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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What to do when you win the lottery

…or get your tax refund.

Suddenly you have a ton of money! Yeah! But what do you do with it? You are my wise and clever reader, so you know it is not smart financial planning to blow it all on a sports car. But this new money isn’t in your budget, so how do you fit it into your spending and your goals?

First, you celebrate! It’s exciting, you have a little spare cash! Go buy that jacket you have been dying for. Try that new restaurant. Replace your ratty old gym clothes with something that makes you excited to exercise. Make the celebration reasonable- it should be about 10-20% of your new ca$h money. Spending $500 on a new tv when you got a $1000 tax refund might be going overboard, but maybe getting HBO might be a nice splurge.

Next- look at your debts and your savings goals.

  • Can you pay off a credit card with this cash? Won’t that feel awesome, to not pay interest anymore?
  • Is it enough to make yourself an emergency fund? Then you won’t have to worry about unexpected expenses, and the amount you were saving already towards your emergency fund can go to feed the general pot.
  • Can you invest it in your 401k or your Roth IRA? Earn some crazy compound interest on this free money to make even more free money?!!
  • Should you use it to pay off some student loan debt?

If I were you, I would do a mix of the things above with my newfound cash- but you have to be wise about it (consider your interest rates, my friend). If you can pay all of your debt off- do it! But paying just some of your debt off all in one big chunk may not actually be the best choice.

What if the cash you just received is big for you, but it is just a fraction of your overall debt?

Suppose you are the newly graduated Dr. John Doe. Medical school sure was fun, but the average cost of med school is $170,000. Your monthly payments are almost $2,000. Yikes.

But wait! An unknown- yet extremely wealthy- elderly relative just died peacefully in his sleep. He was so proud of his great-great-nephew the doctor that he left Dr. Doe $20,000.

If Dr. Doe immediately puts that $20,000 into the balance of his student loans, he will now owe $150,000. His monthly payments will be a little over $1,700. Is that much better for Dr. Doe, who may be struggling to make his rent while working those crazy shifts as a resident at his new hospital?

Depending on Dr. Doe’s income, it might be better to save the $20,000 and to use it to make the monthly payments. He can make 10 months worth of payments with the $20,000. The total interest he will pay will be slightly more than if he had paid a lump sum off at once- but not by much (an $8,000 difference). I suspect that early in his career, Dr. Doe would value 10 months of being able to pay his bills worry free more than he will value $8,000 after he is an established doctor.

 

Moral of the story: when you suddenly come into some money, think about your overall financial picture. Paying off part of your debts all at once might not make sense if you are struggling to make monthly payments- but if it lowers them enough to ease some of the burden, then go for it! Look at the parts of your budget that are difficult for you (maybe you just can’t quite squeeze enough cash into your emergency fund) and use the newfound money to help with those areas that are challenging.

Congrats on that lottery win, by the way!

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