Cherry Picking Student Loan Payments – How to Save Big and Pay Down Your Loans Faster

April 10, 2013

If you owe multiple student loans, you may just be shuffling along, paying your monthly payments and longing for the day that you’ll be debt free. But have you given any thought to how you could get there faster? You may think you have no choice in the matter, but there are some ways you can pay down your loans faster and – most importantly – save big on interest rates.

Personal finance and debt guru Dave Ramsey has two methods he recommends for attacking debt – and student loan debt is no different. His tactics are the Snowball Method and the Avalanche Method. Both are quite different. One will make you feel better faster and the other will save you big in the long run.

For purposes of comparing the two debt management strategies, we’ll construct a scenario to test both methods. Suppose we have a marketing associate Dan who graduated six months ago and has four student loans that are due to start repayment. Let’s say he’s earning a $50,000 salary and has four student loans that together total $39,000.

The Snowball Method

This debt management strategy can be applied to any debt, but for purposes of this conversation, we’ll focus solely on student loans. The Snowball Method is meant to provide you a rapid sense of accomplishment so that you will build debt-paying momentum and want to keep on tackling debt as rapidly as possible. Using the Snowball Method to pay your student loans, you would focus on the lowest balanced items more aggressively so that you get a sense of accomplishment by paying it off as soon as possible.

Under this plan, Dan’s discretionary income will be applied to the smallest debt first. So rather than paying $50 on Loan 1, he will pay $135. This will allow him to pay off Loan 1 in 24 months rather than nearly six years. Once that loan is paid off, he can then devote the entire $135 he’d been paying on Loan 1 over to Loan 2 (the next smallest loan) for a total monthly payment of $244.27.

Once that loan has also been extinguished, that amount will go toward Loan 3 (the next smallest) for a total monthly payment of $441.69. Finally, all of the payments will be applied to Loan 4 at a monthly rate of $613.23 until it has been extinguished.

Here are your results under the Snowball Method:

The Avalanche Method

The Avalanche Method is meant to minimize the amount of interest you pay on your student loans by prioritizing the highest interest rate loans to receive the extra discretionary income. With this student loan payment tactic, you would maintain your normal payments on the three lower interest rate loans and then bump the payment on the highest interest rate loan.

Under this plan, Dan’s discretionary income will be applied to Loan 3 first. So rather than paying $197 per month on Loan 3, he will pay $292. This will allow him to pay off Loan 3 in just over four years rather than 10 years under the standard plan. Once that loan is paid off, he can then devote the entire $292 he’d been paying on Loan 3 over to Loan 2 (the next smallest interest rate loan) for a total monthly payment of $391.

Once that loan has also been extinguished, that amount will go toward Loan 4 (the next smallest) for a total monthly payment of $563. And Loan 1 would be paid off shortly after Loan 2 because it is a smaller loan.

Here are your results under the Avalanche Method:

Comparisons

By applying a little discretionary income to the largest loans under the Snowball Method, Dan will save nearly $4,800 in interest compared to the standard repayment plan. By utilizing the Avalanche Method, Dan will save over $6,400 from the standard method and nearly $1,600 from the Snowball Method. And if your loan balances are higher, the interest savings will grow exponentially. Your interest rates will also play into this equation.

Another factor that may play into how fast you can pay off the loans and what your interest savings will be is whether the additional payments are applied to principal or interest. If your lender will allow the additional amount to go solely toward principal, the savings gap will widen. You will have to contact your lender and find out how you need to draw their attention to the additional payment amount and what your options are for applying it to your loan balance.

If you are carrying student loans, a great way to see repayment options, view loan balances and contact your lender is by using Tuition.io’s free student loan management and optimization tool.