In the first article in this series on student loans, you learned about student loan basics which enabled you to be strategic in financing your post-secondary education. In this second article, you’ll learn the steps to repay student loans at an accelerated rate.
When it comes to any loan, the sooner you pay it off, the less money you spend. This is because every month the lender takes the interest rate times the principal and adds the amount to the total amount you owe. Reducing the principal reduces the interest which reduces your overall cost. Let’s review a couple of strategies for repaying debt at an accelerated rate and then some methods to make that strategy come to life in a relatively quick and painless way.
Note: Please be aware you will need to review the terms with your lender if you are interested in paying off a private loan early. Some lenders charge fees for extra payments, payments exclusively toward principal and/or a lump sums to erase the debt completely. It can still be worthwhile but the fees may impact the strategy and methods you choose.
Repayment Strategies
Before you begin to repay your debt at an accelerated rate, you’ll need to have a strategy to determine which debt you want to eliminate first. Taking a page from famous financial guru Dave Ramsey, I recommend choosing between the two strategies known as “Debt Snowball” and “Debt Avalanche”.
Both strategies have the same result of eliminating your debt, but the starting point looks different. If you apply the Debt Snowball method, you focus extra payments on the debt with the lowest principal. However, when you apply the Debt Avalanche method, you focus extra payments on the highest interest rate.
How does this apply to student loans? Review the example below, which compares three different student loans:
As you can see, under the Debt Snowball method, you’d start with Loan A because it has the lowest principal at $5,000. If you choose the Debt Avalanche method, you’d start with Loan C because it has the highest interest rate at 6%.
Again, no matter which strategy you choose you will be paying down debt faster and spend less money than if you make minimum payments. It really just depends on about how patient you are and what bothers you more – high interest or high principal.
Repayment Methods
Once you’ve selected your strategy, you’ll need to take steps to make it a reality. Below are five key methods for repaying your student loans ahead of schedule:
Choose a repayment strategy
Whether it’s the Debt Snowball or Debt Avalanche approach, being consistent is key in repaying debt as fast as possible.
Pay off interest before the grace/deferment period ends
Paying off interest before the grace or deferment period ends is especially beneficial if the interest that accrued during the grace or deferment period is capitalized. But it’s critical that when you send that payment to the lender, you specify it is specifically for interest accrued. Otherwise, they will simply apply it to your first payment which won’t save you near as much money.
Put any “extra” (Christmas, birthday, bonus, tax refund) money toward loans
Receiving money is probably the best gift you can get as a young person right out of college (or even still in school). I know it’s tempting to spend it all on concert tickets, a night out or something else just for you but I highly encourage you to put at least a percentage toward your student loans. It can make a big difference in the long run! But this time, it’s critical that you tell the bank to apply the extra funds to the principal only. If you do not specify this condition, they will (once again) apply it to your next payment which won’t save you near as much money.
Pay half of the monthly payment every other week
This is a great method for tricking yourself into making an extra payment every year. This is because the lender will send you 12 bills a year – one for every month. But if you pay half of the amount every other week, you actually make 13 full payments. Here’s an example of how this simple step can impact your loan:
Convinced this is a step in the right direction for you? You can automate it in as little as five minutes by setting up an automatic payment from your bank account to the student loan lender.
Make extra payments toward the principal whenever possible
Can’t commit to a consistent method? Then just put money towards it when you can! Maybe it’s your tax refund. Maybe you get a 2% raise at work. Maybe you get some sort of inheritance – whatever, whenever, however you do it, it’s rarely a bad idea to put money toward the principal!
Consolidate or Refinance
Finally, there’s the option of refinancing or consolidating. These two terms are often used interchangeably but they are different processes. See the visual below to understand how they compare:
The most important note is which loans are eligible for each action. Specifically, only federal loans are eligible for consolidation.
And while consolidating sounds like a good idea, especially if you don’t have the credit score to refinance, I recommend weighing the pros and cons of doing so, listed below:
As you can see, consolidating is not a decision to be taken lightly. There are a variety of factors to consider, both specific to the loans as well as your situation. For more information, I highly recommend exploring the resources available on the Federal Student Aid website.
TL; DR
Student loans suck. But they are worth it! According to the Social Security Administration, college graduates on average earn between $630,000 and $900,000 more over their lifetime than high school graduates. So how do you manage them?
1. In one place, capture all of your loans by recording the loan type, principal, interest rate and term and your monthly payments (not sure what the monthly payments will bet? Here’s an easy-to-use calculator).
2. Review the list of repayment methods to choose which works best for you.
3. Put your plan into action!
You can do this!