Strategies for paying down student loans
April 25, 2015 2:56 PM Subscribe
I have several federal student loans from graduate school. They are in groups according to interest rate (5-8%) and the balance on each varies, from $2500-$60,000. Is there any benefit to proportioning the payment to each group, or strategy for paying them down while making income-based payments?
I am just beginning the process of paying my loans back at an income-based rate, and I see that I can divide my monthly payment among the different loan groups. Is there any benefit in throwing money at the low principal, medium-interest group, or should I try to proportion my payments to the higher principal groups? Or does it really matter? I was granted income-based repayment so my monthly fee is something like $375, versus $1000 on the standard repayment plan. I realize this payment is based on a 25 year repayment calendar, but would love to pay them off sooner. (Although it's unlikely I'll ever move into a higher income bracket).
Also, will paying more than the monthly amount affect my income-based status? (Not a lot, but, say, $20-50 each month), or is it better to save that money or do something else with it?
I am just beginning the process of paying my loans back at an income-based rate, and I see that I can divide my monthly payment among the different loan groups. Is there any benefit in throwing money at the low principal, medium-interest group, or should I try to proportion my payments to the higher principal groups? Or does it really matter? I was granted income-based repayment so my monthly fee is something like $375, versus $1000 on the standard repayment plan. I realize this payment is based on a 25 year repayment calendar, but would love to pay them off sooner. (Although it's unlikely I'll ever move into a higher income bracket).
Also, will paying more than the monthly amount affect my income-based status? (Not a lot, but, say, $20-50 each month), or is it better to save that money or do something else with it?
Best answer: This debt reduction calculator by vertex42 on google docs will tell you precisely what the costs and benefits are of paying off your loans using different strategies and payment amounts. It doesn't include anything about income contingent repayment deals though.
posted by srboisvert at 3:35 PM on April 25, 2015 [3 favorites]
posted by srboisvert at 3:35 PM on April 25, 2015 [3 favorites]
I would go for paying off the small balances first just to get them out of the way and for the feeling of success :)
posted by saradarlin at 3:40 PM on April 25, 2015 [1 favorite]
posted by saradarlin at 3:40 PM on April 25, 2015 [1 favorite]
Best answer: robertthebruce: "I am just beginning the process of paying my loans back at an income-based rate, and I see that I can divide my monthly payment among the different loan groups."
You can't control how much you borrowed at this point. What you can control is how much interest you pay, and to do that you should be targetting the highest interest rate first, regardless of principal size. People like to go on about 'seeing positive results' and 'behaviorial finance' but IMO, the entire point of planning is to avoid falling into those cognitive traps.
Depending on your income, you might also be looking at forgiveness plans. The standard repayment plan, which is 10 years, has you paying roughly 1000 a month. IBR is related to a 25 year repayment plan, but also has caps on payment size. A low enough income can put you in a situation where your payment is lower than interest accumulated, in which case 25 years is not long enough to actually pay loans back. For example, 375*12*25 =$112,500 in payments total. If your balance is higher than that, making extra payments might not make a dent!
Another important thing to consider is how retirement accounts and IBR interact -- if I'm reading current rules for IBR right, the lower your AGI, the lower your payments. So there's a virtuous loop where the more you put into a 401k or IRA, the less of your income goes to taxes and loan repayments. And obviously you throw the money you save into the retirement plan, thus lowering your tax and debt burden further, until this infinite series converges.
posted by pwnguin at 4:41 PM on April 25, 2015 [3 favorites]
You can't control how much you borrowed at this point. What you can control is how much interest you pay, and to do that you should be targetting the highest interest rate first, regardless of principal size. People like to go on about 'seeing positive results' and 'behaviorial finance' but IMO, the entire point of planning is to avoid falling into those cognitive traps.
Depending on your income, you might also be looking at forgiveness plans. The standard repayment plan, which is 10 years, has you paying roughly 1000 a month. IBR is related to a 25 year repayment plan, but also has caps on payment size. A low enough income can put you in a situation where your payment is lower than interest accumulated, in which case 25 years is not long enough to actually pay loans back. For example, 375*12*25 =$112,500 in payments total. If your balance is higher than that, making extra payments might not make a dent!
Another important thing to consider is how retirement accounts and IBR interact -- if I'm reading current rules for IBR right, the lower your AGI, the lower your payments. So there's a virtuous loop where the more you put into a 401k or IRA, the less of your income goes to taxes and loan repayments. And obviously you throw the money you save into the retirement plan, thus lowering your tax and debt burden further, until this infinite series converges.
posted by pwnguin at 4:41 PM on April 25, 2015 [3 favorites]
Whoops, forgot a bit:
robertthebruce: "Also, will paying more than the monthly amount affect my income-based status? (Not a lot, but, say, $20-50 each month), or is it better to save that money or do something else with it?"
On this I'm divided. It depends really, on how big the loans are. 8 percent is super high for a risk-free rate, so normally I recommend you pay down the loans before figuring out retirement. But there's also tax intermingled: student loans are tax adjustments (deductions you don't need to itemize to take), and retirement savings are tax advantaged.
If you're certain you won't be getting any loan balance forgiven in 25 years, it makes sense to pay off the highest interest rates. I don't know at what interest rate my advice would flip, but FWIW, my loans are at 2.25 percent fixed and I am in no hurry to pay them down.
posted by pwnguin at 4:46 PM on April 25, 2015
robertthebruce: "Also, will paying more than the monthly amount affect my income-based status? (Not a lot, but, say, $20-50 each month), or is it better to save that money or do something else with it?"
On this I'm divided. It depends really, on how big the loans are. 8 percent is super high for a risk-free rate, so normally I recommend you pay down the loans before figuring out retirement. But there's also tax intermingled: student loans are tax adjustments (deductions you don't need to itemize to take), and retirement savings are tax advantaged.
If you're certain you won't be getting any loan balance forgiven in 25 years, it makes sense to pay off the highest interest rates. I don't know at what interest rate my advice would flip, but FWIW, my loans are at 2.25 percent fixed and I am in no hurry to pay them down.
posted by pwnguin at 4:46 PM on April 25, 2015
Assuming you have a minimum payment for each loan, it does make sense to pay the smallest *balance*, rather than highest interest, because by cutting your minimum payment you have given yourself better liquidity - if anything goes wrong while you are paying off the loans, you are more likely to be able to meet the new, lower repayment, and psychologically, it feels like you are making more progress, and it is motivation that will really make the difference.
If there is a big difference in interest, you can fiddle around with which loan is a priority of course.
posted by Elysum at 9:07 AM on April 26, 2015
If there is a big difference in interest, you can fiddle around with which loan is a priority of course.
posted by Elysum at 9:07 AM on April 26, 2015
Do you have a "safety cushion" in savings? It's generally recommend that you have something like 3 months of income or 6 months of expenses, in an easy-to-access account. This lets you weather unanticipated problems (medical bills, expensive car repairs, loss of a job, etc. ) that would otherwise throw you into financial chaos that is 1) terribly stressful and 2) very expensive due to overdraft fees, missed-payment penalties, high-interest emergency loans, etc.
If you don't have a safety cushion, you should make the minimum payment on your loans and put the rest into fairly liquid savings (like an online, interest-bearing savings account or short-term CDs.)
The above is just general advice; I'm not sure how it would affect your student-loan income status.
posted by BrashTech at 10:41 AM on April 26, 2015
If you don't have a safety cushion, you should make the minimum payment on your loans and put the rest into fairly liquid savings (like an online, interest-bearing savings account or short-term CDs.)
The above is just general advice; I'm not sure how it would affect your student-loan income status.
posted by BrashTech at 10:41 AM on April 26, 2015
Response by poster: Thanks for all of the responses. I will start with throwing money at the higher interest rate loans first, and aim to make a dent in these loans.
posted by robertthebruce at 8:10 PM on May 16, 2015
posted by robertthebruce at 8:10 PM on May 16, 2015
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If you are planning on paying off your loans earlier, you'll pay the least overall if you target your extra money toward the higher interest loans. Paying off the smaller balance loans has a bigger psychological impact, and has the benefit of lowering your minimum monthly payment - but that one doesn't apply to you if you already have IBR-lowered monthly minimums.
posted by fermezporte at 3:07 PM on April 25, 2015 [3 favorites]