By Warren Taylor, BankMobile President
College is over. You have a job. It is time to start paying off your student loans. This blog post will not address all the various types of student loans (Federal, State, private sector, etc.) and their repayment terms – as that would be a very long blog! This article is more about how to pay off your loans as quickly and as cheaply as possible.
Should You Consolidate?
First, you may want to explore loan consolidation. This is where all your student loans are reviewed, with their different interest rates and repayment terms, and then paid off by consolidating them into just one new loan with one monthly payment. For many, this is a good way to go. Your overall interest rate may be reduced, thereby saving you money. It helps that you have one payment to make each month, instead of five loan payments all with different due dates. The only real danger to consolidating loans is that you may lose some benefits that some of your loans may have – like loan forgiveness, loan forbearance, etc.
Choosing the Best Loan Term for You
When choosing a loan term, picking the shortest repayment time in order to get the lowest interest rate may not make sense. Your rate will be lower, true, but your required monthly payment will also be very high. This high monthly payment may hurt your chances of getting other loans – like a mortgage because your “back end” ratio is too high (see my first blog on budgets for an explanation). Picking the longest term may not be wise either. True, your monthly payment will be low, but because you are taking so long to pay off the loan, you will pay the most in interest since the term is longer and your rate will be higher (typically the longer the repayment term, the higher the interest rate). Just when you thought you were “getting” how this loan repayment term thing worked, I need to add another complication. It’s based on rewards. If a 10 year repayment term has a 5% rate, and a 15 year term has a 10% rate, it may be in your best interest to take advantage of the shorter loan term because your interest rate is cut in half. We would be happy to help our BankMobile customers with this decision – just give us a call.
How to Repay Your Student Loan Off Faster
Let’s get to repaying your loan – and sharing some “tricks” on how to repay a loan faster. The average college student graduates owing $27,000 in debt. This is the amount of the loan in our example. Most loan program terms range from 10 to 25 years – consolidated loans have some shorter terms as well. Your monthly payment for a 10 year loan, at 7% interest, on $27,000 would be $313.49. If you pay an extra $24.18 a month, you will shave a full year off your loan – paying it off in 9 years instead of 10! Making this slightly higher monthly payment will save you over $1,150 during the life of the loan. I use the iOS app “Loan Calculator – What If?” to calculate loan payments.
Using the same example above, I could get a 10 year loan @ 7% interest, or they offer me a 15 year loan at 7.5% interest. I might be inclined to go with the 15 year offer at 7.5% interest. Why? Well, my mandatory monthly payment would drop from $313.49 to $250.29. This lower payment might help keep me under my 36% back-end ratio, thereby allowing me to get a mortgage or other financing if needed. Second, if I or my spouse got laid off, if we had an emergency repair, a health crisis, having a required loan payment of $250.29 would allow me to keep my loan current and take the extra money to pay for the emergency. If you do take the longer term, and here is where you need this discipline, I would still recommend you pay the higher monthly payment of $337.67. By paying this extra $87.38 per month, you would pay off the loan in 9 years and 4 months.
So what is the right choice? Without knowing your ratios, income, debt levels, and other factors, it is very hard to tell you what to do. However, here are some general guidelines to follow:
1. I would probably suggest going with a fixed rate loan instead of a variable rate loan. Why? Interest rates are at historic lows. There’s a greater likelihood that rates will go up than come down. So taking on a variable rate loan now will likely lead to higher interest rates, hence higher monthly payments, in the near future. On a fixed rate loan, your payments will not go up if interest rates go up. Again, choosing the right loan depends on your income, debt, and discipline.
2. Whatever your required loan payment is, pay more. Think about it, in the example above, paying $24.18 more a month (that’s basically 80 cents a day), cuts a whole year off your loan term! Imagine if you paid an extra $54.62 a month (that’s $1.80 a day), you would shave 2 years off your loan term – paying your student loan off in 8 years instead of 10 years. Isn’t that worth not having one Starbucks coffee a day? Trade in a cup of coffee per day, shave 2 years off your loan repayment! Perhaps I’ll write another blog on easy ways to save $20 to $200 per month.
3. Always pay your debts on time – even paying them a day late or $1 short can hurt your credit rating. But, if you do want to pay off debt quicker than normal, start with paying the extra money on your highest rate loan. This means you use extra money you have saved from not going to Starbucks anymore to pay off your credit cards first, student loans next, and your car loan will probably be your lowest interest rate loan. It’s amazing what an extra $1 a day can do to reduce a loan balance!
Maintaining a low level of debt is key to creating a successful financial life for yourself. Now, let’s shed the debt!
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The views and opinions expressed by the author are not necessarily those of BankMobile. The blogs are intended as general financial knowledge that may or may not be applicable to your individual needs. Always contact your accountant for tax advice.
All company/product/service mentions in this post are not intended as an endorsement and the views of that company do not represent the views of BankMobile or Customers Bank.