In the prior post, we talked about student loan debt from a parent’s perspective. Now we’re going to dive into the details of student loan repayment (when you're the borrower).
The credit card mantra “pay off your highest rate debt first” doesn’t always apply to student loans … it’s much more complicated.
Different Types of Student Loans
There are a variety of loan options: government-sponsored subsidized or unsubsidized, in addition to private loans. Federal subsidized loans look at financial need of undergraduate students, and the government pays interest on this loan while you’re in school. Federal unsubsidized loans are available to undergraduate and graduate students, regardless of financial need. Private loans are usually a “last resort,” after you’ve already borrowed from the government but still have an unmet need. Private loans typically have higher, variable interest rates compared to government loans.
Look at the student loan debt detail. Check to see if it is a government loan with a fixed interest rate or a private loan with a higher variable rate. Look at when you originally incurred the debt, too. The date of the first disbursement impacts the interest rate on federal loans.
Debt Snowball vs. Avalanche
When it comes to paying off any debt, there are generally two available methods: the snowball or avalanche. Debt snowball entails paying off the debt with the lowest balances first (regardless of interest rate), while debt avalanche guides you to pay off the highest interest rate first.
Conceptually, debt snowball makes a lot of sense. When you’re working toward any financial goal, it is easier emotionally to celebrate the small wins. If you want to run a marathon, any trainer would advise you to stick to a regimented schedule that gradually increases the distance you’re running before race day. With credit card debt, pay off the $1,000 credit card balance first, then the $2,000 balance, and so on.
Financially, however, the debt avalanche method is most prudent. For example, you focus on the highest interest rate of 20% and work your way down to the 2% rate.
Dave Ramsey made the debt snowball famous, stating “what I have learned is that personal finance is 20% head knowledge and 80% behavior.” If you are motivated to pay off the debt no matter what, the avalanche method makes more sense. But if you’re honest with yourself and know you need an accountability partner, get one. That accountability partner may be a friend also trying to pay down debt, a spouse, or an outside financial advisor. He or she is there to keep your emotions in check when the debt avalanche method seems too difficult.
Too many loans to track? Consider consolidation if you want to make a single monthly payment rather than multiple payments. However, be careful of the longer repayment term – you’ll accrue more interest over the life of the loan if you fail to make extra principal payments.
Heather Jarvis is a student loan expert with a plethora of resources on her website. The “Tools” section of her website includes links to the Public Service Loan Forgiveness Program and Income Driven Repayment Plans for Federal Student Loans.
Please share this article if you found it helpful. If you review the links in this blog post and still feel stuck, please reach out to me or another XY Planning Network advisor.
Even if college is several years away for your oldest child, it is never too early to start planning. Setting up a self-directed 529 Plan is a great way to start saving for college. We’ll dive deep into college savings on the next blog post.
Deb Meyer, CPA, CFP®