Congratulations. You’ve finally done it. You celebrate with your family and friends, showing off your degree. With college now behind you, you are excited to take your first step into the working world. Things get off to a slow start, as it take you a couple of months to find a job. It’s not a job doing exactly what you wanted, and it pays a little less than what you had hoped for, but it’s a job so you take it.
A few months later, the first bill for your student loans pops up in your inbox. Your minimum payment is $300 a month. Between loan payments, car payments, rent, utilities, food and gas you’re stuck living paycheck to paycheck, each month falling a little bit further behind. You start racking up credit card debt, as you can’t afford to pay off the full amount each month. Eventually you miss a loan payment, then a car payment, then rent. Your loans go into default, your car is repossessed, and you are evicted from your apartment.
Homeless, you wander the streets with nothing more than the clothes on your back and a deflated football that in your hallucinations you believe to be a dog named Snappy, scrounging for loose change so that you can buy some alcohol to forget the pain if for only a few moments. On a cold windy day, you sit on a bench with your dirt encrusted coat wrapped tightly around you. A gust of wind picks up Snappy, and blows him into the road. There, before your eyes, Snappy is crushed instantaneously by the tires of a passing car. You howl in pain as your only friend is now gone, leaving you alone. “Oh,” you weep, “oh, if only I had better managed my student loans!”
Now, that was a bit of an extreme example, but I wanted to test out my creative writing skills. So yeah, nothing like that is going to happen to you, but perhaps you might find yourself in a situation like the following:
A recent college graduate living paycheck to paycheck lies awake at night stressing over whether or not he will be able to pay his bills for the month.
A young married couple can’t go on a vacation with many of their close friends as they can’t afford the trip due to their loan payments.
An employee has to work at a soul-sucking company with an abusive boss, and is too afraid to leave because even being out of work for a couple of weeks might mean they will run out of money.
These are all much more realistic situations a person could face in their lives. Many people out there are really enslaved by their student loan debt. At the very least, student loan repayment is a major source of stress for people. This report put out by the Boston Fed showed that 57% of people with student loans are concerned about being unable to repay them. Why be enslaved to your debt? Why stress out about it?
That’s why I’m writing this blog. Hopefully, to help you learn about student loans, learn how to manage them, and ultimately how to be free from them. In the last 2 posts, I have covered the topic of student loans for someone just starting college, and for someone who is in the middle of college. In this post, I will be writing about the college graduate. A person who is working full-time, and making payments on their student loans. In other words, a person who has hit reality. It can be easy to forget about our loans when we don’t have to pay them back, but when we start getting those bills in the mail it is a whole different picture.
So, you need to start paying back your loans. How should you do this, and how can you do this the most effectively? And how can you pay back your loans so you’ll be debt-free the fastest? Well, it’s pretty simple
Step 1: Make the minimum payment on your loans each month. This one should be a no-brainer. In order to avoid having your loans go into default, you need to pay the minimum amount specified by your loan servicer each month. In this post, I discussed all of the bad stuff that happens if you default on your loans. So, in order to avoid default and everything that comes with it, the first step is to pay the minimum balance on each loan every month.
Step 2: Pay off your loans early. Paying off your loans early will save you money in the long-term, since there will be less time for interest to compound, and less principle for that interest to compound on. Not only will you save money by paying off your loans early, but it will also help you to be debt free faster.
The best way to pay off your loans as quickly as possible is take any money left over after your minimum pat on one loan, instead of spreading that extra across all of your loans.
There are two common methods used to determine which loan to prioritize payments on, which I will call the Snowball Method and the Highest Rate Method.
In the Snowball Method, any extra money above your minimum payments is put towards the loan with the lowest balance. For example, say you have three loans:
Loan 1 has a balance of $2,000 and an interest rate of 4.66% with a minimum monthly payment of $50.
Loan 2 has a balance of $8,000 and an interest rate of 7.53% with a minimum monthly payment of $100.
Loan 3 has a balance of $5,000 and an interest rate of 4.29% with a minimum monthly payment of $75.
After making a combined minimum monthly payment of $225, you have an extra $100 to put towards your loan payments. Since this is the Snowball Method, you would put that $100 towards Loan 1, which has the smallest balance. Once Loan 1 is paid off, any extra money would then go to Loan 3 (which would then have the smallest balance). Once Loan 3 is paid off, you can then put all extra money into the last remaining loan, Loan 2.
This method is often preferred because it gives you a psychological advantage. In this method, you knock out the smallest loan quickly, then move up to the next largest loan, and so on. By focusing on the smaller loans first, you get the satisfaction of paying off a loan completely. It doesn’t matter that it may have only been a small loan, that feeling of accomplishment from wiping one whole loan off the list can keep you going in what seems like a neverending stream of loan repayments.
I think you can better understand the appeal of the Snowball Method when you look at the other suggested method, which is the Highest Rate Method. As the name suggests, in this method you put any extra money towards the loan with the highest interest rate first. When that loan is completely paid back, you put the extra payments towards the loan with the next highest interest rate and so on.
The advantage to this method is that you will end up saving the most money in the long run. Because you are focusing on the loans with the higher interest rates, you are giving that interest rate less principal to compound on, and less time to compound as well.
So, if the Highest Rate Method will save you the most money, why would anyone choose the Snowball Method instead? Well, as I mentioned before, the Snowball Method will give you tangible results sooner, as it quickly knocks off your smaller loans. Applying the Highest Rate Method to our example, the first loan to be focused on would be Loan 2, which has a balance of $8,000. While putting your extra money towards that loan first will save you more money in the long run, it’s going to take a lot longer to pay off that loan.
This is where we see the advantage to the Snowball Method. Instead of slugging through a huge loan first, you quickly knock off some smaller loans to get the ball rolling. Like making a snowman, you start small and keep on rolling until you’re debt free.
Personally, I prefer the Highest Rate Method to the Snowball Method. But each person is different, so what is important is finding the method that will help you the most in paying off your loans. Are you the type who wants to start with the small milestones and work your way up to the big ones? Maybe the Snowball Method is better for you. Are you someone who doesn’t need any milestones along the way, and instead will be content knowing that they are saving a little extra money? Then perhaps you would fit into the Highest Rate Method.
Whichever method you pick, the important thing is to stick with it. And this brings us to our final step.
Step 3: Stick with it! So much of paying back your loans has to do with discipline, the discipline to keep your head down and send out those checks each month, no matter how hard it can seem. Your student loans aren’t going to go away magically on their own, and while it may seem daunting, you just need to keep on plugging away at your loans. Maybe you can make a chart of your loans, and watch the balance decrease very month to keep you going. Or maybe, you’re the type who just needs to set up the automatic payments and not think about your loans until they’re paid off. But you need to stick with your repayment plan; many people fall off the wagon and find themselves right back where they were at the start. Don’t let this be you!
So, in conclusion, it’s pretty simple. There are 3 steps to paying back your loans and being free from that debt. In case you forgot already, those steps are:
Step 1: Make all the minimum payments on your loans.
Step 2: Choose either the Snowball or Highest Rate Method for your extra payments.
Step 3: Stick with it!
Follow these steps, and you will find yourself on the way to debt freedom!
P.S. I wrote out the whole blog and realized I forgot to add one part in. I didn’t really want to go back and edit it in, so I threw it down here. When making extra payments to a loan, be sure to specify that you want that extra money to go towards the principal of the loan. Some loan companies will try to screw you by applying it to the interest, so make sure you instruct them to put that towards the principle. It’ll save you money that way.