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Four steps to crushing your student loans. How to optimize your payments, how to think about extra payments on your student loans vs investing, and more.
I get a lot of questions about student debt. 44 million Americans are tackling student loans as part of their financial journey, and those loans total to $1.45 trillion. That’s a lot of wealth to unlock, and there are certainly strategies that will help to do that.
I want to point out that I don’t have firsthand experience with student loans. I narrowly avoided student loans through a combination of parental contributions, merit scholarships, and graduating a year early to avoid an extra year of tuition that would have taken me over the top and into loan land. So what I’ve done here is drawn from firsthand advice through interviews, consulted the best resources I could find for student debt strategies on the web, and combined it with my broader investing and decision making frameworks. The result is four concrete steps to take charge of your student loans.
Here’s what we’ve got.
Start Tracking: You Make What You Measure
I am a huge believer that you make and improve only what you measure. If you are counting the number of push-ups you can do, you will find every tweak in the book and squeeze out every opportunity to improve your number. If you are trying to cut out caffeine, counting the number of cups you have per week will actively change your behavior and help you make progress quickly. Likewise, you need to be regularly tracking your student debt figure to create the same avalanche of progress. It’s about building momentum, and tracking your this key metric will build this momentum.
You can do this with any number of methods. You can build your own spreadsheet or make your student loan provider portal your home page. Personally, I like my tools automated. The less friction there is, the more likely and more frequently I’m going to check the figures, and the more likely I am to succeed.
Since we are also focused on building total net worth, I like using a tool that gives you a single pane of glass you zero in on your student debt figure as well as see your overall net worth picture regularly. The tool I use is called Personal Capital, and it’s free. You can hook up all your accounts so that it uploads all the balances and transactions for you to see in one place. I check mine almost every day. There are numerous similar offerings like Mint and your own personal spreadsheet, so do whatever works for you. What matters is most is putting in place a tracker that you are looking at regularly, at least once a month if not once a week.
Optimize Your Terms
This is one of the biggest optimizations you can make, and it takes only minutes. There are numerous private companies who will essentially extend you financing at a new interest rate and pay off your existing loans. Your relationship then be with that new company.
There are two reasons why your interest rate in a refinance might be better than what you’re paying now. First, interest rates may have decreased since you took out your loans. Second, as a full-time employee you may be able to attract creditors you could not have when you were a student. Your credit profile may be more attractive and less risky than it did before, allowing you to command better rates than when you initially took out your loans.
If you haven’t explored this option, it takes less than 5 minutes to run a quick screen and could save you thousands of dollars in interest over the years. There’s an excellent free tool at LendEdu which allows you to compare refinancing rates from over 12 of the major vendors in the space. It doesn’t affect your credit to run a personalized search (they do what’s called a soft pull of your credit, which is the same thing that happens if you’re shopping for a mortgage or an auto loan).
If you find a better rate, you will save thousands of dollars over the course of paying off your loans. If you don’t, you are out 5 minutes for checking.
Before making the leap, note that if you are refinancing federal loans with a private lender, you will lose some protections – make sure you don’t have need of them (many people don’t). These are:
- Income-based repayment plans should you find yourself in a career where making the standard minimum payments is otherwise impossible.
- Loan forgiveness for taking particular public service jobs.
- Deferment or forbearance due to hardship under federal rules (your private loan will have its own terms for deferment/postponement you should evaluate carefully).
Check out your options and weigh the pros and cons. It only takes a few minutes.
Get A Discount for Auto-Debit
Many lenders offer a discount of 25 basis points on the interest rate for signing up for auto-debit. With auto-debit, your monthly payment comes directly out of your bank account. This has the added benefit of forcing good behavior on your part. You won’t miss a payment. The work is done for you.
Crystallize Your Pay-Off Plan
What To Pay Off First
If you have multiple loans outstanding, stack rank them by interest rate. Pay the minimum on all loans, and take all the extra cash you have and start paying off the highest rate first, as much as you can sock away.
Should I Pay Off More of My Student Loans or Invest/Buy A Home?
I think of this as an easy comparison of “returns.” You pay a certain interest rate on your student loans. When you consider investing in stocks, bonds, or anything else, they too offer an expected return (to read more about what I think those are, read this and this). Finally, the decision to purchase a home will also yield an expected return. Your job is to compare all these rates of return and determine which is the most efficient place to put your excess cash to work.
The chief advantage of paying down your debt is that you are getting a “guaranteed return” of whatever the interest rate is. By paying off your 7% loan, you are keeping 7% interest in your pocket. The exact return is known.
For things like stocks, bonds, and real estate, there is some uncertainty in the outcome. You are looking at a range of outcomes. This means that if the expected returns are fairly close between paying accelerating your payoff of your loans and investing it in another asset, I would generally choose the certainty of paying off the loans.
Given today’s environment in which I’ve got some fixed income stuff yielding only about 5.5%, any student loan with an interest rate of 5%+ would be the priority to me over investing those dollars in the market. I’d probably prioritize them even at 4.5% over investing in the market given the certainty of the return and my current appetite for risk. Your bar may differ depending on where you would deploy those extra dollars.
Should I Pay Off More Student Loans or Save For An Emergency Fund?
As for savings, I think folks are advised to build an overly large emergency fund at the expense of paying off their student loans. The typical recommendation is to have 6 months of expenses in an emergency account. My recommendation would be 3 months. Pay the minimum on your student loans until you’ve saved up 3 months of expenses, then proceed to dump all your excess cash into paying off your loans or investing, whichever shows you the better ‘return’ discussed above.
Why 3 months?
Almost all of us have what I would call “springy debt.” You probably have credit cards that give you an additional 30 days of float for no charge. You also probably have good enough credit that you qualify for credit card offers that allow 12 months of interest-free financing. If you somehow burn through your three months of savings, you have all of these to fall back on for more time. For those who have investment accounts, I think you can lower your emergency account to 1-2 months. You are able to liquidate assets if you need more cash, and you will have 1-2 months of savings plus at least a month of credit card float cost-free to do any liquidating you need at the right time.
The choice of emergency fund size might not seem like a big deal, but it is.
If you have $6,000 of expenses per month, carrying a 6 month vs 3 month emergency fund leaves an extra $18,000 sitting around.
That money could be out either working for you in the stock/bond market or paying of your student loans, all of which are probably possible returns of 5-7%+. At 7%, you are losing $1,260 a year. That $1,260 every year for the rest of your life, since you’re keeping that emergency fund around forever. Don’t forget compound interest. Assuming that 7% also continues to grow at 7% a year, over the course of 30 years, having a few months’ extra expenses in an emergency fund will cost you $117,672!
Generate/Free Up Extra Cash For Paydown
Our natural tendency is to look for one big dramatic gesture that can bring in the big bucks. The truth, however, is that for most people, the best strategy is to layer a dozen good habits and strategies together to slowly build yourself an excess cash stream to pay off your loans. Done this way, it can feel (almost) painless to make progress. Here’s how to get there.
The Mindset: Red Alert
If you have student loans, it’s important to recognize you are in a debt emergency. Every year you put off extra payments is more money out of your pocket due to compound interest. Compound interest is such a huge benefit to you as you built your nest egg, but it is an equally powerful enemy when you are the borrower (the exception is if you are arbitraging by borrowing dollars you can put to work in a higher-yielding job for you, as sometimes happens via mortgages in real estate).
You will want to delay major luxuries for after you have paid off all your student debt. The biggest areas you can cut expense are often housing and transportation. Maybe you don’t want a roommate, but it would save you $10k a year. Can you stand that for two years in order to be financially free years earlier? Lifestyle inflation is your enemy right now. You should hold your standard of living right at where it’s been for as long as you can. This doesn’t mean you will lead a life of “deprivation” forever. This is a temporary measure to get you to a better place for the many additional decades of your life.
Income and Expense Optimization
Trawl the archives for more ideas on how to generate more income as well as how to reduce your expenses. Make a commitment to implement one of these every week or two. You’ll see the payoff as you do your regularly checks on your student loan balance. As you get a dozen frying pans in the fire, a few of them will yield huge returns for your situation, and you’ll know where to double down. Perhaps you start your own blog after reading how much folks have been able to generate as a side hustle, and it takes off. You won’t get these opportunities if you don’t have something in the fire. Or perhaps you don’t want a long project but you’re open to half hour one-time projects that could save you thousands like a money rotation strategy or installing ebates for passive rebates as you shop online.
Consistent, incremental additions are the name of the game.
Motivation: Case Studies
Want some more detail on how it’s been done before? Here are the stories of a few folks from different walks of life who tackled large sums of debt.
Your student debt is completely beatable. As with asset-building in general, the trick is to be consistent and make small, consistent improvements week after week. With small, regular efforts each week, you’ll be waving goodbye to your loans in the rear view window before you know it.
Any tactics that have helped you make headway on your student loans? How do you think about student debt in relation to your other financial decisions? Share your own experiences in the comments!