With educational debt averaging $27,000 per college graduate – and many owing even more – this is somewhere between a house and a car’s worth of borrowing. If you don’t own a home, then student loans are probably your highest dollar amounts of debt. But you have to consider your student debt in the context of your overall debt, financial obligations and interest rates. The sheer dollar amount of your loans may send you into a tailspin, but slow your roll and read on!
We write here frequently that the best way to deal with student loans is to pay as much as you can as fast as you can to defeat your debt ASAP. We’ve even proposed some radical methods to churn cash to devote to your student loans. That being said, there are some measures that you could use to find cash to pay your educational debt that we absolutely don’t recommend:
#1: Don’t Prioritize Lower Interest Debt
Federal student loans are typically around 8% or less. PLUS loans are set at 7.9%, unsubsidized direct loans accrue interest at 6.8% and if Congress doesn’t act soon, subsidized loan interest now at 3.4% will double. These rates are much higher than credit card interest rates averaging 13-15.25%. And if your credit is less than stellar, your credit card interest may be above 20%.
If you’re paying just the minimum monthly payments on your credit card debt to have extra money to devote to your student loan payments, you’re making a mistake. Making minimum credit card payments will see your principal reducing at a snail’s pace (or not at all).
Better Idea: Instead, pay your student loans as normal. Fast track your credit card payoff and then quit using them! Once your high interest credit card debt is vanquished, devote that cash to your student loan debt (or next highest interest rate debt).
#2. Don’t Prolong Debt
Standard student loan repayment plans run 10 years. Any extension of that time period exacerbates the amount of interest you will ultimately pay. The same goes for any debt. For instance, $27,000 in student loans paid over 10 years at 6.8% will generate $10,286 in interest. Stretch this to 20 years and you’ll pay $22,465 in interest! Some student loan debtors may be tempted to pay off their student loans with cash from a home equity loan or a home refinance.
If you have a $150,000 mortgage at 5% you’ll pay $140k in interest over the 30 year term. If you decide to tack on your student loans with a refinance, you’ll have roughly $177k in principal. This will increase your interest paid to $165k. This is significantly higher than paying your student loans separate from your mortgage.
Better Idea: Instead, pay your student loan debt as normal and leave your mortgage alone. If there’s a chance to refinance your mortgage at a lower interest rate (without extending the years in repayment), take the difference between your current and refinanced monthly payment and devote that toward your student loans!
#3. Don’t Rob Your Future
If you’ve got money going into a 401(k), you may be tempted to scrap saving for retirement to focus on your loans. This is a tricky proposition. Here’s why. Saving for your retirement is critical and the longer between when you tuck money away and when you need to use it, the greater your interest benefit will be. If you’re earning $50k in salary and your employer offers a match of 50% on up to 6% contributed to your 401(k), you’ll invest $3,000 and your employer will add $1,500 to that.
By continuing to invest in your 401(k) during the same 10 years you’re paying on your student loans, you’ll have accrued roughly $75k in your retirement account. This is many thousands more than the student loan interest costs without making higher payments so it’s a better deal. Plus, that money will end up amounting to hundreds of thousands of dollars when you retire and your student loans are a distant memory!
Better Idea: If you get a bonus or other windfall, invest that toward your debt, always remembering to prioritize your highest interest debt first!
#4. Don’t Increase Your Taxes
When you put money into your 401(k), it lowers your income tax liability. If you’re in the 15% tax bracket and contributing as we mention above, you’ll pay $450 less in income taxes. Not paying FICA/Medicare on the 401(k) contribution nets you $225 more in savings. This tax benefit is in addition to the financial benefit you enjoy by investing in your retirement.
And if you already have money in your 401(k) that you’re considering withdrawing to pay down student debt, consider this. If you take out $15,000, you face a 10% early withdrawal penalty plus 20% in income taxes withholding. If you’re in a 15% bracket, you’ll get 5% of it back but that still nets you a tax impact of 25%. Plus, if you’re not fully vested, you’ll sacrifice your employer match. If you withdraw $15k and lose $7,500 in matching funds, that increases your net impact of this withdrawal to 75%! That’s horrifying!
Better Idea: Use the $675 from your payroll tax savings as a once-a-year principal payment to your student debt and you’ll pay off your loans in eight years instead of 10 and cut your interest paid by a little more than $2,000.
#5. Don’t Damage Your Credit
If you’re in a panic over the sheer dollar amount of your student loans, you may be tempted to skimp or skip paying other bills to make additional student loan payments. Yes, this will reduce your student loan debt faster and see you paying less interest, but could actually cost you more in the long run. If you run late on paying other debts, this will be noted on your credit report.
Dings on your credit report lead to higher interest rates when you seek new credit and can even drive up your existing interest rates. Many credit card companies include interest rate increase riders tucked into the fine print of the terms and conditions that they can raise your interest rate by as much as 15% for any late payments not only on that credit card but any other debts you have.
Better Idea: Pay all of your debts on time. If your money is tight, you may need to pare down your living expenses. If you do have additional cash above and beyond your minimum payments, it should be dedicated to your highest interest rate debt.
If you do choose to devote spare cash to paying credit card debt off rather than making additional principal payments on student loans, that’s okay – with a caveat. Once you get that credit card paid off, you can’t run the balance back up – that’s turning your debt avalanche into a debt disaster zone. Credit card debt should be avoided at all costs!
Once you pay down a card, freeze it in a chunk of ice so you can’t use it, cut it up (but keep it active) so you can‘t use it but it still shows positive on your credit report or store it somewhere where you can only get to it in case of emergencies – think buried in a jar in a crawl space… These tips can prevent you from making impulse buys that you’ll regret later and that will exacerbate your debt situation! And if the unthinkable happens and your house or office burns down, having your cards stored offsite will be one less thing to have to replace.
Keeping track of exactly how much you owe and making sure your monthly payments are being properly updated is key to debt management. For this purpose, why not try Tuition.io’s free student loan management tool? You can see your balances, review monthly payment postings, check out repayment plans, pay off dates and contact your lenders in our easy-to-use interface!
Also check out these other recent blogs on student loan payment strategies: