For those that graduated this spring, they’ve dealt with an overwhelming amount of zoom courses over their four years. Despite this, schools for the most part did not reduce the price of tuition, leaving students with a virtual experience, yet still saddled with large student loan debts.
For recent college grads that are graduating with student loans, you may be wondering how fast it makes sense to pay down this debt. You may here from others that socking aside all of your excess cash flow toward student loans to pay them down as soon as possible is that best strategy, but that is not always the case. Here's why you may want to tweak your strategy:
The argument for paying down student loans:
- Saving on interest – All of these loans carry an interest rate. For new grads, federal loans typically have a 6-month grace period after graduation where payments are not required. It’s simple math here, though, the less time that your loans are outstanding, the less interest you’re required to pay which saves you money long term
- Lower debt to income ratio – This also helps down the road. As a recent college grad, you may not be thinking about buying a house tomorrow. But when you are, you’ll be limited when calculating home affordability if you have a large amount of student loans.
- Opening opportunity later – Without student loan obligations later in life, you’ll be able to use your cash flow toward other goals (Investing or saving for things like a down payment / vacation)
However there are reasons why you may not want to be so aggressive with your student loan payback:
- Do you have an emergency fund? – This is the “Oh shoot” fund and comes in handy when the unexpected occurs. A good rule of thumb is 3 months of expenses set aside for that bad day when things come up like an unexpected medical expense or your car breaks down. Without the emergency fund established first, you can be living on the edge if your entire focus is on paying down the student loans.
- Other debts – Do you have other high interest debt such as credit card debt? If so, making more than the minimum payment on your student loans may not be a great idea. Think about paying down credit card debt like making an automatic return on your money (likely in the range of 10%-25%). If you have outstanding credit card debt, it may make sense to tackle that first.
- How about that free money first? – If your company offers a retirement plan, check to see if they offer an employee match. This is “free money” to you that you are leaving on the table if you are not contributing up to at least that level.
- Tax deductions – While student loan interest is pesky, the interest on your payments is tax deductible up to $2,500 annually. This deduction is phased out at income limits above $70,000 for those filing single and above $140,000 for those filing jointly.
- Student loan forgiveness – There’s been a lot of talk in Washington about blanket student loan forgiveness up to a certain dollar amount. While that is still up in the air, public service loan forgiveness (PSLF) may be available for those working in government organizations after making 120 qualifying payments. If eligible for PSLF, paying the minimum amount on monthly payments may be a better option than making aggressive payments on the loans.
- Refinancing – As a recent grad, your mailbox has likely already been bombarded with marketing material from companies offering opportunities to refinance your loans. While refinancing may restrict the flexibility to your federal loans, exploring the options available is not a bad idea. You may be able to significantly lower your interest rate and monthly payments by consolidating your loans.
As a recent grad you’ve got a lot on your mind and looking at that large debt may feel intimidating. But take the time to assess your options to find the strategy that makes the most financial sense for your situation.
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All the best,
Andrew Holmes, Certified College Planning Specialist™
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