Strategies to Pay Back Your Student Loans

Many students today are placed in a difficult financial situation at a very young age. A college education is critical these days as an entrance to a career that offers opportunities for advancement, but that education costs money. Today, education is paid for by many students via loans. I’ve recently talked to many young people about their student loans and since this topic has generated a lot of interest, I want to discuss some thoughts and strategies for paying these down. If you have a child, grandchild or know somebody who has loans then do me a favor and pass this on to them if you have a chance as I’m writing this mainly for the college aged and younger adult crowd. While I’m no expert on the mechanics of the student loan system, the strategies involved in paying of these loans are similar to other types of debt, with the exception that for the most part student loans cannot be discharged in bankruptcy. As such there are strategies that can be used to pay these down faster and hopefully pay less interest over the life of the loan.

Economic Woes

First, if you have little or no debt give whoever it was that paid for college a big hug. Heck you might even splurge and take them out to dinner. They have done you a great service as you’re likely starting out in life thousands of dollars ahead of many of your peers.

Unfortunately, that’s not the case for most students and in many cases parents probably feel guilty that their children had to take on this burden. Believe me that was likely not their intent when they planned for college so I think it’s important for students to understand something of what many parents went through. Our generation was hit extremely hard by the last decade’s rolling economic recessions. Many parents spent what in better times would have likely been some of their most productive earnings years just trying to make ends meet. The 2007-2010 years is now being referred to as the Great Recession and it came along right in time for many of today’s students to go off to college. Many parents spent those years just trying to pay the bills. Even if they still found a few extra dollars to invest for college, the US stock market spent over a decade going nowhere and it had two bear markets where stocks lost better than 50% of their value. Think of it this way, a dollar invested in 2000 for your college could have been worth less the day you enrolled in college, depending on when you attended school. Neither the recessions nor market collapses were a great environment for college savings.

It’s A Worthy Investment

First, let's think of this debt as an investment in your future. This may be a cliche you’ve heard many times over, but it’s true. If you have the average $30,000 in student loans, then for about the price of a new car you’ve invested in a system of learning or perhaps a field of discipline that should result in higher wages for you over the years than if you had never gone to college. If a university degree means you can earn on average 20-40% more over your lifetime, then the return on your investment will dwarf the debt many times over. You’ve invested in yourself, and that’s not the same as borrowing money for a car that depreciates quickly and doesn’t generate income for you.

Loan Options

Regardless of the reasons that required you to take out student loans, you still need to pay off the debt. As with any loan, the goal is to pay down the principal as quickly as possible in order to pay less interest over the life of the loan. Since student loans are almost impossible to discharge in bankruptcy, and the few ways to receive government forgiveness on these loans don’t usually apply to most people, here are some payment strategies to consider as you start to repay those loans.

Consolidate Your Loans

Your first step when tackling your loans is to decide if consolidation is right for you. Two things to consider when researching your consolidation options are whether you can refinance your loans at a lower rate, and what timeframe or loan term will work for you.

There are many financial companies that offer consolidation, and they will help you crunch the numbers to see if it’s a viable option for you, so do your research online and talk to others who have gone through this process. Many of these companies can be researched on the web. One caveat to consolidation is that federal loans carry specific protections if you find yourself financially strapped and having a difficult time repaying your loans, such as deferment or an income-based repayment plan. Private loans may not offer the same protections; so if you think you could run into repayment trouble, do your homework and look at the fine print.

Consider Repayment Timeframe

The standard payment period for most loans is ten years. If your loans fall within this period, you will pay less in interest than those using longer time frames, and your interest rate will also likely be lower. Unfortunately, you will be stuck with a higher monthly payment.

If you have a considerable amount of debt, you may want to take the maximum amount of time to pay off your loan, usually 25-30 years. The monthly payment is less but it will ultimately cost you much more in interest over the full term of the loan and the interest rate will likely be higher. The lower monthly payment could give you more breathing room to apply extra funds to your loan as your financial situation changes and improves. Just because you have a 25-year term doesn’t mean you have to take that long to pay it back. Having the flexibility to pay a lower monthly amount might be to your advantage, particularly as you are starting your career.

Paying It Back

Once you’ve figured out if you can consolidate your loans and how long you are going to take to pay off the debt, then you should find a way to pay off the loan as quickly as possible. You will still need to pay back every penny of the principal, but you can reduce the amount of interest you pay. Every dollar you pay off earlier is less interest charged to you over the life of the loan, so make paying off this debt a priority if possible. If you want to see this in action, there are handy calculators available to show you how the numbers add up. Now let’s look at two common methods for paying down debt and how they apply to student loans by using the following examples:

Student A has four years of undergraduate college and has accrued debt at the following amounts and interest rate: $4,000 at 6.25%, $8,000 at 6.35%, $7,000 at 6.00% and $9,500 at 6.15%. Student B has three years of undergraduate loans at these levels and amounts: $5,000 at 6.15%, $4,500 at 6.35%, $6,000 at 6.25% and three years of graduate school at the following: $20,000 at 6.75%, $20,000 at 6.875% and $18,000 at 7%.

Snowball and Avalanche

Two of the most common and popular early payment methods are called the snowball method and the debt avalanche method. Students who use the snowball method pay off loans by size, smallest loan to largest. After the smallest is paid off, they roll the money you were paying on that loan into the next loan and keep at the system until all the loans are paid off. The theory behind this is that it helps you to stay on track if you can see some progress in the loans diminishing. Using this example our students would pay extra principal down on their loans in this order.

Student A:                              Student B:

$4,000 @ 6.25%                    $ 4,500 @ 6.35%

$7,000 @ 6.00%                    $ 5,000 @ 6.15%

$8,000 @ 6.35%                    $ 6,000 @ 6.25%

$9,500 @ 6.15%                    $18,000 @ 7.00%.

                                                $20,000 @ 6.875%

                                                $20,000 @ 6.75%

The debt avalanche approach has you allocate extra money beyond your required monthly payment to the loan with the highest interest rate. As you pay these down, you start tackling the loan with the next highest interest until the debt is extinguished. This is what the avalanche method would look like for our hypothetical students:

Student A:                                Student B:

$8,000 @ 6.35%                     $18,000 @ 7.00%

$4,000 @ 6.25%                     $20,000 @ 6.875%

$9,500 @ 6.15%                     $20,000 @ 6.75%

$7,000 @ 6.00%                      $ 4,500 @ 6.35%.

                                                 $ 6,000 @ 6.25%

                                                 $ 5,000 @ 6.15%

Note that the debt avalanche approach would likely save you more money in interest as you are paying down the highest loans first but it could be potentially the least psychologically satisfying as you don’t see your loans disappear as quick. Of course you could also use some combination of these approaches.

Give It Your All

The important thing is that you make a disciplined effort to pay down the debt as early as possible. This can be easier if you have just graduated from college and haven’t grown accustomed to a higher standard of living in your first few years out of school. If possible, make repaying your debt your number one personal finance goal with any extra discretionary income. Even paying an extra $50 per month can make a difference in the long run.

Get creative with finding extra money to put towards your loans. Research profitable side jobs or hobbies that will bring in a secondary cash flow. Let your family know that you would appreciate money to pay down your debt instead of a new pair or shoes or gift cards for Christmas or birthday presents. Make it a goal to use every extra dollar to get rid of your loans. Don’t forget to celebrate your achievements. Build an incentive system so as you reach different goals on your loan repayment, you can look forward to a special dinner or fun activity.

I’m happy to discuss student loan debt with young people. If this is you, or if you have a child or grandchild with student loans, call me at 708.488.0115 or email us at lumencapital@hotmail.com or pass my information on to them.

About Chris

Christopher R. English is the President and founder of Lumen Capital Management, LLC-a Registered Investment Advisor regulated by the State of Illinois. A copy of our ADV Part II is available upon request. We manage portfolios for investors, developing customized portfolios that reflect a client’s unique risk/reward parameters. We also manage a private partnership currently closed to outside investors. Mr. English has over three decades of experience working with individuals, families, businesses, and foundations. Based in the greater Chicago area, he serves clients throughout Illinois, as well as Florida, Massachusetts, California, Indiana, and other states. To schedule a complimentary portfolio review, contact Chris today by calling 708.488.0115 or emailing him at lumencapital@hotmail.com.

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