Hi Everyone! Welcome Back to Melissa Making Cents.
Last week I talked about the Student Loan Debt Crisis and the effects of the $1.5 Trillion in debt. I had someone ask me why I thought the loans were so bad. She pointed out that she would be building her credit through paying her loans on time. And she was right! Loans are not ALL Bad.
How a student loan works
So here are the basics…. A loan in its simplest form is money that is given to you with the expectation that you will pay it back with an agreed upon interest rate. The amount you take out is called the principal of the loan. The Term of the loan is the number of payments you will make, and the APR is the Annual Percentage Rate, or interest rate, you will be repaying over time. The rates can be a fixed number or variable rate based on an economic indicator known as the London Interbank Offered Rate, or Libor.
A good rule of thumb is that you can expect to repay $100 for every $10,000 you borrow, over a 10 year period.
How does the Term of the Student Loan affect you?
Extending your payments for a longer term will allow you to have lower payments. In this case, let’s look at the list of schools we were narrowing down for this student. The Funding Gap is the amount in loans we would need to take out to finish all 4 years. As you can see from School A, if our payments were $481 for 10 year we are making total loan payments of $57,738. If we choose the 25 years repayment option because of budget issues we could reduce our monthly payments to $279 a month, but over 25 years we are looking at repaying a grand total of $83,770 or almost DOUBLE the amount we originally borrowed! Yikes!
Making Extra Payments on Student Loans Helps
Wanna pay off those loans a little quicker? Let’s make extra payments! How will it make a difference? Well.. The student above decided to make an extra $100 monthly payment towards the $43,339 loan. By paying $581 instead of $481, we are able to pay off our loan in 7.8 years instead of 10 years. Saving us $3,106 in interest! Is your budget flexible enough to pay a little more? For $681 you will be done in 6.5 years, and for $781 you can celebrate in 5.5 years. Every little bit helps, so even if you are paying an extra $20 a month, you are still doing yourself a favor.
Tell Lenders how you want the extra payments applied
Did you know that Lenders are solely responsible for determining how your extra payments are applied? Let’s this about this for a sec…. If you are the lender/bank, in the business of making money, where would you apply that extra money? 1) To the principal balance where it reduces the money you receive? Or 2) To the interest payments that continue as long as the principal balance is higher? If you guessed #2… You are absolutely correct! When you are making extra payments talk to your lender and tell them you want to apply your extra payment to the principal balance. It reduces your interest payments in the long run!
Oh and by the way.. When making extra payments to your student loans, make sure to tell them NOT to advance your next Due Date. You want every payment to count!
No extra room student loan payments in your budget?
If your budget simply can’t handle the extra payments, you may have 3 additional opportunities to put a dent in that debt.
- Tax Refunds - According to the IRA, the average refund for the 2019 filing season was $2,729. That’s certainly a healthy chunk of change to go towards debt!
- Pay Raises - Cha-Ching! For most people, a pay raise equates to increasing the size of your budget. So instead of adding in weekly lunches out, let’s use the additional money to reduce that debt.
- “Windfall money” - Gifts, Bonuses, Legal Settlements, or Inheritances. These may be uncommon, but effective in diminishing those payments!
When making extra student loan payments just doesn’t make cents..
For any Student Loan Borrowers that are going thru the Public Student Loan Debt Forgiveness process (PSLF), you may not want to make the extra loan payments. Qualifying for the PSLF program is tricky enough at the moment based on the current requirements. So, if you are attempting to qualify, making extra payments it could derail your plan. It may be best to use the extra funds to pay off other forms of debt, build your own savings, or even fund your company’s retirement plan.
Debt CAN be beneficial
Our student was exactly right… Debt is not always bad. It does help build your credit, which you will need in life. The biggest bit of advice I can give you is to make sure you know what you are getting into. Make a well informed decision about taking out student loans and have a good estimate of your monthly budget and payments when you graduate.
Until next time… this is Melissa Making Cents
Melissa Anne Cox
CERTIFIED FINANCIAL PLANNER™