Best strategy for paying student loans?
September 22, 2009 2:37 PM
I’m in grad school and work full time. I have several Federal student loans in deferment, all of which are subsidized or unsubsidized with different interest rates. I have an extra $500 each month that I'd like to use towards my loans. If I want to have lower monthly payments when my loans go into repayment, should I make extra payments now towards the interest from unsubsidized loans with a lower interest rate or the principal of subsidized loans with a higher interest rate? Or is there a better approach?
Background info: I have 1.5yrs left for school, and I’m 90% sure I’ll continue to work full-time until I graduate. Other than my mortgage and these loans, I have no other debt (car and credit cards paid off). I have ~6 months of savings in a high (well, 1.4%) yield savings account.
My loans are distributed something like this:
Loan A: Unsubsidized, 1.8% interest rate, $5,000 balance
Loan B: Unsubsidized, 6.8%, $12,000
Loan C: Subsidized, 2.8%, $6,000
Loan D: Subsidized, 6.8%, $3,000
Right now, I make $150 monthly payments on the unsubsidized interest on Loans A & B. My lender will let me specify how I want to apply the $500 each month (Loan A/B/C/D, interest or principal). I know the usual advice is to target the higher interest rates first (as discussed here), but I’m unsure how this applies with subsidized vs unsubsidized loans. For example, Loan A has a lower interest rate than Loan D, but Loan A has a higher principal balance and is unsubsidized.
I want to make the smartest decision with these payments. My goal is to get rid of my loan fast, but I also want to minimize my monthly payment amount when my loans go into repayment. Should I focus on the principal of Loan B since it’s so high? Or should I spread out the money across the loans? If I have the money to pay off Loan D, should I go ahead and do that?
Background info: I have 1.5yrs left for school, and I’m 90% sure I’ll continue to work full-time until I graduate. Other than my mortgage and these loans, I have no other debt (car and credit cards paid off). I have ~6 months of savings in a high (well, 1.4%) yield savings account.
My loans are distributed something like this:
Loan A: Unsubsidized, 1.8% interest rate, $5,000 balance
Loan B: Unsubsidized, 6.8%, $12,000
Loan C: Subsidized, 2.8%, $6,000
Loan D: Subsidized, 6.8%, $3,000
Right now, I make $150 monthly payments on the unsubsidized interest on Loans A & B. My lender will let me specify how I want to apply the $500 each month (Loan A/B/C/D, interest or principal). I know the usual advice is to target the higher interest rates first (as discussed here), but I’m unsure how this applies with subsidized vs unsubsidized loans. For example, Loan A has a lower interest rate than Loan D, but Loan A has a higher principal balance and is unsubsidized.
I want to make the smartest decision with these payments. My goal is to get rid of my loan fast, but I also want to minimize my monthly payment amount when my loans go into repayment. Should I focus on the principal of Loan B since it’s so high? Or should I spread out the money across the loans? If I have the money to pay off Loan D, should I go ahead and do that?
1.8% and 2.8% are virtually nothing, especially given that most lenders will give you as much as .25% off for setting up direct debit. I would advice you to start paying down the higher balance, unsubsidized loan (Loan B).
Alternatively, you could get most of the way towards paying off Loan D as there's little more satisfying that ticking off a loan as paid in full.
posted by jedicus at 2:44 PM on September 22, 2009
Alternatively, you could get most of the way towards paying off Loan D as there's little more satisfying that ticking off a loan as paid in full.
posted by jedicus at 2:44 PM on September 22, 2009
These are good interest rates all around, something you'd be well off to pay back slowly. However, you can't put a price tag on peace of mind, so I hardly blame you for wanting to put some money in.
Do not pay a penny on loans A or C until you absolutely must. Those are good loans to have, and the interest rate is no worry whatsoever. Loan C is perfect, subsidized for interest rate. A is not bad either, 1.8% isn't going to hurt to build for a little bit, since you have something else to take on.
Pay only on loan B until you must pay on others. That will save you the most money in the long run, as well as cutting the largest loan down in size to a less threatening level. Loan B is priority one. Loan D is next, if you wind up having a windfall or increased income which permits paying down a loan further. By the time you finish, loan C will be your next target, then loan A. You're right, go by interest rates. In this case, there's enough difference between the subsidized and the unsubsidized that your loan A is really nothing to consider paying off until at least B and D are done.
Don't touch your savings for this either. While you're technically losing out by not paying off 6.8% interest from a 1.4% interest account, you're wiser than most people in having six months of cushioning in case work falls apart.
posted by Saydur at 3:05 PM on September 22, 2009
Do not pay a penny on loans A or C until you absolutely must. Those are good loans to have, and the interest rate is no worry whatsoever. Loan C is perfect, subsidized for interest rate. A is not bad either, 1.8% isn't going to hurt to build for a little bit, since you have something else to take on.
Pay only on loan B until you must pay on others. That will save you the most money in the long run, as well as cutting the largest loan down in size to a less threatening level. Loan B is priority one. Loan D is next, if you wind up having a windfall or increased income which permits paying down a loan further. By the time you finish, loan C will be your next target, then loan A. You're right, go by interest rates. In this case, there's enough difference between the subsidized and the unsubsidized that your loan A is really nothing to consider paying off until at least B and D are done.
Don't touch your savings for this either. While you're technically losing out by not paying off 6.8% interest from a 1.4% interest account, you're wiser than most people in having six months of cushioning in case work falls apart.
posted by Saydur at 3:05 PM on September 22, 2009
What those two said - put it all towards Loan B.
- There's no good reason for you to pay off loans that are still being subsidized, and thus aren't accruing any interest.
- At 1.8%, Loan A is accruing interest at a rate less than inflation. That means that the longer you wait to pay it off, the less real money you actually use.
If it helps, think of it this way: As inflation happens (at, say, 3% per year), most salaries will rise to match it. So if you made 50k this year, it would cost you 10% of your salary to pay off the loan. Next year, you'll make 51,500, while your loan will only be at $5090, which means it will only cost you 9.88% of your salary. In 5 years, it'll only be 9.4% of your income. The longer you wait, the less goods and services that money will buy, and the better off you are.
Bottom line: if your interest rate is lower than inflation, pay it off as slowly as you can. (Inflation isn't so high right now, seeing as how we're in a recession, but it's still much better to pay off the high interest one.) If you finish paying loan B, I'd actually start working towards loan D before paying A off.
posted by chrisamiller at 3:24 PM on September 22, 2009
- There's no good reason for you to pay off loans that are still being subsidized, and thus aren't accruing any interest.
- At 1.8%, Loan A is accruing interest at a rate less than inflation. That means that the longer you wait to pay it off, the less real money you actually use.
If it helps, think of it this way: As inflation happens (at, say, 3% per year), most salaries will rise to match it. So if you made 50k this year, it would cost you 10% of your salary to pay off the loan. Next year, you'll make 51,500, while your loan will only be at $5090, which means it will only cost you 9.88% of your salary. In 5 years, it'll only be 9.4% of your income. The longer you wait, the less goods and services that money will buy, and the better off you are.
Bottom line: if your interest rate is lower than inflation, pay it off as slowly as you can. (Inflation isn't so high right now, seeing as how we're in a recession, but it's still much better to pay off the high interest one.) If you finish paying loan B, I'd actually start working towards loan D before paying A off.
posted by chrisamiller at 3:24 PM on September 22, 2009
Kill the 6% ones first, and delay, delay, delay on the <3>
Echoing what Saydur said, the security of having a big savings cushion is worth money. There's NOTHING better than not having to worry about money, and a fat savings account is the only way to get there.
$10K in living expenses in the bank is worth more than $10K less in debt. The day when you NEED to take out a loan is precisely the day you become a "bad bet" from a bank's perspective and is when they'll refuse to lend you money.
Once you have a house, you're in debt for pretty much the rest of your working life, so the most important thing is how you manage debt rather than how quickly you can get out of it. Don't focus on paying things off. Focus on increasing your safety net.
posted by paanta at 3:50 PM on September 22, 2009
Echoing what Saydur said, the security of having a big savings cushion is worth money. There's NOTHING better than not having to worry about money, and a fat savings account is the only way to get there.
$10K in living expenses in the bank is worth more than $10K less in debt. The day when you NEED to take out a loan is precisely the day you become a "bad bet" from a bank's perspective and is when they'll refuse to lend you money.
Once you have a house, you're in debt for pretty much the rest of your working life, so the most important thing is how you manage debt rather than how quickly you can get out of it. Don't focus on paying things off. Focus on increasing your safety net.
posted by paanta at 3:50 PM on September 22, 2009
Yup, B, D, C, A. Pay off higher interest loans first. You can even set it up as an optimization problem in Excel.
posted by pravit at 4:28 PM on September 22, 2009
posted by pravit at 4:28 PM on September 22, 2009
I would be cautious in how much you repay and how fast. Try to keep six months to a year worth of living expenses and then use extra to repay the loans.
Student debt is extremely flexible. You can get it deferred for up to 3 years based on economic conditions, which stops the interest for your subsidized loans (which I'm sure you know). You can also get up to 3 years of forbearance (no questions asked, basically), in which interest accrues but you don't have to make any payments. During deferment/forbearance, any interest is kept in a separate account and is not capitalized until you go into repayment. (So the loans accrue simply interest, not compound interest). Then, directly before you go into repayment, you can pay off all that interest and it will never capitalize and you won't pay interest on the interest, so to speak.
All this being said, pay back the highest interest, unsubsidized loans first. Then pay back the rest, in order of their APR.
posted by Happydaz at 7:38 PM on September 22, 2009
Student debt is extremely flexible. You can get it deferred for up to 3 years based on economic conditions, which stops the interest for your subsidized loans (which I'm sure you know). You can also get up to 3 years of forbearance (no questions asked, basically), in which interest accrues but you don't have to make any payments. During deferment/forbearance, any interest is kept in a separate account and is not capitalized until you go into repayment. (So the loans accrue simply interest, not compound interest). Then, directly before you go into repayment, you can pay off all that interest and it will never capitalize and you won't pay interest on the interest, so to speak.
All this being said, pay back the highest interest, unsubsidized loans first. Then pay back the rest, in order of their APR.
posted by Happydaz at 7:38 PM on September 22, 2009
If it were me, I'd put every spare penny into Loan B, and then shift your focus when the interest starts on Loan D.
posted by timdicator at 6:39 AM on September 23, 2009
posted by timdicator at 6:39 AM on September 23, 2009
Thanks so much for the advice, everyone! I definitely see the value in focusing on Loan B first, so that'll be my payment strategy.
I also appreciate the reminders about holding on to my savings, and not repaying too much too fast. Debt makes me nervous (in the rare event that I use a credit card, I immediately pay it off the same day) so my urge was to dip into my savings (I know, I know) to pay off Loan D, then focus on the lower balances. I see now why it's smarter in the long run to focus on Loan B first.
Thanks again!
posted by yeoja at 10:48 AM on September 23, 2009
I also appreciate the reminders about holding on to my savings, and not repaying too much too fast. Debt makes me nervous (in the rare event that I use a credit card, I immediately pay it off the same day) so my urge was to dip into my savings (I know, I know) to pay off Loan D, then focus on the lower balances. I see now why it's smarter in the long run to focus on Loan B first.
Thanks again!
posted by yeoja at 10:48 AM on September 23, 2009
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posted by yeoja at 2:40 PM on September 22, 2009