Pile O'Debt
May 29, 2011 8:09 PM   Subscribe

My husband is about to graduate from grad. school, and I need some advice about strategies for repaying our loans.

He is graduating from grad. school with about $49,000 in debt (interest rate is 6.8% - they are federal Stafford loans). He also has about $14,700 in loans from under-grad (interest rate is 5.5%). I am a little confused and overwhelmed about our best strategy to repay these loans.

If we choose a 10-year repayment plan for the Stafford loans, it looks like our total monthly payment would be about $800 (that's including both loan payments). He will make about $40,000/year when he starts, and I make about $34,000/year, so that payment would be a little tough, but we could do it until we have kids and need to pay for daycare. If we choose the 20-year plan, our payment would be about $500/month. I hate to pay all that extra interest on the 20-year plan, though.

I'm just not sure about how to allocate our resources. We'd like to buy a house at some point, but is it silly to save for a mortgage while still carrying this education debt? On the other hand, I don't want to wait till we're 48 to start saving for a mortgage...we'll be trying to help our kids with college at that point! How do people do this?? Can we choose the 20-year plan and then pay more when we can (eventually we will both make more money), or do those extra payments not go towards the principal?

Thanks in advance for any guidance you can provide. I just want us to be smart about the way we tackle this debt, so any advice is appreciated!
posted by anonymous to Work & Money (12 answers total) 6 users marked this as a favorite
How is 800 a month not doable with almost 80k in combined income? Post tax that's more than 4k a month. You should be able to prepay the hell out of that. So that's what I would do: save until you have a 6 month buffer or so, then pay all you can towards the loans. Also take the longest time period they offer because you can always pay more.
posted by wooh at 8:41 PM on May 29, 2011

Stafford loans do not carry any prepayment penalties, so any extra you can devote to it will go straight to principle without any long-term implications. If you are disciplined (or can fake it, e.g., by setting up automatic withdrawals), then the thing to do is line up the lower payment to preserve flexibility while making the larger payments. Since the Stafford loan bears a higher interest rate than the undergrad loans, any spare cash should be directed to it.

I don't know where you live so I haven't any clue how far you can stretch your $74,000 household income. However, now is a great time to live under your income levels--since you're probably used to student life--and devote whatever you can to repaying the loans. Try to set a budget that accounts for your true needs, like clothes for new jobs, reliable transportation, emergency fund, etc. but places a premium on repaying the loan. If you make a serious effort, you might be able to repay them in three or four years and then you'll be free.
posted by carmicha at 8:43 PM on May 29, 2011 [1 favorite]

Check with your lender, but I don't think student loans usually have a prepayment penalty. So you might as well commit to the lower amount of $500/mo, and then pay extra when you can. $800 is about 13% of your combined gross income, which is noticeable but not at all unmanageable, especially considering the liklihood your incomes will grow in the future. So without further details, I'd guess you could save for a house while paying off the debt, but it really depends on how you control your expenses and how quickly your incomes grow.
posted by blue mustard at 8:43 PM on May 29, 2011

I actually consolidated as follows when I graduated (May 2008):
-remaining consolidated undergrad loans. ~14K, ~4%
-subsidized and unsubsidized Staffords - ~40K 6.8% or thereabouts
-Grad PLUS loans ~6K 8.75 or thereabouts.

30 year payback put repayment amount at $380. Like you, I didn't like the idea of the extra interest so I overpay whenever I can. This gives me the freedom to only pay the monthly during tight months but paying, on average, $500/mo. has me on track to pay it off in 13 years. I hope to pay it down more quickly as I retire other debt/earn a little more. It's easy for me to have it applied to principle, but that may depend on your servicer.

You should have a grace period with the stafford loans so that gives you some time to thin about the numbers and how they'll work for your family. I'm not paying this down as quickly as I could because the consolidated rate isn't bad and others are higher.

Good luck!
posted by TravellingCari at 8:43 PM on May 29, 2011

Any extra payments you make will go first toward any accrued interest, and then towards the principal. It's probably better to take the longer term and make the highest payments you can now, then have the flexibility when you need it. But beware: a consolidation loan (which is what the 20 year term would be) will roll the smaller debt with the smaller interest rate in with the larger one, giving you a larger interest rate on that loan. Disclaimer: it's been a long time since I worked in the industry, and it's possible things have changed. But read the fine print on the consolidation offer.

Regarding the mortgage vs. loan issue, that's going to be a personal choice. Getting rid of debt is the smartest choice, but you also have to balance that with having a life. If you could pay $1255 a month, you'd be done with it in five years, but that's all you'd be doing for five years — paying it off.
posted by clone boulevard at 8:45 PM on May 29, 2011

Can you do any freelance work that can bring in extra $$? At some point you'll both move up in salary, too--you're not likely to stay at 34K for your entire career.
posted by Ideefixe at 8:52 PM on May 29, 2011

Sorry, posted too soon. Play around with a student loan repayment calculator (there's tons online) and see what you think for the repayment options.

Also, note that once you consolidate the interest rate goes from variable to fixed. The rates change every July 1st, and there's no way to really anticipate which way they're going to go. The year I got my consolidation the loan was written in May, foolishly, and as a result I got stuck with the going rate at the time (8.25%). Two months later they went down THREE POINTS. Yeah, that was awesome. Good times!

Here's the historical rates for staffords.
posted by clone boulevard at 8:54 PM on May 29, 2011

Also, note that once you consolidate the interest rate goes from variable to fixed.

I think that has changed again - when my staffords were disbursed they were fixed.

Wikipedia and this site among others seem to back up my memory on them being fixed.
posted by TravellingCari at 9:07 PM on May 29, 2011

Yeah, sorry, I misspoke there (haven't been in the industry for over 12 years and it's kinda late). It's always been fixed based on when you take out the loan initially, but the consolidation is a new loan so it will have as its rate whatever the current rate is on the day the loan is made. That rate changes every July 1 — so if you want the current rate, get the consolidation done soon. If you want to gamble that it might go down July 1, wait. The page I just linked explains how the rate is determined. The historical rates chart might also help with your odds!
posted by clone boulevard at 9:38 PM on May 29, 2011

I have almost the exact same situation: finished grad school about 6 months ago, have the same types of grad loans with similar values and rates to what you describe. Like TravellingCari, I chose to opt for the longer-term, lower-monthly-payment plan to give me more flexibility. But as I was evaluating the repayment options, I wrote down what the monthly payment was for the shorter-term plan, and I try to pay that amount each month anyway. With my Stafford and GradPLUS loans there is no prepayment penalty, so this works out well.

One caveat with this plan -- if you pay online, the loan servicing center will direct the extra funds however they see fit, likely not to your benefit. If you want to put the extra money toward your highest-rate loan principle (which will save you money in interest over time), you have to call their customer service people each month after your payment clears to tell them where the extra money should go. It's a minor annoyance, but I think a 5-minute phone call once a month is worth the savings in interest.

My understanding is that if you consolidate these loans, they will calculate a weighted average interest rate for the new, single loan, based on the interest rates and principles of the original loans. Mathematically it works out that you'll pay the same amount if you follow the payment schedule, but if you're planning to prepay the high-interest loans when you can then it'll be cheaper to skip the consolidation.
posted by vytae at 10:52 AM on May 30, 2011

The consolidation rate is the weighted sum of your existing loans:
"If you have variable interest rates on your Federal education loans, you may want to consolidate. The interest rate for a Direct Consolidation Loan is fixed for the life of the Direct Consolidation Loan. The rate is based on the weighted average interest rate of the loans being consolidated, rounded to the next nearest higher one-eighth of one percent and can not exceed 8.25 percent."
-- Federal Direct consolidation loan website (an official .gov site)

So consolidation would not present immediate relief to you; what you need is a time machine to go back and take loans out before 2006, who's loan rates reset every year to the 91-day Treasury bill. A conversion from variable to fixed, under this scheme will not result in immediate savings, but the 2.25 percent I consolidated at in 2009 is the lowest one can hope to get, so now's the time for anyone who's grandfathered and hasn't already consolidated.

Since anon's loans are fixed, consolidation is not particularly useful. I'm not sure where that 5.5 percent is coming from though.

How do people do this??
Well firstly, most people don't take out expensive grad student loans to land a job paying 40k a year. And secondly, they all bought houses back when you could take use banking tricks to buy a house with no downpayment. Of course, the lender and borrower are now fucked, and until all parties recognize this and allow the prices to fall, you're kinda fucked too. On the plus side, I find renting isn't too bad. Someone else mows the lawn and cleans the pool!

Ultimately what you're asking is how to budget. We don't have enough information here, but here's a wild guess:

Monthly Income: $6166

Monthly Expenses:
Rent+utilities: $1400
Food: $600
Taxes: $1800
Minimum loan repayment: $800
Health insurance: $30 (+ untaxable employer paid benefits)
Transportation: $120
Clothes: $100

Monthly savings goals
Retirement: $500
Emergencies: $100
Home downpayment: $500

There's plenty of wiggle room here for you to correct my guesses, and fill in blind spots in my budget. The question is, how long will it take to save up an appropriate 20 percent downpayment @ $500 a month? If you're looking at million dollar houses in California, 30 years. If you're somewhere more reasonable, much sooner. Where I live, 80k is a decent combined salary and homes go for between 150k and 200k. Even then, it'll still take you 4-6 years to build up a downpayment at that rate.

The way many people cope is by skipping out on retirement contributions and emergency savings. It's not Financial Planner Platonic Ideal, but reducing retirement contributions is common and can work out okay if you don't buy the biggest house you can afford and continue saving for emergencies.

There's also the tax burden to consider. Mortgage interest is deductible, retirement contributions can reduce taxable income, etc. Student loan interest is also deductible, but if you discount 6.8 percent by your top marginal bracket, it's not likely a large enough incentive to change your planning. But make sure you're properly figuring withholdings so that you get as small a federal refund as possible.
posted by pwnguin at 11:36 AM on May 30, 2011

Check with your lender, but I don't think student loans usually have a prepayment penalty. So you might as well commit to the lower amount of $500/mo, and then pay extra when you can.

I came in here to basically say that. I set up my loans on a 20 year plan, then pay as much as I can every single month above the minimum amount. It means I'm on track to pay off much earlier than 20 years, and I can throttle back when I want to up my savings, or buy a house, or have kids.
posted by NotMyselfRightNow at 3:04 PM on May 30, 2011

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