Student Loans: Debt for Life (Or Not?)

College students are graduating with an average of $38,000 in student loan debt after attending 4-year college.  That’s an astronomical amount of debt for someone in their early 20s especially when the average starting salary for a recent college grad is only $50,000.

That means the average college graduate begins their life with a debt-to-income ratio well above average.  But what most people don’t know about student loan debt is what kills them in the long run.  Here’s some information to help you pay off those student loans before you cash out your 401k.

Interest Rates.  If you’re like most, you borrowed through FAFSA which means that your loans carry an annual interest rate of 6.8% (and rising).  This rate is several points higher than any interest rate in any almost any other consumer industry.  Interest is calculated on the total balance at an annual rate and then accrued monthly with each installment that becomes due.  So if you have an average amount of debt, say $38,000, your loan is accruing interest at the rate of $2,600 a year, or $215 a month.  (Calculate your annual interest by multiplying your total debt balance by 0.068; Divide by 12 for the monthly amount).

Deferment and Forbearance Programs.  While most lenders will permit you to defer payments if you’re unemployed or underemployed, what they don’t always tell you is that interest continues to accrue during this period for most programs.  So if you defer payments for a year (for any reason) your loan balance will grow.  In the example above, after one year of deferment, your balance would grow to $40,600, which in turn increases your annual interest charge to $2,760.  After a second year of deferment, your balance would increase $43,360, and so on each additional year.  If you absolutely must defer payments, plan the shortest possible deferment and be prepared for your new, higher balance.  Higher balance usually means a higher minimum payment.

Make a Monthly Payment; ANY Payment. Obviously you will have to choose a payment plan that’s right for you.  Start by talking to your lender to see what programs they offer.  However, consider paying the accruing interest each month.  This will at least keep your balance from growing.   If you are gainfully employed, however, you should have a plan and a budget.  You can calculate your payment based on when you would like to pay off the loan (e.g., 5 years), or you can base it off your your available disposable income ($500/month). Either way, you will need to prepare a monthly budget so you can be sure to have enough to cover your basic necessities, a little bit for savings, and a monthly student loan payment that won’t have you paying off debt into your retirement years.  You can play with the numbers by using a payoff calculator like this one:

As I’ve discussed in past articles, a monthly budget will keep you from overspending and help you to maximize your cash flow so you can devote as much as possible to student loans.  A good budget should endeavor to meet the following guidelines:

30% for housing expenses (rent and utilities)

15% for transportation (vehicle expenses or public transportation)

15% for food and personal items (groceries, cleaning supplies, toiletries, clothing)

20% for miscellaneous or discretionary spending (cell phone, cable/internet, leisure, recreation and social activities)

20% for savings and/or debt payments                                                                                           

= 100% Financial Security

Although you might have to make sacrifices now to tackle your student loan debt, in the long run you’ll be glad that you’re not saddled with growing debt when you’re ready to buy a house or start a family down the line.

Bankruptcy.  Unfortunately, current bankruptcy laws do not allow debtors to discharge student loan debt.  However, if you’re saddled with credit card debt, making those minimum payments are probably preventing your from paying down your student loans.  Since credit card debt is quickly and easily discharged in bankruptcy, eliminating credit card debt will free up more of your income to pay down student loan debt.  Qualifying debtors can eliminate 100% of credit card debt in as little as 4 months with no payments.



Call: (908) 353-6700    Text: (908) 266-4843    E-Mail


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