you could have many, all at different interest rates.
Interest: Know how high your interest rate is. I have four loans and they vary in rates from 2.38% to
10.75%. High interest rates will kill you. Take them out first.
Simple vs. Compound – While it is my understanding that most student loans are simple interest, this may not be the case for all student loans. It’s important to understand how your loans are calculated. Compounded loans will accrue interest faster than simple interest.
Variable or Fixed? Are the interest rates on your loans variable or fixed? If they are variable, they could change at any time, which in turn could increase your payments with little to no warning. Take this into account when choosing which loan to pay off first.
Amortization schedule – Take a look at your amortization schedule to help you visualize your loan amount, payments, and interest accumulated over time. Seeing all of the interest paid, you will surely find the motivation to pay on your student loan debt faster.
Payments: Realize that when you make a payment it is first applied to any late payments or fees, then to accrued interest, and then to the principal balance. So, for example, even though my $75/month payment was on time, only $30 or so of it was being applied to the principal.
Action Items for Paying Off Your Student Loans
- Get organized. Your student loans aren’t the only thing you are worried about paying each month. If you haven’t already, set up a budget and goals. Mint.com is a very helpful tool to assist you with this. By pulling in your financial information from your banking accounts, credit cards, student loans, mortgage, etc. you can see what’s coming in, and what’s going out (your transactions). It’s easy to set up budgets within Mint.com, and there are even pie charts that give you a visual of where everything is going. Best part is you can also set up a goal. This is where incorporating that extra money for your student loans comes in. With anything, it’s best to plan and stick to it!
- Avalanche vs. Snowball- If you have extra money to put toward your loan (and you should) apply it to the loan with the largest interest rate first. Once you’ve paid off the highest interest rate loan, take the total monthly payment of that loan and roll it into the next highest interest rate loan, etc. This is called the Avalanche method. There is also the snowball method, which is where you start paying on the loan with the lowest total amount (to help you pay off one loan the quickest). While this is helpful to get momentum and motivation, the avalanche method helps pay down your overall debt faster and saves you the most interest total. Check out this handy calculator I found that compares the two ways: www.unbury.me. For me, Avalanche got me out of debt a month sooner, and $240 cheaper. Every little bit counts!
- Pay More Than the Minimum. You’ve heard that paying the minimums is bad, and it is easy to keep putting off paying extra. But learn from my mistake, by paying the minimum on my loans since I graduated, I’ve thrown away over $4,000 and done nothing but tread water. Note: If you have multiple loans, you should pay the minimum on all of them except the one loan you’re working to pay off first using either the avalanche vs snowball above. All your extra money should go toward one loan at a time.
- Pay on Time: Even though you may be paying your bills on time you may not actually be paying down the loan. BE AWARE OF THIS! If you can’t tell me if you know if your loan is like this or not, NOW is the time to look into it! Financial advisor and founder of Amiti Advising, Tony Aguilar, has these helpful tips to share:
“Make two payments per month, rather than one for certain types of loans to reduce the amount of interest you pay and speed up the pay-off timeline.”
“Set up automatic bank transfer, because you may reduce your student loans by 0.25%.
- Have an emergency fund. Life happens and it’s important to have some money set aside to carry you through things like car repairs and insurance deductibles, but any extra money you have should be going toward paying down your loan. It’s a matter of opinion, but if your focus is getting out from under your student loans, you should consider putting off maxing out your 401K for a few years and put your extra money toward paying down debt. If your company has a matching 401K, you may choose to invest up to the matched amount.
o As Mitch D. Weiss, a professor in finance at Hartford University, put it, “When the cost of the debt you carry is greater than the return you can reliably (and safely) earn on the money you have on deposit or invested, it would then make sense to pay down the debt with the extra cash flow you’re able to generate. Just take care to explicitly instruct the lender to apply the amount of the extra payments to principal. Otherwise, you’ll be giving your lender the gift of interest they haven’t yet earned.”
- Should you refinance or consolidate your loans? Refinancing and consolidating your loans could lower your interest rate, in turn saving you money. However, this could also extend your loan length. Make sure you ask what the total amount (including accrued interest) of the loan would be.
Most of the success stories I have heard have not been all that spectacular or creative. Those who have paid down their thousands of dollars of debt in just a few years usually scored a high paying job out of college, or worked 60+ hours a week. Living well below your means is probably the best way to pay off your loans the fastest. There’s no quick and easy way and it takes motivation, hard work, and discipline. If you have any helpful tips in paying down your student loans, please share them with everyone in the comments below. Thanks!
Special thanks to Allesandra Lanza, Director of Corporate Public Relations, and Betsy Mayotte, Director of Regulatory Compliance and Privacy for American Student Assistance for taking the time out of your day to speak with me. And thank you to Nikki Lavoie and Patricia Nash Christel spokeswomen from Sallie Mae in providing me with helpful information.