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Student Loans: To Pay or Delay, That Is the Question

Mathew Kerbis

Student Loans: To Pay or Delay, That Is the Question

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There’s a lot of advice out there about paying off your student loans. This article provides some guidance on where to start. Everything mentioned in this article is not considered financial advice, so make sure to consult a financial advisor before making financial decisions.

Calculate How Much You Currently Spend
Whether to pay off your student loans aggressively or put that money to good use elsewhere depends on many factors. To maximize this choice, track what you earn to determine what you can spend. When it comes to improving your financial well-being in general, this is an essential first step.

Track What You Earn

Tracking what you earn is simple. You can track your net earnings in a spreadsheet if you get paid twice a month. Net earnings are income after taxes, insurance, 401(k), and other deductions. Total up each month and total up each year to give yourself an understanding of the cash you have on hand to spend on living expenses, student loans or other debts, and non-necessary items or experiences, and how much you can potentially save.

Track What You Spend

The next step is to start tracking every cent you spend. Most banking apps have started to incorporate tracking features native to the app, and there are other third-party options such as Intuit’s Mint. However, those apps and features allow you passively to track your spending. To really understand your financial well-being, you must consciously be aware of your spending. Consider instead using a spreadsheet app such as Microsoft Excel or Google Sheets, so you are forced to be actively aware of your spending.

Make a Budget

Look back at your app or spreadsheet and start paying attention to your purchasing habits. Categorize your spending into subjects like groceries, gas, social, medical, clothes, insurance, and rent or mortgage. How granular you get is up to you. Maybe you hit up your local café every morning? Then you should probably track spending at cafés as well. Do you frequently visit the dry cleaner? Then consider adding a category called laundry. Some of these categories with monthly payments, like rent, make sense to track monthly, but you might want to track other categories every week.

After a month of tracking your weekly spending and net income, set yourself a weekly spending limit. In addition to your other tracking, you also need to track how much you go under or over your weekly limit. With these data at your disposal, you can now see exactly how much money you have left either to pay off your student loans aggressively or instead put toward other debts or savings goals. You can also see where you are spending money on the inessentials. You can then reduce that expense and have even more money to put toward debts and savings goals.

Track Student Loan Payments and Decide Payment Amounts

If you have student loans, add a category to your tracking spreadsheet called “student loans” to enter your monthly amount on student loan payments. This category should include your minimum payment and any extra payments you put toward your student loans to pay them down faster.

At the start of each month, go back and look at how much money you saved. Decide how much of last month’s savings you want to keep in your savings account, and decide how much you are willing to pay on top of your monthly student loan payment. You can gamify this exercise by challenging yourself to see how much you can save each month and how much of those savings you can put toward extra payments on your student loans. You can also try to beat your prior month’s extra payment!

Paying more money than the minimum payment on your student loans can be a smart financial decision because it’s worth more money at the end of your loan. Based on the terms of your loans, interest that is not paid off will likely capitalize at the end of a set period, such as 30 days or on a certain day like the 22nd of each month. In other words, that interest is added to your principal balance.

For example, if you owe $100, you have a 10 percent interest rate, and you don’t make a payment during the first 30 days, then the $10 in interest becomes part of your principal balance. For the following month, you will be charged 10 percent interest on $110 instead of $100, so the following month, you will owe $11 in interest, and so on. These are small numbers to explain the concept, but you can see how not paying off your interest would significantly impact student loan totals of $10,000 or $100,000. Check your loan terms to know if and when interest capitalization happens for you. Thus, regardless of whether you decide to pay much more than your monthly minimum payments, you will benefit by paying at least the full amount of interest plus principal every month on your student loans.

Consider Savings Goals and IRA/401(k) Returns

Savings Goals

Another critical factor to consider is hitting your savings goal before making extra payments on your student loans. A savings goal commonly recommended is to have at least six months’ worth of living expenses saved up, but whatever savings goals you make are up to you. If you’re following this advice and tracking what you spend, realize that you’re looking backward at the money you have already saved and not future savings. In other words, don’t make extra payments on student loans with money you don’t have. You can make this extra payment at a different time than regularly scheduled payments. Every month is going to be different. Sometimes you have to pay your insurance premium, a car repair, a copayment for a doctor’s visit, or some other expense that only occurs a few times a year. Being overzealous in making extra student loan payments can be good, but remember to consider necessary and unexpected expenses.

IRA and 401(k)

There are other ways to spend that extra student loan payment that will benefit you in the long run, such as continuing to put funds away into a savings account or certificate of deposit, or a retirement account such as an IRA, Roth IRA, or 401(k). This comes down to a balancing act, but it should be a lot easier if you are tracking everything.

If your firm or company offers a 401(k) match up to a point, then do your best to hit the contribution up to that match as soon as possible. It’s basically free extra money. While it’s easy to set it and forget it in your 401(k), many plans let you pick how your money is invested. If you get financial advice on allocating your 401(k) or other retirement investments, you can see returns of greater than 10 percent, which is probably a higher interest rate than your student loans. Since retirement funds are often pre-tax (excluding a Roth IRA), it’s worth even more.

Watch your retirement fund’s annual rate of return for a year or two, and if it is consistently higher than your student loan interest, then consider putting more money toward your retirement than your extra student loan payments. 

Consider Other Major Life Goals

Consider your opportunity cost of using that money elsewhere. For example, if you want to purchase a home, you need to set aside funds for a down payment. Ideally, this should be separate from your emergency fund, although keeping them in the same savings accounts could increase your savings interest yield. Depending on your timeline, it simply won’t be possible to put money into savings, retirement, and aggressively pay down student loans when saving up for a financial goal like buying a house. Purchasing a home will be easier if your debt to income ratio is lower, so keep paying down those student loans if you want to become a homeowner, even if that means doing so less aggressively.

So, take some time and reexamine your spending habits. Ask yourself if that money is better spent on your student loans or other debts or saving for your future and retirement. There is no need to live a completely austere life, but engaging in this exercise and weighing these factors will help you get more control over your finances and your financial well-being.

The 2021 ABA YLD Law School Student Loan Debt Survey Report examines the issues at the heart of the student loan crisis and offers recommendations. Read the report.

Listen to the November 15, 2021, episode of theYoung Lawyer Rising podcast for more financial tips about borrowing and credit.