Understanding Debt and What It’s All About
Coming out of college, I didn’t realize the impact of student debt until I went on to Sallie Mae’s website to view my student loan. Originally expecting to see only $25,000 worth of student loan debt, I quickly learned the power of compound interest the hard way. I accumulated over roughly $5,000 of interest over the course of 4 years, totaling my loans to $30,000. Unfortunately, I didn’t realize interest accrued while in school and I didn’t think about paying off my debt during my college years. With four loans in total, three with a 6.5% interest rate and one with 3.5% interest rate I needed to develop my game plan on how to pay these off as quickly as possible. Below are the steps I took to pay off my student debt as fast as possible.
7 Step Short List:
- Identify Your Loan(s) With The Highest Interest Rate
- Find a Roommate or Live at Your Parents’ House
- Use Your Tax Return as a Lump Sum Payment on Your Loan
- Automate Your Payments
- Increase Your Payments Each Month
- Put Unexpected Cash Towards Your Loan.
- Be Passionate About Paying Off Your Loan(s).
1. Identify Your Loan(s) With The Highest Interest Rate
Identify which loan(s) has the highest interest rate and pay it off first. Let’s say you have two loans, the first one is $10,000 at 6% and the second loan is $20,000 at 4%. You may think to yourself, well I should pay off the higher principle loan first, or at least get it down to $10,000 before paying off the 6% loan due to the higher principle. THIS IS NOT RIGHT, although it may seem that way with an accrued interest of $800 ($20,000 * 0.04) for one year if no payments to the principle are made, compared to an accrued interest of $600 ($10,000 * 0.06) for one year.
However, if you break down the interest you pay per day, you will notice a payment made on a loan with a higher interest rate will save you lots of money in the long run. Let’s break this down.
If you look at the table above, you will notice the impact from a payment of $300 to a loan with a higher interest rate compared to a $300 payment to a loan with a lower interest rate but higher principle. Paying $300 off a 6% loan will reduce your incurred interest paid per day by 5 cents ($1.64 – $1.59) instead of only 3 cents when paying $300 on a 4% loan, even though the principle is higher. The key point here is, pay off your loan with the highest interest rate first, always!
2. Find a Roommate or Live at Your Parents’ House
Cut your monthly rent and living expenses in half by finding a roommate and splitting your costs. Unfortunately, I had to move out of my parents’ house due to my job, however I immediately found a roommate to help cut my costs in half. I used that money that I would have paid in rent (allocated if living by yourself) towards my loans. You can apply this same strategy if you are able to live with your parents and allocate the costs of living expenses towards your loans.
3. Use Your Tax Return as a Lump Sum Payment on Your Loan
If you receive a nice tax return, put it towards your loan instead of blowing it on a new materialistic item. I allocated 100% of my tax return towards my loan because I wanted to become debt free ASAP. I treated it as unexpected income and put towards my loan to help drop the principle, reducing the amount of interest accumulated.
4. Automate Your Payments
If you have the option to automate your student loan payments, you should always opt in. Most lenders will give an interest rate deduction of roughly 0.25-0.50% if you opt in to automate your payments. This small reduction in an interest rate may not seem like a lot, but it can save you a lot of money over the course of paying off the life of your loan. To learn more about the power of compounding interest and how much 0.25-0.50% can make please check out the post on compounding interest at http://www.firststepfortune.com/2016/04/26/compound-interest-and-saving-for-retirement/.
5. Increase Your Payments Each Month
If you only pay the minimum payment on your loan each month, slowly increase your monthly payment. This is a great strategy to leverage if you prefer the security of an emergency fund or simply want money set aside for personal spending. Let’s say your minimum payment is $500. If you can make this payment successfully for two months without any sacrifice or “financial burden”, then increase your payment to $550 or $600. Continue to slowly increase your payments in small increments to help accelerate paying off your loans.
Small increments have a tremendous impact on your loan payment strategy and help accelerate the payment process without having the feeling of financial instability. Set a goal of what dollar amount to pay each month and increase your contribution until you reach your goal. My goal was to allocate $1,200 each month towards my loan as my standard payment, not including any additional payments I made, with unexpected cash.
6. Put Unexpected Cash Towards Your Loan.
Do you have an upcoming birthday or received unexpected cash from a refund? Instead of buying a materialistic good, put that money towards your loan. If you go out to lunch or dinner with your friends and decide to pay with your card while your friends pay you back with cash. Put that cash towards your loans instead of spending it on something else.
7. Be Passionate About Paying Off Your Loan(s).
Lastly, be passionate about paying off your loan and becoming debt free. Action is the fundamental key to success. Without the right mindset you will find yourself paying only the minimum payment each month and having a student loan for 10 plus years. Motivation should sink in once you realize how much interest you pay per year, week, and day. Take the first step towards accelerating your loan payments and analyze your interest payment with a loan calculator.