"I'm going all in", "I'm not even going to try", "time to double down", and "it's not worth it." This isn’t chatter at the casino I hear; these are the paralyzing thoughts of what to do with student loans. It is rare today when I meet a couple in which at least one person does not have student loan debt.
Some people have tunnel vision, and all they can think about is paying off the loans, consequently sacrificing all other goals like saving for retirement or building an emergency fund. Others do their best ostrich impression, putting their heads in the sand, and tend to every goal or need while ignoring their loans for as long as possible. Neither of these strategies is ideal. I’ve outlined some strategies that I’ve seen work for folks:
Snowball Debt Strategy:
This strategy can work for anyone with debt spread over multiple accounts, not just student loans. Often student loans are issued in a series of debts coinciding with the semester they are taken. As a result, a person may only be making two or three loan payments, but the payments are then distributed among many different individual loans. It is not uncommon for a person to have anywhere from six to ten loans.
First, list your loans by balance largest to smallest. If balances are close, list the loan with the higher rate first. Next, figure out how much extra you can pay every month, even if it’s only $25. Now when you make your payment, apply that extra amount to the loan with the smallest balance. When that loan is paid off, continue to apply the extra amount to the next lowest balance in addition to the amount you paid monthly for the now retired loan. The amount you will continue to be paying monthly will stay the same (what you’ve been paying plus the extra amount), but as each loan is paid off, more of the payment will be allocated to the next lowest balance, resulting in this snowball debt strategy.
This does three things for you. First, it pays off the student loans faster and systematically. Second, some of the loans will be totally paid off, and you will feel relief that the number of loans is smaller. Third, if your budget gets tight one month, you have more flexibility on the required payment; but if possible, try to pay the same amount every month until the loans are paid off.
You can also start by paying off the loan with the highest interest rate first. This will result in paying less interest however the time it takes to retire the first loans will take longer, delaying some of the early relief.
This option sounds so obvious, but it is incredible how many people don’t do this. Rather than address the loans, they do nothing. They are spending thousands of dollars in loan interest over the life of the loan by doing nothing. If you want to use the snowball strategy, consider only refinancing the larger loans and leaving the small ones alone knowing they will be paid off shortly.
Public Service Workers:
Depending on your occupation there may be loan forgiveness options. I’ve worked with several clients who are teachers and nurses. Schools or hospitals in low-income areas are able to offer loan forgiveness as a way to attract talent. Teachers can have up to $17,500 of loans forgiven with just 5 years of employment. If you have Perkins loans, 100% of the loan can be forgiven, following a tiered schedule starting in year one. Public service workers can qualify for forgiveness after 10 years with no missed payments.
The first step to any of these strategies is to understand where you are currently. Log your accounts, and take an inventory of each loan and rate. Check to see if your employer offers any benefits. Often just getting started with a plan can provide some emotional relief. There are a lot of moving parts to a plan, and managing debt is only one part. Consider consulting with a Certified Financial PlannerTM professional to customize a debt snowball strategy or to find the optimal ratio between loan payments and saving. It doesn’t have to be all or nothing.