6 Ways to Slay Your Student Debt This Year

Slay-Student-Debt

From Susie Q: I’m not as familiar with student debt as I am with the other topics on which I write, so was pleased to accept this guest post from Kate Underwood.  Kate is a freelance writer and staff writer for Club Thrifty, a website dedicated to helping people dream big, spend less, and travel more.  With Kate’s permission and approval, I’ve interspersed some comments and numerical examples in italics to expand on a few of her points.

Unless you’ve been living under a rock, you’re probably aware that we’ve got a bit of a student loan crisis on our hands. The amount currently owed by borrowers isn’t in the billions…nope, it’s actually past the $1 trillion mark!

Chances are, you don’t want to be saddled with your own student debt forever. Debt can hold you back from buying a home, starting a family, traveling the world, and other exciting parts of life. Don’t let student loans ruin your dreams – it’s time to start slaying your student debt this year.

Think it’s impossible? Check out the following ways to attack your student loans with a vengeance.

Follow A Budget

A budget is an essential financial tool that gives a job to every dollar you earn. Get yourself on track by making and following a smart budget. Be sure to account for all necessary expenses, including your student loan payments.

Balance out how much you’re earning with how much you’re spending (and don’t spend money you don’t have). When you’re stuck with student loan debt, it’s key to eliminate luxury spending. Put every spare dollar, after necessities, into paying off your loans.

While it’s tempting to overspend when you get your first “real” job, it’s a bad move. Don’t make the mistake of financing new cars or spending too much on stuff you don’t need. Living within – or below – your means could make a big dent in your student debt. Just live like a college kid for a little longer.

Susie Q adds: For a more detailed discussion of how budgets can be helpful, check out this post or start here for my week-by-week guidance on creating a budget using a spreadsheet template I’ve provided.

Trust me, it’ll be worth it! The faster you pay off your loans, the sooner you can get started building wealth and planning for your next big goal!

Start Repayment Right Away

That little grace period from your lender is appealing, but don’t hang out there too long. The sooner you can begin repayment, the better.

Even during the grace period, interest accrues for many types of loans. So, while you’re allowed to postpone repayment for a time (usually 6 months), it’s prudent to begin repayment as soon as possible.

Susie Q adds: As an example, if you have a $30,000 balance on a 5% loan with 15 years left in the term and don’t defer your payments during the grace period, your payments will be $237 a month. You’ll pay a total of $12,703 in interest over the life of the loan. If you make the same payments and defer your loan, you’ll pay an extra $1,628 in interest payments and extend your loan by 13 months (6 months of grace period and 7 months of extra payments to cover the extra interest).

Pay Extra Each Month

Once you know what your minimum payment amount is every month, don’t get too comfy with it. If you push yourself to increase that amount by even $25 or $50 more each month, you could destroy those loans much faster! At the very least, round up to the nearest $10 or $50 mark. So, a minimum payment of $62 could be rounded up to $70 or $100.

Just be sure that, if you’re making extra payments, they’re applied to the principal, not the interest. If you’re in doubt, talk directly to your lender or loan provider to find out how you can go about doing this.

Susie Q adds: Using the same example as above, if you don’t defer your loan for the grace period and round up to $250 a month, you’ll save over $1,000 as you’ll pay only $11,676 in interest and will pay off your loan a full year earlier.

Another tip: make biweekly payments rather than monthly. After one year, this simple step will add up to having slashed an extra month’s payment off your total. However you choose to set it up, paying more than the minimum will lead to student loan freedom sooner!

Refinance Your Loans

One strategy for paying off your loans faster is to refinance your student loans. The general idea is that if you refinance to a lower interest rate, you’ll end up paying less over the life of the loan. Plus, you can pay them off faster, since you won’t owe as much in interest! Win-win!

A couple of factors to beware of: you usually don’t want to refinance if your credit score has taken a recent hit. That will likely only get you a higher interest rate – you definitely don’t want that! Also, if you plan on utilizing student loan forgiveness programs, you typically need to stay away from refinancing. Most of the forgiveness programs will disqualify you if you’ve refinanced.

If you’re unsure about how to go forward with refinancing, Credible is an online loan marketplace that can make that decision easier. Compare interest rates for which you may qualify with different lenders in order to make the best choice.

Susie Q adds: Using the same example as above, if you are able to re-finance your loan at 3.5% and continue to make the same $237-a-month payment, you’ll save over $5,000 as you’ll pay only $7,485 in interest and will pay off your loan almost two years earlier. This savings will be offset by any fees you need to pay when you re-finance your loan.

Now, if you’re such a rock star that you plan to pay off the full balance within a really short time, like 2 or 3 years, refinancing might not be worth the trouble. Just pay those babies off and be done with them!

Start A Side Hustle

One of the best ways to pay off any debt fast is to increase your income. I’m a big proponent of side hustles. You can make extra cash to pay down debt and side hustles are often super flexible with your other responsibilities.

If you’re looking to begin your own side hustle, you can check out these work-from-home jobs and see which might be a good fit. The possibilities are nearly limitless, so be creative and think about your skills and things you enjoy doing anyway.

You could start doing freelance writing or blogging from home (our favorites!). Or start selling your to-die-for cakes for special occasions. Try your hand at bookkeeping, photography, or proofreading or any number of other ways people are raising their income.

Susie Q adds: For more ideas about ways to increase income or reduce expenses to help free up money to reduce your student loan debt, check out this post. Also, if you decide to pursue a side hustle, you’ll want to make sure you don’t spend more money than you earn!

Just imagine how much extra money you could throw at your student debt by starting a side hustle!

Use Employer Benefits

Some companies are looking to build positive relationships with employees by offering student loan repayment assistance. So, before you decide to take a job, it might be beneficial to ask if it offers this option. If you’ve already signed on to work somewhere, talk to your HR department to see if it’s available.

You should also explore various government student loan forgiveness programs. Though it’s extremely important to follow all of their rules to be eligible, if you’re working in a career field that allows you loan forgiveness, you might as well go for it!

A piece of advice: save enough during your repayment period that you could pay the entire loan balance off just in case the forgiveness doesn’t come through! Most applications for forgiveness so far have been rejected, so those borrowers are still on the hook for the full balance.

Say Goodbye to Student Loans Fast

Debt sucks. You know you don’t want to keep your student loans around forever, so use any and all of these tips to slay your student debt as fast as you can!

 

The Basics of Loans: What You Need to Know

Loans are the financial instruments people use to borrow money.  Whether they are getting a mortgage to buy a house, borrowing money to buy a car (as opposed to leasing or paying cash as discussed in this post),  or other large purchase, not paying off their credit card in full or borrowing money from a friend, they are taking out a loan.  In this post, I will cover the basics of loans, including:

  • an introduction to the key terms
  • a description of how loans work
  • the factors that determine your monthly payment
  • some common borrowing mistakes

In other posts, I talked about the pros and cons of pre-paying your <a href=” https://financialiqbysusieq.com/should-chris-pay-off-his-mortgage/”>mortgage</a> and ideas for paying off your <a href= “https://financialiqbysusieq.com/slay-student-debt/”>student loans</a> more quickly.

The Basics of Loans: Key Terms

There are four basic terms common to almost all loans.  They are:

  • Down payment – The amount you have to pay in cash up front for your purchase.  For large purchases, such as homes, condos and vehicles, the lender requires that you pay for part of the purchase immediately.  This amount is the down payment. The lender wants you to have a financial interest in maintaining your purchase so it doesn’t lose value (as in the case of a residence) or lose value more quickly than expected (as in the case of a car).  For some other types of loans, no down payment is needed. Examples of such loans are student loans, credit card balances and personal lines of credit.
  • Principal – The amount you borrow.
  • Interest rate – The percentage that is multiplied by the portion of the principal you haven’t repaid yet to determine the amount of interest you owe.  Interest rates are usually stated as annual percentages. They are divided by 12 to determine the interest that is due each month.
  • Term – The time period over which you re-pay the loan.

The Basics of Loans:  How They Work

How the Money Moves

When you borrow money, the lender usually pays a third party on your behalf.  For example, when you buy a home or use a credit card, the lender gives the money directly to the seller or its escrow agent.  For some loans, the lender gives the money to you, such as with a line of credit. The amount of money the lender gives you or pays on your behalf is the principal.

You then re-pay the loan by paying the lender periodically (usually monthly or bi-weekly).  For most loans, you start making payments immediately. For some loans, though, such as student loans and some car loans, you don’t have to make payments right away.  Most student loans don’t require any re-payments until after graduation. When entering into a loan that doesn’t require immediate payments, it is critical to understand whether interest will be adding up between the time you enter into the loan and the time you start making payments.  Several years of interest, even at a low rate, can increase the amount you need to re-pay substantially.

Payments Include Principal and Interest

Part of each payment is the interest the lender charges you for letting you use its money.  The rest covers repayment of the principal. For example, if you borrowed $20,000 (the principal) at 5% (the interest rate) and started making monthly payment right away, the lender would calculate the interest portion of your first payment as 5% divided by 12 (months) times $20,000 or $83.33.  Your monthly payment also includes some principal. If you have a 10-year term on this loan, your monthly payment will be $212.13. In this case, you will re-pay $128.80 ($212.13 – $83.33) of principal in the first month.

In the second month, you’ll pay interest on $19,871.20 which is the original $20,000 you borrowed minus the $128.80 of principal you paid in the first month.  Your interest payment will be $82.80 and your principal payment will be $129.33. Every month, you will pay more principal and less interest. The chart below shows the mix of interest and principal in each of the 120 payments of your 10-year loan.

Loan Interest and Principal by Month

Factors that Determine Your Monthly Payment

The monthly payment on a loan is a function of three numbers:

  • Interest rate – the higher the rate, the higher your monthly payment.
  • Principal – the more you borrow, the higher your monthly payment.
  • Term – the longer the term, the less your monthly payment.

Sensitivity to Interest Rate and Term

The table below shows the monthly payment on a $20,000 loan for a variety of combinations of interest rates and terms.

Term (in years) Interest Rate
3% 5% 7% 9%
5 359 377 396 415
10 193 212 232 253
20 111 132 155 180
30 84 107 133 161

The amount of principal for all of the loans in the table above is $20,000.  Therefore, when the total amount of your payments increases, it is because you are paying more interest.  The table below shows the total amount of interest you would pay for each of the same combinations of interest rates and terms.

Term (in years) Interest Rate
3% 5% 7% 9%
5 1,562 2,645 3,781 4,910
10 3,175 5,456 7,866 10,402
20 6,621 11,678 16,214 23,187
30 10,355 18,651 27,902 37,933

Even with the loans with interest rates as high as 9% have much higher payments and total interest than loans with lower interest rates. The interest rates charged on credit cards are often even higher than 9%. This table shows the importance of avoiding the use of credit card debt and refinancing your credit card debt through another lender if it is very large, if at all possible.

What Determines the Interest Rate?

There are several factors that determine your interest rate.

The Economy

The first is the economic environment. If interest rates, such as those on government bonds, are high, the interest rate you will be charged will be also be high.  The US government is considered to have almost no risk of not re-paying it loans, whereas individuals have varying levels of risk. The higher the risk that a loan won’t be re-paid, the higher the interest rate.  Therefore, most loans to individuals have an interest rate that is higher than the interest rate on a US government note, bill or bond with the same maturity.

Credit Score

Along the same line, your credit score is also an important factor in determining your interest rate.  When you have a higher your credit score, lenders believe the risk you won’t re-pay the loan is lower so they charge you a lower interest rate.  My post on credit scores provides lots of details on how to improve your score.

Collateral

A third factor in determining the interest rate is whether or not you pledge collateral and how much it is worth relative to the amount of the loan.  If you pledge collateral, the lender can take it from you if you fail to make your payments. Examples of loans that automatically have collateral are vehicle loans and mortgages.  On those loans, the lower the ratio of the principal to the value of the collateral, the lower the interest rate. That is, if you make a larger down payment on a particular house, your interest rate is likely to be lower than if you make a smaller down payment.  Examples of loans that don’t have collateral are credit cards and student loans. When there is no collateral, interest rates tend to be higher than when you pledge collateral.

Co-Signers

Another approach for reducing your interest rate is to have someone with a better credit score co-sign your loan.  The co-signer is responsible for making your payments if you don’t. For young people, parents are the most common co-signers.

The Math behind Your Monthly Payment

In this section, I’ll briefly explain the math that determines your monthly payment and will provide a bit of information about the Excel formulas you can use.  Feel free to skip to the next section on common borrowing mistakes if you aren’t interested in this aspect of loans!

Present Values

The fundamental concept underlying the determination of the monthly payment on a loan is that the sum of the present values at the loan interest rate of the monthly payments on the day the loan is issued is equal to the principal.  A present value tells the values today of a stated amount of money you receive in the future. It is calculated by dividing the stated amount of money by 1 + the interest rate adjusted for the length of time between the date the calculation is done and the date the payment will be received.  Specifically, the present value at an interest rate of I of $X received in t years is:

Present Value of Single Payment

The denominator of (1+i) is raised to the power of t to adjust for the time element.

The present value of all of your loan payments is then:

Present Value of Monthly Payments

where t is the number of months until each payment and i is the annual interest rate.

Solving for Your Monthly Payment

This amount is set equal to the principal.  The monthly payment can be calculated using a financial calculator, such as in Excel, or mathematically.  The Excel formula is pmt(i/12, t, X). It will give you the negative of your monthly payment. ipmt and ppmt return the portion of each payment that is interest and principal, respectively.  In month y, the interest is ipmt(i/12, y, t, X).

For those of you who really like math, you can also calculate the monthly payment directly.  If payments were made forever (an infinite series), the sum above would equal X/i. We need to eliminate the infinite series of payments after the end of the loan to determine the present value of the loan payments.  Those payments have a present value of X/i divided by (1+i)term.  If we subtract the present value of the payments after the loan term ends from the present value of the infinite series, we get

Principal Formula

That is a bit of a messy formula, but, having gotten rid of the big sum, it can be solved using a fairly basic calculator.

Common Borrowing Mistakes

Some people end up in difficult financial situations, in bankruptcy or even homeless due to poor borrowing decisions.  A few of the more common mistakes are identified below.

Not Understanding the Terms

Many mistakes result from not reading or not understanding the loan agreement.  For example, some loans (mortgages in particular) have teaser rates or adjustable interest rates.  If the interest rate goes up on your existing loan at some point in the future, your payments will also go up.  If you have an adjustable interest rate on a loan, you want to make sure you’ll be able to afford higher payments if interest rates increase.

Another example of a loan provision that can be problematic is a balloon payment.  Under some loans, the monthly payment is calculated as if the loan has a long term, such as 15 or 30 years.  However, after a shorter period of time, say 5 or 10 years, the remainder of the principal must be re-paid and the loan terminates.  If you haven’t built up enough cash to re-pay the principal or can’t get another loan at a rate you can afford, you might default on your loan.

High Cost of Ownership

Many things that people buy with a loan come with other costs that they haven’t considered and might not be able to afford.  For example, when you buy a car, you not only have to make your car payments, but also will need to pay for insurance (including physical damage coverage at a fairly low deductible if required by the lender), gas and maintenance.  Similarly, while you may be able to fit your mortgage payment in your budget, you also need to be able to afford the costs of utilities, homeowners insurance and maintenance. In some cases, these additional costs lead to financial difficulties.

Mistakes that Increase Monthly Payments

Some mistakes cause people to have higher payments than necessary.  For example, if you take out a personal loan from a bank, you often have the option to post collateral.  If you do so, your interest rate is likely to be lower, possibly by as much as 50%.

Another way people end up with monthly payments that are higher than they need to be is to take out a loan that is bigger than necessary.  For example, if you can afford to make a larger down payment than you actually make, the principal on your loan will be higher which increases your monthly payment.  Many loans have pre-payment penalties which make it cost-prohibitive to pre-pay your principal to bring it back in line with the amount you should have borrowed in the first place. Also, if the lower down payment increases the ratio of the principal to the value of your home by too much, it will also increase your interest rate which further increases your payment.

Overestimating the Value of Your Collateral

Another problem people encounter is an inability to borrow as much as they need because they overvalue their collateral.  Common issues that arise include:

  • Lenders get their own appraisals of houses.  The lender’s appraisal is often lower than the purchase price and sometimes even lower than the assessed value.  If the appraisal is less than the purchase price, the buyer must increase his or her down payment so the ratio of the loan to the appraised value is within the lender’s limits.  Even worse, some banks won’t issue the mortgage at all if the difference between the appraisal and the purchase price is too big, even if you increase your down payment. In those situations, you need to either find another lender or re-negotiate your purchase price.
  • Lenders use the National Auto Dealers Association (NADA) Guides to value used cars.  These values can be different from Kelley Blue Book. In particular, the NADA Guides adjust the value based on the specific location of the vehicle.  Also, the values in the NADA guides assume that the vehicle is in pristine condition for its age. If it has had any heavy use at all, the lender will reduce the value before determining the value of the collateral.
  • For used cars, washed titles are also a problem.  When a car has been severely damaged, its title is changed from the more typical “clean” title to a salvage title.  However, when a car’s title is transferred from state to state, its damage history can get sometimes get lost as some states do not require salvage titles.  However, other sources, such as CARFAX, maintain the information about the damage. Lenders will check these other sources before determining the value of the collateral.

While collateral helps reduce the interest rate on your loan, it is important to consider these points in determining the value of your collateral.

The Scoop on Credit Scores

Credit scores are one of the most important financial numbers.  Credit scores not only affect the interest rate you pay when you borrow, but also your ability to borrow and other important financial transactions. It has been a long time since I’ve borrowed money, so I talked to Cody Jensen, a consumer loan officer at Missoula Federal Credit Union, to get the most current information.  In his role as a loan officer, Cody spends a lot of time educating young borrowers, so he was a terrific resource.  Here is a summary of the interview (with a few tidbits I found on line to expand on a few of his points).

What are Credit Scores?

Most lenders and vendors use the national score calculated by Fair Isaac Company.  It is a number between 300 and 850 that measures your creditworthiness and is sometimes called FICO score.

How are They Used?

Your credit score affects whether you can get a loan (see this post for more about loans) and, if so, the interest rate you will pay.  The lower your credit score, the higher the interest rate you will be charged.

Your credit score also impacts other financial transactions, such as:

  • Landlords use it to evaluate whether to rent to you.
  • The amount that you will pay if you lease a car (see this here for more on leases).
  • Most companies issuing you a contract, such as cell phone providers and cable companies, use it to decide whether you have to pre-pay for your services. That is, if you don’t have a high enough credit score, you will need to pay in advance for your services or make a significant deposit.
  • In many jurisdictions, car and homeowners/renters insurers use it as a rating variable. The lower your credit score, the higher the insurance premium you will have to pay, all other things being equal.

What is a Good Credit Score?

The thresholds vary between categories depending on the user of the information. The chart below shows the approximate distinctions considered by many vendors.

What Determines My Credit Score?

According to Investopedia, there are five factors that determine your credit score:

  • Payment history – Do you pay your bills on time. Timely payment for a long period of time will improve your credit score.
  • Credit utilization – The ratio of the amount you owe to your credit limit on credit cards.While you want a score that is more than 0% (i.e., using your credit cards is good), as the ratio increases above 30% your credit rating will decrease.
  • Length of credit history – The length of time you have used credit, either through student loans, other loans or credit cards. The longer you have used credit, the higher your score will be.
  • New credit – The amount of recent increases to your credit (e.g., new credit cards or loans). Once you have established credit, taking on additional loans or credit cards will lower your score.
  • Credit mix – The types of credit you use. Using different types of credit, such as loans and credit cards, improves your score.

The chart below shows the weights given to each of these factors.

What Can I Do to Improve my Credit Score?

Whether you are just getting started with credit or have an established credit history, here are some things you can do to improve or maintain your credit score:

  • Pay your bills on time. As indicated above, paying at least the minimum payment on your credit cards and making your full installments on any loans by their due date combine to be the biggest contributor to your credit score.
  • Wait until you have a couple of years of experience on your record. By taking the time to establish your credit experience before taking out a loan, you can reduce your interest rate or increase your ability to get a loan.
  • Get a secured credit card. If you are just getting started or need to re-build your credit, you can use this type of credit card.
    • When you open the account, you need to put down a security deposit that is higher than the limit on the credit card, often 110% of the credit limit. For example, if you get a card with a $1,000 credit limit, you’ll need to give the issuer a security deposit of $1,100.  This deposit will be returned when you close the account.
    • Ask someone else to co-sign on the credit card. In this case, the card becomes a shared secured credit card.
    • To improve your credit score, you’ll want to pay off all your charges every month.
    • You will establish a strong payment history, which improves your credit score, by using the secured credit card regularly for a period of time.
    • A secured credit card doesn’t count as a loan so it doesn’t hurt the credit utilization part of your credit score.
  • Make sure there is a balance on your credit card on the last day of the calendar month.
    • That’s when FICO checks your balance, so it is the date on which credit utilization is calculated.
    • You can then pay it off when your bill is due to improve your payment history and avoid interest payments.
    • You score will improve if your balance is between 3% and 30% of your limit on the last day of the month.
  • Check your credit information as maintained by the credit bureaus (Equifax, Experian and TransUnion). This information includes all of your loans and credit cards, your outstanding balance at the end of each month and your payment history.  You are allowed to request your credit report (but not your credit score) for free from each bureau once a year.  If you want it more often than that, you need to pay a fee. You can either enter the information on Annual Credit Report.com’s web site or print a form and submit it by snail mail.  I know a few people who have found mistakes (usually due to identity theft or confusion with a person with a similar name) that have hurt their credit scores. There is a process by which your credit report can be corrected, though it isn’t always easy.

What Are the Causes of Low Credit Scores?

Obviously, not paying your credit card bills or re-paying loans will lower your credit score.  Other factors that can lead to a lower credit score are:

  • Late payments. Again, whether you make your payments on time is the biggest factor in determining your credit score.
  • Too much debt (including credit cards and student loans). If you take on too much debt, you are less likely to be able to re-pay it.  When you have so much debt you can’t keep up with your payments, credit utilization will be too high and payment history could become poor.  These two factors alone drive 65% of your credit score.
  • While a divorce itself does not lower your credit score, some aspects of unwinding the finances can put downward pressure on credit scores.  In many marriages, the couple acquires debt based on their combined income.  For example, many couples rely on both incomes to secure a mortgage for a home.  If the couple gets divorced, they now need two households and neither one has sufficient income to pay off their joint mortgage or other debts.

How Do I Find Out My Credit Score?

Many banks and credit card companies will provide you with your credit score for free.  When I log into my bank’s web site, I can see my FICO score.  You can also pay one of the major credit bureaus (Equifax, Experian and TransUnion) for your credit score.