Tips to manage your student loans

This is the final post in my four part series on Student Loan Debt.

Get better loan terms to match your cash flow

Make payments more than once per month. It can be helpful to just go ahead and make a payment each time you get paid (assuming you're on a standard two week or bimonthly payroll). Since student loan interest accrues daily, this can make a big difference over the life of your loan.

Claim the student loan tax deduction. This can help reduce your end of year taxes, but the deduction is pretty limited. Unlike the mortgage interest deduction where you're able to apply all the interest paid in a given year, the student loan interest deduction is capped at a meager $1,500. It's also only available to you if you earn under $70k (single filer cap).

Pay during grace periods if you're able to. Right now is a great example as the CARES Act has reduced interest to 0% and payments aren't required through the end of the year. There's another 6-month grace period after graduation. Use these times to pay down your debt as fast as possible, because that will mean less interest will accrue in the years to come.

Take extreme cost elimination measures. Moving back in with your parents could save you $10k-$20k per year. If you received a large tax refund last year, consider changing your tax withholding. This will give you more money to put towards your loans sooner, which gives interest less time to accrue. You'll reach a point of diminishing returns where that extra dollar isn't really moving the needle on your student loans, so don't become too obsessive over budget tracking.

In the earlier chapter about compound interest, we discussed how powerful a few percentage points can be over the course of just a few years. I watched my loans add nearly $90,000 in interest from 2012 to 2016, even while I was making required payments under the income based repayment plan.

I was paying $52 every single day in just interest.

That's $1,600 per month.

If I'd been able to put that money into my retirement account for those five (5) years instead of throwing it away to Sallie Mae, I'd have a retirement nest egg of over $2 million waiting on me at age 65 (assuming average stock market returns).

I refinanced three times and the first time was the most difficult. I was rejected multiple times.

I was paying $52/day in interest for my 7.5% average federal loans. It took two years and applications with several lenders before I was finally approved by Ernest in September 2017. That was one of the happiest moments in my battle to fight my student loans because it meant my monthly interest would finally drop to under $1000.

Subsequent refinance attempts were easier as I'd been working hard to increase my income and pay down my debt. I refinanced again in 2018 when my balance was down to about $190,000 and found a rate in the mid 4% range. The last time I refinanced it was with Citizens Bank on a 5-year 2% variable rate. I lucked out because rates dropped in 2019 and again in 2020, and since my student loan interest rate was variable, I ended up with a rate of 0.67%.

Exercise:

Take a look at your most recent loan statement. Notice how much of your payment is going towards what you borrowed vs. how much is going to Sallie Mae via interest. This should motivate you to do whatever you can to decrease that interest.

There are both positives and negatives to refinancing.

You'll want to think about your situation carefully before deciding to refinance your student loans.

Positives to Refinancing

Interest rate, interest rate, interest rate. In most cases, you'll be able to drastically lower your interest rate by refinancing your federal student loans.

You can also remove a spouse or parent from being a co-borrower in certain situations. Note that in some situations it can be helpful to have a co-borrower when refinancing, because you'll have an easier time qualifying and it may give you access to lower rates.

Some lenders offer flexible options that are similar to some of the federal loan perks – like skipping one payment per year or offer negotiable payment in the event of a natural disaster or widespread issue like coronavirus.

Also, check to see what kind of discounts your lender offers. Some lenders will discount your interest rate by a quarter point if you enroll in autopay. I've also seen discounts for opening a bank account or credit card with the lender.

Shop around to see if a lender offers cash back for refinancing. Many will offer $500+ if you refinance with them.

Negatives to Refinancing

The biggest risk is that you'll lose out on some of the government programs you get with federal loans. Things like deferment, forbearance, and income based repayment plans won't be an option. In most cases, those plans do far more harm than good and can put you in a situation where your loans are negatively amortizing. They are growing even while you're making payments.

Private loans aren't eligible for public service loan forgiveness, so if you're a teacher or government worker who is several years into potential forgiveness, you'll want to carefully consider your options before changing anything. I'd recommend talking to a financial advisor or CPA.

If you borrowed loans over the course of several semesters, you probably have 10 or 20 different loans of various amounts. It can be confusing to keep track of these and one common trick is loan consolidation.

When you consolidate your existing loans, your servicer will pay off all existing loans and originate a single new loan.

In addition to the convenience of having all of your loans merged into one large new loan, you might also be able to qualify for an income based repayment plan that you didn't qualify for previously. Remember that we cover income based repayment plans and why they're often dangerous earlier.

My experience consolidating federal loans:

I didn't do enough research around loan consolidation. I'd done some cursory research and learned that I could get my loans forgiven in 20 years with PAYE, so I promptly called Navient and put things in motion. They told me I'd need to consolidate my loans first. No big deal, right?

I assumed it just meant the new loan balance would be the same as adding up all the separate loans. I wasn't changing lenders or seeking better terms.

Well, I didn't realize that by consolidating my loans, all of the interest would be added to the principal and now my monthly interest accrual would be far more than what it was previously.

Why you should think twice before consolidating

Your previous payments under income based repayment plans will be wiped out and the 25-year forgiveness clock starts over at 0!

They will take an average of your existing interest rates and round up to the nearest fraction of a percent. While this may not seem like much, it can add up to thousands of dollars over the lifetime of your loan.

Interest capitalizes and your new balance will be larger than you might expect.

Since this is essentially a new loan, your credit score may dip by a few points since age of accounts is a factor that impacts your score. This is really only an issue if you've been paying the existing loan for years and don't have older accounts on your credit report.

Overall, I don't really recommend consolidation unless you're a recent graduate and haven't accrued much in terms of interest or qualifying payments. If you can qualify for refinancing with a private lender, that will get you a better interest rate and potentially better customer service too.

Get Aggressive with Your Payoff Goal.

Understand your loan terms. It is absolutely critical that you know all the details and terms of your loan. You should know your loan balance, interest rate, repayment period, and whether your loans are private, federal or mixed. It's tempting to hide from your loans and avoid feelings of being overwhelmed when you've got a giant balance hanging over your head, I know this. But once you face the loans head on and commit to understanding them, you'll feel a greater sense of control in your ability to combat them.

Understand your income.

Know how much income is coming in at the beginning of every month, and make sure to set a plan before the money hits your bank account. Your income is the biggest debt fighting tool in your arsenal, so you want to make sure you're using as much as you possibly can to pay down debt.

Is your current income stable or does it fluctuate? Do you have the potential to increase your income through job promotion or salary renegotiation? Are you able to substantially increase your income by working more hours (e.g. sales, nursing, software development, or other freelance roles)? Do you need to change your career trajectory to get your income on the right track?

You can’t accurately assess your income without factoring in taxes. Your tax rate can fluctuate substantially between states, and just remember that the more money you earn, the higher percentage your income will be taxed. Avoid the trap of only thinking about your future earnings as gross income, because it will create an inaccurate picture of payoff speed. Always consider the amount that will be hitting your pockets once all taxes, healthcare, and other paycheck deductions are taken out.

Get a grip on your budget.

Monthly expenses are an extremely important determining factor for paying off your loans. It's surprising how few Americans know their monthly expenses and have any experience budgeting. If this is you, don't feel bad. I've struggled budgeting for years due to time constraints, lack of discipline, or just forgetting. Decide to get a better handle on your budget. There are a number of mobile apps and tools like Mint that you can use to budget effectively. You can simply connect them to your bank account and track expenses by category.

Some guiding questions to ask yourself:

Do you have non-negotiable expenses like alimony or child support?

Do you have expenses that you could cut back on like a car or apartment you could exchange for a cheaper alternative?

What about the area where you live? Is it possible to move somewhere cheaper while making roughly the same income?

You might also find that you're able to earn 5%-10% more due to lower state taxes. Texas and Florida have no income tax, whereas a state like California will hit you with 10% income tax.

Set a reasonable pace. This is a marathon. Not a sprint. You're probably looking at a time frame of 18 months and 5 years.

It's easy to be pumped up and want to talk about loans constantly when you're locked in on your goal of paying them down, but be sure not to get too carried away with daily progress updates and obsessive budget tracking.

Find a way to remind yourself regularly without making it depressing or stressing yourself out too much. Some stress is good, but too much stress can be debilitating and can cause you to give up. The best reminder will be something you can see regularly and something that can be a subtle pressure while also being gratifying when you make some progress.

Scheduling your Final Loan Payment

Once you understand the above, you're going to set a future date as your target loan payoff. Personally, I like to set two goals representing a range of possibilities.

Goal #1 is the slowest acceptable date by which I'd be happy to pay off my goals. This is there as a baseline and it should keep you from feeling discouraged if you have a setback, but you should really have your sights set on Goal #2.

Goal #2 is more of a stretched goal representing the fastest possible payoff date if you work as hard as possible and things tend to go your way. This goal should be ambitious yet achievable. You shouldn't need to rely on some miraculous payout like an inheritance or winning the lottery. It's counterproductive to rely too heavily on things outside of your control when setting your payoff goal.

Anchor Payoff Goal to a Significant Future Event.

Anchoring goals to future real life events will make it more real to you. You'll stay more motivated, and any time you think about that future event, you'll think about your goal and what you need to get there. By visualizing the payoff and adding a meaningful emotional context, you're scheduling your student loan payoff as an inevitability in your mind.

Examples of dates with some kind of significance:

• Before my 30th birthday.
• Before my kid starts elementary school.
• Before the next World Cup.
  

Saving, Investing, and Other Financial Decisions

Emergency Fund

Focus on saving a small emergency fund. Everything else should go towards paying down your debt. The size of your emergency fund depends on a few things. You'll want to consider your existing income and how reliable it is. You'll also need to think about your monthly expenses to know what you need to survive without that income.

Is your income steady or does it fluctuate?

If you have a steady salaried job, it's probably okay to limit your emergency fund to just two months of expenses. This also assumes you're in a good industry where you could find a new position in 4-6 weeks. If you're in a dying industry and there's less ease of movement between jobs, you're going to want much more cushion.

If you're in a commission based job or if your income fluctuates seasonally, it's a good idea to have a higher savings account to carry you through potential dry periods. This can be particularly important if you run your own business.

What if you're someone who is a "saver" by nature?

Remind yourself that it doesn't make sense to just stash money away while being crushed by student loan interest. Odds are high that your loans are growing about 100x faster than any gains you get from having funds in a typical savings account.

What about Retirement Contributions?

While many will argue in hindsight that they could've paid their loans off faster by investing in the market, that logic really only works in hindsight. There's no guarantee that you'll get returns in the market this year, BUT IT IS GUARANTEED that your student loans will grow at X percent this year.

Important Caveat

It can be financially prudent to consider this if your employer offers generous retirement matching. If matching isn't available to you, I wouldn't even suggest that you think about retirement contributions until you've either stopped the bleeding by refinancing your student loans down the 2% range or have them paid off completely.

Should I Buy a House?

I've heard many try to rationalize buying a home by saying it's smart to buy a house when you have student loans, because you can refinance the house at a later point and cash out some equity to pay down towards your student loan. While this sounds great in theory, it rarely works out that way in practice.

First, you are making a bet on the housing market to increase. Second, home ownership can be more expensive than renting due to taxes, repairs, insurance, etc... If you're counting on having a bunch of home equity due to monthly mortgage payments and appreciation overtime, you shouldn't expect to have enough to cash out for 5-10 years. Third, you're probably going to pay a higher interest rate since you have a high student loan balance. This means it'll take longer to draw any cash out for that student loan pay down.

There's another suggestion that buying a home can be beneficial because you benefit from the mortgage interest deduction. Keep in mind that you're essentially just moving debt from your student loans to your house when you do this. Be aware that while there's a lot of excitement around home ownership, and many of these rationalizations sound good in theory, in practice, it'll take much longer and be far from a "sure thing" to get any sort of payoff.

Is it okay to use forbearance if I suddenly can't pay my loan?

You should avoid putting your loans into forbearance at all costs. When you use forbearance, your accrued interest will get added to your principal and your loans will grow faster due to the compounding effect.

The only situation I'd recommend using forbearance is if you suddenly lose your income and aren't able to make your next loan payment. In this situation, you're only using forbearance to avoid defaulting on a payment.

Instead of using forbearance, try to recertify under one of the income based plans if you've suddenly gone through a drop in income.

What about other big debts like credit cards?

Approach #1 - Debt Snowball

You can follow Dave Ramsey's "Debt Snowball" method which has worked for millions of people. With the snowball method, you pay off debts smallest to largest.

Assume you have a credit card with a $5,000 balance, a car loan with $15,000 outstanding, and your student loan has $100,000 remaining. In this situation you'd direct your extra payoff funds first to the credit card, then to the car, then to the student loans.

This is pretty simple and works to keep you psychologically motivated. It's like working out. It's much easier to keep going to the gym once you start losing weight and looking better. By paying off your debts from the smallest to largest, you're able to build momentum which gives you victories with each small debt you pay off on your way to larger debts.

Approach #2 - Debt Avalanche

Or you can adopt a more math-based approach where you pay debts off according to the highest interest rate first.

If you have a $100,000 student loan balance with 8% interest while your car loan of $15,000 carries an interest rate of 6%, it would be prudent to tackle the student loan with any extra funds because the cost of that loan is higher than the car. If you have a $5,000 credit card balance with 20% interest, you're going to want to make that your priority and pay it off as soon as possible.

Tools and Resources

I'm sharing the calculator I used to compare the various forgiveness options, future net worth, and how to tackle loan repayment. If you're considering any of the income based repayment strategies, you should definitely look at it and consider your approach.

You can find detailed instructions for this tool and a link to the Google Sheet. I'm also sharing the google sheet I used for progress tracking and motivation towards reaching my payoff. Visit my website here, and feel free to go ahead and make a copy of the sheet. Each of the four tabs covers a different payment scenario. Feel free to play around with the numbers to get a sense of how you could best optimize your repayment strategy.

Enter your current salary, and how much you think your salary will increase each year. If you're making big moves and don't expect a constant percent based growth (e.g. if you're a doctor in residency), you can enter a hypothetical salary manually in each cell.