Don’t get ambitious about your student loan bill. Build up a decent-sized emergency fund first
So you want to pay down your student loan debt quicker than scheduled. Should you?
When my editor assigned me this piece, I called Zac Bissonnette, the twentysomething financial guru and author of the New York Times bestseller How to be Richer, Smarter and Better Looking Than Your Parents. Zac, who I consider a friend and, therefore, will not refer to in proper newspaper style as “Bissonnette,” is someone who is very anti-debt, so I thought for sure he would tell me that everyone should pay down their bills asap.
By the way, I have no idea if Zac is better looking or smarter than his parents, but I do need to say he is quite handsome indeed and also pretty damn smart.
Back to the subject at hand.
This, dear readers, is why we call journalists “reporters” and we conduct interviews. Zac did not say what I expected him to say. Instead, he told me the situation is … complicated.
First, he said, we need to know to whom the bill is owed. If it is a Department of Education loan, Zac says he would not tackle it till he contributed enough to a 401(k) or other retirement plan to get an employer match. That’s because the interest rates on the loans are fixed (depending on the type of loan, rates are currently between 3.4 to 7.9%), and one will almost certainly do better to take the free money from one’s employer, invest it in the stock market, and pay down the loan at the required rate.
What if you just don’t like debt? Should you walk away from that money for almost nothing your employer is offering?
Well … yes.
“I think it is a thing where people should do what they want,” Zac told me, saying he has spoken to many, many recent college graduates who hear all the arguments about why they should invest in their 401(k) before paying down their college loans and let it be known they get it, but they want to live debt-free. He’s cool with that.
On the other hand, I admit I have my questions about this. This is why financial advice is an inherently ambiguous enterprise, even as people try to pretend there are firm rules of the road.
For instance, I graduated from college in the late 1980s with $12,000 in student loan debt, not to mention a few thousand more in interest. I faced a monthly bill of $110 for twenty years, a situation I found so intolerable that when my grandparents died and I inherited $10,000 in the early 1990s, I took that money, tossed in a few thousand more in wedding gifts I received when I married my then recently acquired husband, and paid off the bill in full.
Was it the right thing to do? Well, probably not. Frankly, I – and my then new husband – got lucky. We never sever suffered an emergency where we would need that money, and were forced to resort to a credit card because I’d taken just about all our spare cash and tossed it at my student loan.
So here is a suggestion from me: don’t get ambitious about your student loan bill till you’ve built up a decent-sized emergency fund, at least three months worth of living expenses in a nice bank account. If you ever need that money back, it won’t come via the low interest Federal Perkins Loan program but instead courtesy of Visa. As for mom and dad… they aren’t an emergency fund unless their names are Mitt and Ann Romney.
Back to Zac. There is one situation where he saw little ambiguity. If your loan is a high-interest one issued by a financial services institution, pay it down as fast as you can. Many of these loans have variable interest rate, some as high as 18%.
So how do you pay down a loan ahead of schedule?
There are small, common sense steps you can take. One is easy. If you have steady employment and good control over your finances, arrange to pay your student loan bills via automatic payments. Both the Department of Education and the banks like this method of repayment so much, they will almost always arrange to give you a break on your interest rate if you sign on the dotted line, usually around 0.25%. We’re not talking riches, but free money is free money.
However, automatic account deductions are not recommended if you don’t have steady employment or excellent control over your finances. Why? This is when bad things happen to good people’s checking accounts. Too many things can go wrong when you don’t enjoy a regular paycheck, or pay bills erratically, or otherwise simply don’t mind what is in your piggybank.
However, the most effective strategy is the obvious: if you pay more than your minimum payment, you will pay down your student loans quicker than if you just send your loan holder what is required every month.
A couple of thoughts: if you are dealing with multiple loans and payees, think strategically. While it’s tempting to go after the smallest debt first, in fact you should target the bill with the highest interest rate.
Second, for inspiration, play with online student loan calculators, like the ones at Finaid.org. You can play with numbers, and see what putting extra money toward your loans every month will do for your long-term bottom line. (You can also check out the Guardian’s Student loan calculator in the top-right corner of this article’s sidebar, which tells you how much you’re accumulating in interest alone).
Third, think about what you really want to sacrifice to pay off this debt. I would not recommend the strategy adopted by Brian McBride, a CNN associate producer who wrote recently about how he had eliminated $26,000 in student debt over a two-year period by “skipping meals” and dining on protein bars to make it through the days.
Fourth, make sure you can afford it. If you target $100 a month to pay down a debt with, say, a 5% interest rate, make sure you aren’t going to need to turn to a credit card with a 15% interest for $75 of that every month. That’s not going to get you to the debt-free promised land. I would urge you to start small. Make sure you can afford an extra $50 a month before you move up to $100.
Last, gimmicks won’t get you there. Take SimpleTuition’s SmartBank debit card, which offers up something called SmarterBucks. You get 0.05% back on the first $100 on a purchase, and 1% when the amount charged goes above that number. That is, if you are wondering, 50 cents on a $100 gas bill – an example I just borrowed from their website.
Finally, understand, this piece is for the fortunate. If you are working two jobs still barely keeping up with your bills, ignore this entire article. I know you are doing the best you can.