Outsmarting your student loans

Woohooo you graduated! Things are great! You have that coveted degree (or two) and you never have to take an exam again! Yeah!

Just one thing though…you still have to pay for that degree. For new graduates (regardless of your field) this can be daunting. When I first calculated my loan repayment amounts I had to pour myself a stiff drink for the shock…yikes. The number was pretty high- almost as much as my rent! That is with scholarships, working multiple jobs, eating lots of beans and living a very slenderized lifestyle! It’s not easy being edumacated, that’s for sure.

Luckily, things aren’t as bad as they seemed. First of all, there are a number of repayment plans that are a little more forgiving than the evenly-spaced-repayment-over-ten-years plan. These alternative plans have encouraging titles, such as “Pay as You Earn,” and “Income Based Repayment,” and they will make paying back your loans a lot more tolerable (at least at first, while you are still working internships while waiting tables on the side). By signing up for one (the paperwork takes a few months, so be prepared) I expect to reduce my required payments by about 75% each month. Some service jobs (government work, teaching etc. etc.) allow forgiveness of the remainder of your loans after 10 years of steady payments (but don’t bet on this! It is still better to pay loans off more aggressively than to assume you will have them forgiven 10 years from now).

Now, that doesn’t mean I shouldn’t be paying more than the minimum, if I can afford it. Paying any more than the minimum (even if it’s just $50 more each month) will save you quite a bit in interest in the long run. The more aggressively you pay back your loans, the less you will pay in interest and the sooner you can move on with your life.

Speaking of interest- if you can afford to pay more than the minimum, all of your extra payments should go towards the loans with the highest interest rates.

Here are a few tricks that will lessen the total cost of your loans and that will not burden you one bit:

  • Loan servicers often offer a slight (.25%) discount on interest if you sign up to have your loans taken directly from your bank account. It is automated (yay! No worries and no late payments!) and a .25% reduction in interest on a 10 year, $50,000 loan comes out to be nearly $1000. I’d like a spare $1000, would you?
  • Consider making your loan payments biweekly instead of monthly (this is especially good if you get paid every two weeks). This way you sneak in an extra month’s worth of payments without even noticing the difference in your paycheck. Suppose you pay $500 each month. $500 x 12 monthly payments= $6000…versus $250 x 26 biweekly payments = $6500. On a 10 year $50,000 loan at 7% you will pay your loans off in 9 years and save $2100 in interest. You never even noticed the difference.

Boom. I just saved you $3100 (and a year’s worth of making payments!) You can thank me in your Oscar acceptance speech.

  • Have a relative with some spare cash? If you are responsible, have a steady income and have a good relationship with this family member, consider offering them the following: they pay your loans off up front and you pay them off to the family member at a slightly lower interest rate. If you were paying 8% on your loans before, offer your relative 5% interest. Set up a formal agreement with a payment plan (loan calculators are just a google away!) If you have proven yourself to be responsible, this could be a win-win: you get a lower interest rate on your loan, your family member gets a guaranteed 5% return on their investment. This won’t work for everyone, but it is an option to think about.

Just remember- even the president had crippling student loans. It happens to everyone (well, not those lucky trust fund babies…) but hopefully these tricks will make repayment a little easier on you.

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Saving for Retirement without a 401k

So far in my life, I have had some pretty stellar jobs (one year I wrote “shark wrestler” when describing my job to the IRS on my tax forms).

Stellar jobs, yes…but so far no 401k has come my way. I am very aware that investing early will lead to much more wealth in retirement because of the miracle of compound interest. I don’t want to miss out on that extra giant pot of money, but how are you supposed to save for retirement without a job that gives you benefits?

The answer is a Roth IRA. It is named after Senator William Roth (DE), who led the fight to help create this awesome savings tool. IRA stands for Individual Retirement Account. Not so tricky!

A Roth IRA is the best choice for twentysomethings. A Roth IRA is a diversified set of investments (similar to a 401k in this way), but the biggest difference between a Roth IRA and a 401k is that a 401k is funded with pre-tax money, and then you are taxed when you take the funds out. A Roth IRA is funded with money you have already paid taxes on. You let the ca$h money sit in there for at least 5 years, and when you take the money out (as long as you are older than 59 1/2) YOU DO NOT HAVE TO PAY ANY TAXES ON IT. NONE. You don’t even have to pay taxes on the compound interest that you have earned. This is an awesome deal!

There is also something called a traditional IRA, but if you are young and expect to make a ton in compound interest (which you do)- then go for a Roth IRA. A traditional IRA is funded by money that is not taxed when you put it in, but when you take the money out you pay normal income tax.

I am a full-fledged Roth IRA fan but there are (very few) reasons why you would choose a traditional IRA instead.

  • Roth IRAs have income limits. If you make over $95k individually or $150k as a couple, you can’t get a Roth IRA. So go with traditional.
  • If you are making a lot of ca$h money now, but you expect to be in a lower income bracket when you retire, you can save on your tax bill by not paying taxes on your investment now (in the higher bracket) and paying them later (when you retire). If you are in your 20s, however, your interest should be massive and you will pay a lot of taxes on that interest (and also can you say for certain what kind of money you will be making when you retire? Please. Just go for the Roth IRA)

Are you convinced a Roth IRA is an excellent choice? Me too. Here are some things to know:

  • In 2014, you can contribute up to $5,500 to your Roth IRA each year. The more you invest at an early age, the better your compound interest will treat you!
  • If you are married, both you and your spouse can have a Roth IRA even if you only have one income (which means double the potential for investing!)
  • You can always take out the initial contribution that you had invested without penalty. This makes the Roth IRA kind of like a secret savings account for yourself- except compound interest is so good I do not recommend that you do this except in extreme emergencies (you have already tapped out all of your other savings accounts)
  • You can set up your Roth IRA to automatically reduce the risk in your portfolio as you get closer to retirement, so you don’t even have to worry about anything. I just picked that option when I opened my Roth IRA and I don’t ever have to fiddle with it (unless I want to, of course!). Extremely low maintenance.

If you want to take out more than your initial contribution (the interest that your money has earned) you will pay a 10% penalty if you are not 59 1/2 yet unless you are taking it out for any of the following reasons:

  • Educational expenses
  • Medical expenses that are over 7.5% of your adjusted gross income
  • First time homebuyers can take out up to $10,000
  • Costs of a sudden disability

So you still have access to all of this money in case of a big emergency. However, if you spend your retirement what will you do when you retire? Also, remember that each $1000 you put in today could be worth over $10k when it is time to retire. I don’t want to rob my future self of that easy money! I pretend that the money is GONE and I have promised myself that I am not touching it. It does make me feel better, though, to have a source of backup funds just in case all of my other financial strategies get tapped out.

Stay tuned for next time- we can talk about HOW you actually set one of these suckers up.

Compound Interest- a Modern Day Miracle!

Albert Einstein — ‘Compound interest is the eighth wonder of the world. He who understands it, earns it … he who doesn’t … pays it.’

This is my favorite and least favorite topic, depending on whether we are discussing investments or debt. For the sake of keeping this post awesome, my examples will be all about investments, but remember that compound interest works just as effectively against you if it is debt.

Say I am 25 years old, and I invest $1,000 and I get a 6% return each year. The first year, I am going to get $1,060. That’s not really that awesome, but it’s not so bad. $60 is better than $0. But then the next year, $1060 gets invested instead of $1,000, and you end up with $1123. Not too shabby… Your interest starts earning interest. You could almost call it…compounded!
If you leave your $1,000 alone (and if the interest rate is steady at 6%, for the sake of this example) in 40 years you will have $10,285. TEN TIMES AS MUCH MONEY AND YOU DIDN’T DO ANYTHING AT ALL.

Number of years

Keep it in your mattress Keep it in your checking (.25% interest) Keep it in your savings (.8% interest) Invest it at 6%

0

$1000

$1000

$1000

$1000

20

$1000

$1111

$1233

$3207

40

$1000

$1168

$1446

$10,285

The first time I learned about compound interest, the author I read wrote that it didn’t really matter how much money you invest, as long as you invest something.
I thought, “Well, this author obviously doesn’t understand that if you invest more money you get more money at the end.” I felt like I didn’t have enough money to start investing and that investments are for people who already have money and if that isn’t a horrible catch-22 I don’t know what is!
But you know what? He was right and I was completely wrong. Because what I had at 25 (ok, what I still have because I am only 28) is time. If you wait until you are 45 with a higher income to invest, you will be making 1/3 of the money you could have made if you started now. Even though I expect to make more money and to be able to invest more at 45, I will never make as much compound interest on the money invested at 45 as I would have on a lot less money at 25.

Examples like this used to piss me off, because I never had $1,000 to invest, and I still don’t have $1,000 sitting in my bank account just waiting to be invested. When I was 24 I was living in a double wide trailer in rural Alabama (true story). A big activity for me was driving an hour to go to Walmart. I barely had any income at all, but you know what I did have? Fifty bucks. I put $50 into a retirement account every month (automatically! I don’t even miss it!), and I just let it sit. And you know what? Compound interest works on $50 too! If I stick to this schedule, in 40 years I will have put in $24,000 (and hardly noticed it was missing, because I automatically moved it) and I will have $93,206. That first $600 from the first year will be worth $6,171. WHAT? Awesome.

Imagine what I could have done if I had started at 18!
(Actually, the answer to that is that I would have paid $28,200 out of pocket and I would have $144,650 by the time I retire at 65. That extra $4,200 and seven years would be worth $51,400! Learn from my missed opportunities, all you 18 year old readers!)

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