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Student Loan Repayment Strategy: Creating a Plan that Works for You
By: iTHINK Financial | May 21, 2020
Use Extra Cash to Pay the Highest-Interest Debt FirstAttacking the highest interest rate debt first is the cardinal rule of debt repayment. You will end up paying less interest over the entire life of your loans if you target the highest interest rate debt first. If you earn a bonus at work or receive extra cash in another instance (graduation, birthdays, holidays, etc.), consider directing extra cash towards your student loan before spending it on something else you might not need.
There’s never any penalty for paying more than the minimum on student loans. You can make an additional payment at any point in the month, or you can make one larger payment on the due date. For example, let’s say you owe $10,000 with a 4.5% interest rate. By paying an extra $100 every month, you’d be debt-free more than five years ahead of schedule, if you were on a 10-year repayment plan.
It’s important to note that when making an additional payment, the student loan servicer will not automatically apply extra payments to your highest interest rate debt. Instead, they will apply the extra amount to next month’s payment. You will have to manually select which loan you want to apply the extra payment in order to make this strategy work. Or, contact your servicer online, by phone, or email, to apply overpayments to your current balance, and to keep next month’s due date as planned.
Enable Automatic Payments to Save on InterestIf you’ve been working for a while and have a stable financial situation, sign up for automatic monthly payments through your student loan servicer. Not only will autopay help you meet monthly payments on time, but many federal student loan servicers and private lenders offer a discounted interest rate if you set up auto-payments. Most servicers offer a 0.25% interest rate deduction, which is typical.
The savings from this discount will likely be minimal. Dropping a $10,000 loan’s interest rate from 4.5% to 4.25% would save you about $144 overall, based on a 10-year repayment plan. But that’s still extra money to help pay off student loans fast.
Contact your servicer to enroll or find out if an autopay discount is available and start saving on your interest!
Balancing Debt and SavingsDon’t stay so focused on paying off your student loans that you forget to save for the future. Find a balance between debt repayment and the importance of saving early for retirement. If your company offers a retirement plan with an employer match, strive to contribute that minimum amount possible to maximize the match. Once you have maximized the match or if your employer does not offer a retirement matching plan, determine whether increased savings or additional loan payments make the most sense. To determine, you will need to consider the current interest rates of your student loans.
Say your highest interest rate loan is currently sitting at 5.5%. You have an extra $1,000 per year to put towards loan repayment or long-term savings. Assume you invest the extra $1,000 per year in the stock market earning a 6% return, you will end up gaining more money investing, $60, than you would have avoided in interest payments, $55. A good rule of thumb is you will likely earn more over the long-term investing if your loan interest rate is below 6%. When your interest rate is above 6%, you should typically direct additional funds toward your loans first.
Additionally, if you receive a holiday bonus from your job, consider building a cash emergency fund. Emergencies come when you are least expecting them. Ease the stress by having some cash to help pay for any unexpected bills. For reference, your emergency fund should be equal to 3-6 months of your living expenses.
Take Advantage of Employee BenefitsSome employers offer student loan assistance or forgiveness as a part of their benefit package or in exchange for working in a service capacity. Public servants, doctors, lawyers, nurses, volunteer organization workers, federal agency employees, and automotive workers may be eligible for student loan assistance or forgiveness. Even if it’s not explicitly stated, student loan forgiveness could be worth negotiating into your compensation package is you expect your student loans to be a significant burden on your finances.
Refinance Your Student LoanRefinancing replaces multiple student loans with a single private loan at a lower interest rate. You can choose a new loan term that is shorter than the one you originally received. This may increase your monthly payment, but it will help you pay your debt faster and save money on interest.
Refinancing your $50,000 student loan from 8.5% interest to 4.5% could let you pay off our student loan debt nearly two years faster. It would also save you about $13,000 in interest.
If you’re using federal benefits, like income-driven repayment, refinancing may not be for you. However, you’re a good candidate for refinancing if you have a credit score in the high 600s, a solid income, and a history of on-time debt payments.
Close your eyes and imagine what your life would look like if you didn’t have student loans? How would your life change for the better? Would you be able to take that dream vacation? Would you be able to splurge more often without worrying about your student loan payment? Getting rid of your student debt is possible, but it requires hard work and sticking to your student loan repayment plan. Need help choosing the right strategies for your plan? Contact one of our student loan advisors and we can discuss your options!
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