The Proper Way to Pay Down Student Loans

Student debt is one of the biggest obstacles students face during and after college. Completing your degree, undergraduate or graduate, is a massive accomplishment-- one that should be met with self-congratulation and optimism for the future. These feelings quickly fade, however, especially in the face of realizing your accomplishments have come at a price – and now there’s a massive debt bill waiting to be paid back. It can be a stressful position to be in: many postgraduates worry that progressing in life is impossible until those loans are paid back. This is not the case whatsoever. Most people don’t realize the importance of paying down debt while saving money for the future simultaneously. It can be a difficult path requiring a systematic plan and discipline, but when working with the right financial adviser, you may be able to save thousands in the long run.

Before even applying for a student loan, you must ask yourself, “what are my opportunity costs?” Getting your degree certainly opens the door to more job opportunities, but at what price? Too many times I see clients with student debt for a degree they’re not even using in a professional setting. Another question to consider--especially for graduate school students-- is, “how far will this progress my career?” If graduate school won’t significantly further your career, or get you to where you want to be, you must consider if the debt you’re about to take on is truly worth it. Some people may not agree, but here’s an example. Say you graduate college and receive a full-time job making $60,000 a year. But, in order to be making $100,000 a year in your profession, you decide to go to graduate school, taking on $70,000 of student loan debt in the process. By the time you’re done with school, you may be lucky enough to hit your goal of earning $100,000 pre-tax at work…but now you’re saddled with $70,000 in debt. If you’re set on going to graduate school, my recommendation is to wait a few years after undergraduate instead of transitioning from one to the other. Give yourself some time to explore your options as far as career paths go, in hopes that you will have a clearer idea of what exactly it is you want to do with your life. Taking this time will help narrow your focus, and help guide you towards getting a degree that suits you best. Either way, going to undergraduate or graduate school costs money. Before you choose to take on this debt, it’s important to understand the ramifications and have a firm financial plan in place.

When paying down any kind of debt, you have to first recognize it’s going to take time. Understandably, many people want to get rid of their debt as soon as possible. If your student loan payment plan has a 10-year term, understand this means your plan is mapped out to actually take 10 years to pay off. Many individuals try to pay their loans off quicker than they should, as they don’t want that debt hanging over them for years and years. This can be a mistake: mainly if it leaves you with little to no disposable income. Being aware of your loan term is crucial, but having a goal of when you want them paid is just as important. You need to have a solid plan of how much debt you want to pay off each year, and a timeframe for doing so. It may be difficult and often frustrating, but as an advisor, I work with clients to create a plan to tackle these obstacles, providing them with a peace of mind that things are going to be okay.

If you’re currently paying down student debt, it’s likely that you fall into one of two categories. Your situation may only allow you to make minimum payments or, you have more than enough to make payments and land yourself in a situation where you’re paying your loans off faster than recommended. For the individuals struggling to make minimum payments, it’s important to sit down with an advisor and create a budget, cutting back where you can. The longer it takes you to make payments, the more interest you’ll end up paying. Just starting out can be frustrating, and that’s why I work with young professionals in these types of situations. In a typical meeting, I would sit down with my client and review their budget to figure out exactly how much money can be applied to these loans (while also saving for other financial goals.) Next, I recommend taking a look into refinancing. Getting a lower rate can save you money in the long term, and hopefully reduce your minimum payment. If you’re unable to refinance, work on paying your “high interest” loans first (rates typically above 5%.) These will accrue the most interest and should be paid off first. It’s crucial to be aware of each loan’s value and the interest rate.

If your current financial situation gives you the ability to pay more than the minimum required payment, the scenario for paying off your loans is much different. Knowing your salary, you may think it’s wise to pay down your debt quicker than your given loan term. This is a common assumption, which can actually end up being a mistake. Check the interest rate on each loan. We know that higher rate loans should be paid off first; but loans with lower rates (typically below 5%) come with some flexibility. If you have a low rate student loan and believe you are in a position to pay down more than the minimum payment, I highly suggest speaking to a financial advisor like myself. Your interests may actually be better served by investing those funds, rather than paying down your loan faster. This may sound counter-intuitive, but let’s put it into perspective. Say you have a 10-year loan term and interest is 4%: you can stick to paying those minimum payments, invest the extra money you would have used, and ideally end up with a return higher than 4% over the course of that 10-year period. Remember: when you invest, your money is working for you. As with any investment, returns are not guaranteed but this concept gives you a much better chance to take what you would have used to pay down on the loan, and actually earn additional income. From there, speaking with an advisor like me will help you decide what do with that additional income.

In the end, when deciding if a student loan is the way to go, it’s important to ensure that the opportunities you are creating for yourself outweigh the financial costs you are incurring. If you do decide to take on loans, be sure to reach out to a financial advisor to help you establish a plan to pay them back. It’s highly recommended to have this plan in place before you begin school, so you have an idea of what to expect upon graduation. You’re not in this fight alone, and I’m here to help. If you have questions, or need help determining how to pay your loans back, please reach out to me!

By Malcolm Jones
Investment Advisor Representative