More and more of us graduated owing student loans and the percentage of those who will borrow to pay for college is constantly on the rise. The prevalence of debt is disturbing enough but when more and more of the debt is going bad – delinquent and default – it’s making it harder on our family finances. We pride ourselves on offering loads of free advice here at our Tuition.io blog – and today we’re launching a several week series that will run every Friday.
In this series, we will consider different debt scenarios and then offer specific advice for those in this situation. Our goal is to provide real-life circumstances that will be highly applicable to our readers and make it easier for them to get their educational debt under control.
For Part I of our series, here’s the student loan debt profile:
#1 Student loan debtors are a married couple with three kids
#2 Student loan debt balance is $60,000 ($40,000 for one and $20,000 for the other)
#3 One partner earns $55,000 and the other partner earns $15,000 working part time
#4 Their tax status is married filed jointly
#5 Assumed: no state income tax, pre-tax deduction for health insurance $70 per week
With disposable income of $613 and $637 in student loan payments, this couple has a debt deficit situation that will cause problems and yet is typical of where many young couples saddled with overwhelming student debt find themselves. So is there hope for this young couple? Yes! Let’s see what’s possible.
#1 Consolidation Let’s dispel this one right away. A consolidation at a 10 year level will not save you a penny and will in fact cost $1 more. Taking a 25 year consolidation will provide significant monthly relief, but at what ultimate cost? You can decrease your monthly payments by $239, but you will more than double the lifespan of your loans and will pay an extra $21,000 in interest! That bumps you up to paying over $33,000 in interest on $50,000 borrowed and is outrageous. Plus if you’re in your late twenties now, instead of being shed of your debt before you’re forty, it will haunt you well into your 50s – yikes!
#2 Graduated or Extended Payment Plans Right away there’s the same problem you’d have as with consolidation. If you tack years onto you repayment schedule, you will see your interest capitalize and grow and grow and grow! The longer you let your debt linger, the more it will cost you and the longer it will complicate and burden your financial life.
#3 Income Based Repayment For having a more affordable monthly payment, IBR is the way to go. With this income and three dependents, the total monthly payment could be as low as $250 per month. That sounds great, right? But there’s a couple of caveats. First, if you anticipate your income will climb significantly and soon, that low payment will no longer be available. Also, because this much lower monthly payment will barely service the interest, you won’t be chipping away at your principal. For the first three years you’re in IBR, the government will cover your interest on subsidized federal loans.
#4 Avalanche Method We’ve written about the avalanche method before where you take any spare income you have and apply it toward your highest interest rate loans. That’s a great approach, but in this scenario, there’s no spare income. But I wonder if we could create some? Read on to #5!
#5 IBR with Avalanche Hybrid Let’s see what you can do with the extra money you’re saving by getting into IBR! If you pay $250 per month under IBR plus the $120 on the private student loan, that totals $370 per month. Then we’ll use another $230 to push into the debt avalanche to fast track the debt! That will give you $13 to spare in the monthly budget rather than being in a deficit. Here’s the plan:
– First: Take the $230 and pay it each month on your private student loan with a request that the lender apply it directly to the principal.
– Result: This will pay off the private loan in full in 32 months rather than 10 years and will give you a long-term savings of $3,300 in interest!
– Second: After the 32 months, you ‘ll take the $350 ($120 + $230) that was going to the private loan and apply it to the principal on the unsubsidized loan.
– Result: This will allow you to pay off the higher interest rate loan within 35 more months. Months paid on this loan total 67 (32 + 35) or a little more than five years. This saves you more than $2,300 in interest when compared to the 10 year standard loan term!
– Third: Now that loan two is paid off, you have $450 ($350 in disposable income + $101 from the unsubsidized loan payment) additional to push onto the last loan.
– Result: In another 51 months, the final loan will be paid off if you can stay in IBR and keep your payment low and then apply all of the extra to principal. This means your total number of years until eradication of ALL student debt is 9.8 years. You’ll pay about $400 more in interest on this loan than you would under the standard 10 year plan because you don’t have as much going towards principal under IBR in the first few years of the loan but then you make up for it in the last few years so it’s almost a wash.
#6 Public Service Consideration If the higher earning partner works in public service and is eligible for tax-free loan forgiveness, the scenario recommended would be to put all the federal loans into IBR, fast track the private loan and then focus all available spare cash onto the non-public employed partner’s debt – if and only if the numbers come out preferable compared to option #5 above.
Final Thoughts Even if you have options like IBR available to you – and in this scenario it’s likely due to the modest salary and high number of dependents plus tax status of married filing jointly – you won’t come out ahead. If you take the lower payment of $250 over 25 years will pay $75,000 and pay your loans off right at 25 year so there will be no loan forgiveness.
But by sucking it up and devoting $600 per month, you’ll be debt free a little bit shy of your decade mark, but more importantly, you will have saved $5,000 in interest! Plus you’ll have the satisfaction of knowing you honored your debt, protected your credit rating and were financially responsible. You’ll be in your mid-thirties, debt free and with $600 extra in your monthly budget to start your kids’ college accounts! It’s important to note that by combining IBR with debt avalanche, although your repayment period is almost as long, your savings can be tremendous with a little forethought and planning!
We encourage you to test some potential scenarios for yourself and caution you away from taking blanket advice from student loan “advisors” that work for your lender. They have no incentive to give you savvy advice. If you know a statistician, they can probably help you model the quantitative risk of each of these scenarios to give you the best results for your particular circumstances.
One of the best ways to get started dealing with your debt is to use Tuition.io’s free student loan management tool so you can view all of your debt at once in our easy to use interface. The snapshot view can clarify your debt situation in a heartbeat. You can also check out the effects of various repayment strategies and contact your lenders with any questions.
Also, please use these recent blogs to inform you while you are developing your own customized repayment plan: