Student Loans: glass half full and half empty?
Updated: Aug 4, 2020
We all know that pessimists see the glass as half empty and optimists see the glass as half full. But can a glass of water be both half full and half empty at the same time? In the case of student loans, I believe so.
Here is the glass half full view: Student loans can be seen as a necessary evil that allow the student to attend and graduate college. That necessary evil can produce years of higher future earnings. Therefore, the student can be better for taking on the burden of student loans.
Others see student loans with a glass half-empty point of view like having a home mortgage (on a very nice house, I might add) without actually owning the house. Student loans are a large monthly expense that push back other purchases or investments for many millennials. Needless to say, they would rather hear nails on a chalkboard at all hours of the day than think about repaying their loans.
Regardless of whether you see the glass as half full or empty, a serious damper on millennials’ spending habits. Many millennials are also ignoring the debt and letting it fester, saying they will deal with it in the future. To make matters worse, there are not many sources of good information on education, methods for repayment, prioritizing loans, or payment options.
Below are some repayment options and strategies regarding student loans:
Refinance Privately: Some student loans can be refinanced with private lenders to lower the interest rate. Lower interest rates can save hundreds or even thousands of dollars annually. Recently, some new lending companies have arrived in the market specializing in high “quality” student loans. These high quality student loans are intended for applicants with good credit scores, steady jobs, and positive cash flow. Since these private companies can be selective in their loans, they offer very low interest rates. Websites such as SoFi, Lendkey, Earnest, DRB, and CommonBond–to name a few– have been offering fixed rates in the 3.5% – 4% range with variable rates even lower.
Ten-Year Public Service Loan Forgiveness (PSLF): This program can forgive the remaining balance of student loans after ten years of monthly, on-time payments while working full-time for a qualifying employer. Qualifying employers include: government organizations, non-for-profit companies that are tax exempt under 501(c) (3), and other organizations that provide certain types of qualifying public service. It is difficult to qualify but worth calling to see*. If qualified, this program can provide a huge relief from student loans.
Income Based Repayment: The primary benefit of this plan is that monthly payments can be much lower than more traditional repayment plans. There are four different plans: income based repayment, pay as you earn, revised pay as you earn, and income-contingent repayment. Typically, the repayment amount is a fixed percentage of income (or discretionary income), such as 10% – 20%. Loans can also be forgiven in 20 or 25 years if qualified for. The main disadvantage is that more interest may be paid compared to a traditional 10-year repayment.
Snowball and Avalanche Methods: Below are two effective and one not effective methods for prioritizing paying off student loans earlier than scheduled. These involve paying off loans ahead of schedule either with extra monthly payments or a lump sum amount.
– Snowball: This method prioritizes extra funds towards the loans with the smallest balances first (regardless of interest rate). Once that loan is paid off, keep the same monthly payment and move on to the next smallest loan balance. This method will pick up speed as the smaller loans are eliminated (think of a snowball rolling down a hill). This method is most effective for those who want to see “small victories” and to feel the progress of paying off their loans.
– Avalanche: This method prioritizes extra funds towards the loans with the highest interest rate. Once the highest interest rate loan is paid off, keep the same monthly payment and move to the loan with the next highest interest rate. This is the most efficient way to eliminate student loans as higher interest rate loans are eliminated first, minimizing interest paid.
– Shotgun Method: This method prioritizes no individual loans and spreads out extra monthly payments equally between all student loans regardless of balance size or interest rate. This method does not efficiently eliminate the number of loans or interest paid. This is not an efficient method to pay down student loans faster than the standard repayment plan.
Work Bonus / Tax Refund: If extra monthly income is difficult to find and the budget is tight, tax refunds and months when there are three paychecks are a good way to pay down student loans. One of the best purposes may be to pay down student loans. This would allow student loans to be paid down quicker than the standard method without affecting your monthly budget. Assuming you are paid biweekly, the same can be said for months where there are three paychecks. If you budget for two paychecks per week, the third paycheck, for those two months, can be used to pay down student loans. If extra paychecks and a tax refund are both used, that could add up to be thousands annually without affecting the monthly budget.
There should be cause for great celebration when the last payment is made towards your student loans! However, until that time it is important to have a plan in place to minimize interest and pay down student loans as efficiently as possible.
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Registered Representatives. Securities offered through Cambridge Investment Research Inc., A broker dealer member FINRA/SIPCS/Investment Advisor Representative. Cambridge Investment Research Advisors, Inc. a Registered Investment Advisor. Cambridge and SecurEstate are not affiliated.