College is becoming increasingly expensive and is leaving students financially crippled upon graduation. Graduates are figuring out how to pay off student loans and are postponing plans to start a family, purchasing a home, starting a business, or saving for retirement. According to debt.org, the average student loan debt in 2018 was $38,390.
The sad thing is some people look at that number and think, “It’s not that bad”. Heck, I’m one of them. Part of it is because I owed three times as much by accumulating $115,000 of debt.
No matter the size of your loan, the impact of your debt is relative to your situation and your income. Freeing yourself from these student loans quickly is difficult but doable.
The basics of student loans
Before beginning, make sure you understand the basics of student loans where you learn about the phases of student loans and severe consequences of not paying back your federal student loans.
TIP 1: Set Up Auto-pay
You can reduce your interest rate by 0.25% and will prevent any missed or late payments on your student loans. Think of this as free money.
Example: If your principal is $75,000, that’s $187.50 in your pocket that you can use to for additional payments to your principal.
Keep auto-pay while you make additional payments throughout the month.
TIP 2: Work More Now, Owe Less Later
No one likes to be told to work more, but the additional income will help you pay down your principal each month and have a greater effect on reducing the lifetime and ultimately the cost of your loans.
Ask your employer about availability for overtime and the overtime rate. Many companies will pay their current employers 1.5x their regular rate for overtime hours. Taking advantage of this may be more lucrative than working at a second job. I have done both but enjoy the second job purely because it is a change in the setting which can be refreshing when working 12 – 14 hour days.
TIP 3: Pay The Interest on Your Student Loans Before Your Grace Period Ends
The end of a grace period triggers interest capitalization where your interest becomes a part of your principal and you will be accumulating interest on a higher balance. Essentially, you will be accruing interest upon interest.
To further drive home the point of why you want to avoid capitalization, let us assume an interest rate of 6% on all disbursements. You have decided to allow your $10,000 of interest to capitalize on your principal of $75,000. If it takes you 10 years to pay off your loans, you would have paid an additional $8,000 on that initial $10,000 that you should have paid before your interest capitalized. Get rid of your interest before it capitalizes.
TIP 4: Minimize Your Expenses
Going from being a starving student to earning thousands of dollars a month is a BIG deal. It is tempting to change your lifestyle within the first couple of years of working. You might buy a new car, buy expensive new clothes, go on frequent lavish outings, or upgrade your housing situation all because of this seemingly steady income. BUT I challenge you to stay in the mindset of the starving student. I’m not saying you should be eating ramen every meal, but understand that you are still in debt. Every dollar you spend is leaving another dollar in your student loan balance digging you further into debt.
If you are a recent student, chances are you know how to be frugal. If you are used to spending $300 per month as a student, try to limit your spending to this amount while allocating everything else into your student loans. The key to successfully do this without overspending is to stay in the mindset of the starving student and avoid lifestyle inflation. By doing this, you should be able to keep your expenses low and save 50-75% of your income.
This means you may need to delay any upgrades and get creative with your housing situation. Living with family/friends, renting out rooms in your house, down-sizing, etc.
You may not have much control of what you earn, but you can gain control over how and when you spend your money.
TIP 5: Pay More Than Your Minimum Balance Per Month.
If you’ve yourself some good by applying tip # 4 by saving 50-75% of your income, you will likely be able to pay much more than your monthly minimum balance.
If you were only paying the minimum required balance, it will take you 10 – 25 years depending on your loan repayment plan. The longer the life of your loan, the more you will end up paying due to interest.
I was shocked when I learned my $97,000 loan accumulated $10,500 in interest upon graduation. I was even more shocked that I would be paying a total of $49,000 of interest if I paid the minimum balance for 10 years under the standard repayment plan. Instead, I paid $18,000 in interest as an additional $7,500 of interest accrued during my repayment phase. Most of this $6,800 on which was before I decided to no longer pursue the Public Service Loan Forgiveness Program (PSLF) – More on this later.
How your payments work: The first dollars are used to pay any outstanding interest and accrued interest that month. If you paid all your interest in a given month, any additional payments will reduce your principal balance. The lower your principal each month, the less interest you accrue each month. Since interest compounds daily, it is beneficial to pay your lender each time you bring home a paycheck. Paying more than the minimum balance becomes an increasingly powerful strategy in paying off your student loans early.
TIP 6: Avoid Income-Driven Repayment Plans (Income-based repayment, Pay as You Earn, etc)
These plans allow people who cannot afford the monthly payments under the standard 10-year repayment plan. Depending on your IBR plan, the monthly payment is 10% – 20% of your discretionary income. Your monthly payments will be determined based on your family size and earnings. In some cases, your minimum payment may even be $0. Depending on your plan, your loans may be forgiven in 20-25 years of qualified payments.
The Income-Driven Repayment Plans seems like a great option at first glance, but do not be fooled. Your smaller payments may not be enough to even touch your principal. The longer you prolong the life of your loan, the more you will owe, especially if your plan allows a minimum payment much less than the accruing interest. But who cares, your loans will be forgiven anyway right?
Yes and no. Your principal and 20-25 years of accrued interest are forgiven, but the forgiven balance is now subject to income tax. Even if your minimum payments for the last 20-25 years were $0, the total you pay in taxes that year will be well over your original loan balance (Double to triple).
One way to avoid paying taxes on your forgiven balance is filing for insolvency. Which means that if you are dirt poor before and after your loans are forgiven, you won’t be responsible for the taxes on your forgiven balance, but who wants their future net worth to be in the negatives? Student loan hero has a great post on loan forgiveness tax and insolvency.
The only way Uncle Sam will truly forgive your loans is if you qualify for the Public Service Loan Forgiveness (PSLF) program which requires at least a 10-year commitment at non-profit organizations. Learn more about the PSLF program and why I changed course.
TIP 7: Demolish Higher Interest Debt First
Avalanche Method: Work to pay off higher interest student loans first. You will reduce your average interest rate on your principal and pay less over time.
Avoid the Snowball Method where you target the smallest loans first, regardless of the interest rate. Mathematically, this method is more costly if you have more expensive loans to pay off. Some may argue that the psychological boosts for the snowball method motivate you to continue paying down your debt. I say, stop being weak. You have money muscles for a reason. If you need the psychological boost, calculate your average interest rate and watch it decrease over time along with your total balance.
Whichever method you use, you still need to pay at least the minimum payment on your other loans.
TIP 8: Pay Off All Credit Cards
Federal student loan interest rates range from 4 – 8% while credit cards generally range from 13 – 30% not including late fees.
Carrying a balance on your credits cards will slow down your path to financial freedom.
Pay off your credit BEFORE your student loan grace period ends. Then shred your cards and never apply for another one until you learn how to manage your money responsibly.
If you are now in repayment and are paying credit companies interest, shred your credit cards and slap yourself being fiscally irresponsible.
Pay the minimum balance on your student loans and allocate additional funds to your credit cards. Repeat until your credit card bill reached $0.
Advanced strategy: If you hold a very large balance on your credit card, apply for an income-based repayment plan to lower your monthly payments on your student loans while you focus on your credit card debt.
TIP 9: Consider Refinancing Your Loans For A Lower Interest Rate
Refinancing your federal loans are available through private lenders like Sofi or Credible. You can refinance and consolidate your federal and private loans into the same repayment option. When you consolidate, it will reduce the need to track multiple loans. When you refinance, you may qualify for a lower interest rate depending on your credit score and other factors. Refinancing will make you ineligible for some federal loan benefits such as claiming forbearance to temporarily pause your payments.
I would consider refinancing if the new interest rate is lower and if you are not planning to take advantage of federal loan benefits like forbearance or student loan forgiveness.
TIP 10: Deduct Your Student Loan Interest From Your Income Tax
If you paid $600 or more in qualified student loan interest in a given year, you are eligible to deduct the amount from your income tax. You will still be able to deduct your student loan interest even if you refinance.
For 2018, the maximum amount that you can deduct for interest paid on student loans remains at $2,500. This can save you hundreds a year.
Example: Your 1098 E tax form received from your lender noted that you paid $1,800 in student loan interest for 2018. If you are in the 22% tax bracket, you should receive a tax return of $396 after claiming your deduction.
For 2018, you cannot claim this deduction if your income is above $80,000 as a single filer. This limit is higher at $165,000 for married couples filing jointly. This deduction is not available to married couples filing separately.
So those students under an Income-based Repayment (IBR) plan who are married filing separately for a lower monthly payment would not be able to claim these deductions. More details on this deduction at irs.gov.
TIP 11: Use Windfalls Throughout The Year to Pay Your Loans
These include monetary gifts, tax refunds, inheritances, or settlements. When people get “free” money, it is tempting to buy the next thing on Amazon, or the new tech item they have been eyeing. Try limiting your spending to true necessities or things you would have otherwise purchased
When you stumble upon windfalls, funnel it all into your student loan payments to buy your freedom.
TIP 12: Borrow From Family and Make Interest Work For You
This may only be a consideration for people who are on excellent terms with their relatives. If you are fortunate enough to have family members who are able and willing to help you financially, count yourself lucky.
Begin by having an open dialogue before your loans even go into repayment. Discuss your strategy for paying these loans and allow them to see how financially responsible you are by your using the tactics above. Explain to them how your student loan interest rate is eating away at all your payments. Express to them that you would rather pay them back with interest than the government and see where the conversation leads. You should also develop a repayment plan for any personal loans.
Summary of How to Pay off Your Student Loans
- Sign up for auto-pay to reduce your interest by 0.25%
- Earn more money through overtime work, a second job or side hustle.
- Pay your outstanding interest before your interest capitalizes
- Consider further lowering your interest by exploring refinancing options
- Practice the starving student mindset and allocate 50-75% of your income to your loans
- Pay more than your minimum monthly balance
- Avoid sticking to repayment plans
- Pay off high-interest debts first, including credit cards
- Shred credit cards if you tend to carry a balance from month to month
- Allocate cash gifts, inheritance or other windfalls to your loan balance.
- Deduct your student loan interest from your income tax
- Explore options for taking private loans from your family with a promise to pay them back
Contribute to Your Company’s Tax-Deferred Retirement Plan Up to The Company Match
I understand your student loans are the more immediate problem but are you going to turn down FREE money? Contribute to your retirement and your future self will thank you!
Other than that, do not pour additional earnings into investments. Especially since those investments accompany uncertain returns while you have guaranteed interest building on existing debt.
Good luck and subscribe to join us on this path to financial freedom
Art is the founder of Flexcents, a blog created in 2018 to help others reach their fitness and financial goals through sharing insights as a physical therapist, personal finance nerd, and self-directed investor.