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Thursday, November 27th, 2014


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Defeating Debt: Beat The Lenders At Their Own Game

This article is part of our 52 week journey through Bill’s latest book, The Graduate’s Guide to Life and Money. Each week, a full excerpt from his book will be presented from beginning to end. To get your copy of his book, visit www.TheGraduatesGuide.com.

You finally made it through all of the tests and the papers and the parties. Now that you are ready to begin life as a real adult, you also have to deal with those stupid college loans. It really does not seem fair. You went through all of those years of pain and suffering and you had to pay for it! Actually, you may not have paid anything yet. Most student loans give you a six-month grace period after graduation before you have to make your first payment. This is good if you have a federally subsidized Stafford loan. With the federally subsidized loans, the government takes care of the interest on your loans while you are in college. The government also covers the interest during the six-month grace period. After that you are on your own…. Sort of.

If you do not have a subsidized loan, and you were not making payments while you attended college, the interest was accruing. This simply means you were being charged interest, but since you did not have to pay, it was simply added to the amount of your loan. You also pay interest on your interest, but we’ll get into that soon enough. As an example, if you borrowed $10,000 unsubsidized your freshman year and did not borrow any more, when you graduate you may have a balance of $12,500 (depending on your interest rate).

If you have a Sallie Mae loan, which many students do, you can get a lot of useful information from their website, www.salliemae.com. Here you will find information about several flexible payment options they offer. You can defer your payments for a certain period of time if you can demonstrate you were unable to find employment. You can also use what they call a graduated repayment plan where you start out by paying a small monthly payment (in theory you will start out making a small salary) and then your payments gradually increase (in theory you will continue to receive raises from your employer). There are also several other options available from Sallie Mae. If you do not have a Sallie Mae loan, you should consult with your lender and see if they offer anything similar.

Other benefits you may receive include the ability to lower your interest rate by allowing for a direct withdraw from your bank account each month and by making the first several consecutive payments on time. Essentially you are rewarded for making life easier for the lender. Another consideration is that the interest paid on college loans is tax deductible. Thus the effective interest rate is actually less than what you pay (we’ll discuss taxes more in Chapter 12). Just understand that by deducting your interest payments, a percentage of that interest comes back to you in the form of tax savings.

Debt is Bad

Before we get into the details of any particular type of loan, let’s go straight to the bottom line. Debt is bad. Some people will argue with me on this point, but for someone in your age group, you should consider all debt to be bad debt. We’ll talk about paying off your debt in a minute, but first let’s talk about not getting into debt (or not getting into any more debt). Why is debt bad? Because you are basically spending tomorrow’s income. That means you might get that new toy today, but if you have to go to work tomorrow to pay for something you already enjoyed, where is the incentive in that? Imagine that you eat at a nice restaurant on Friday night. By Monday the whole memory of the meal is practically faded, yet there you are at work earning money to pay for the meal that was already consumed. That means you get nothing out of working that day, because you already enjoyed it in the past.

Now let’s say you buy a new stereo system for $1,000 on your credit card. You pay the minimum $20 every month. After three years, let’s assume the stereo is outdated, or too many of the parts no longer work. You still owe about $790 on your credit card. So if you decide to pay off your credit card, the next $790 that you earn will be paying for a stereo you no longer have. In other words, to buy a new stereo, you first have to earn $790 to pay off your debt, and then earn another $1,000 after that before you can buy a new one.

For the record, the $1,000 stereo you bought the first time cost you a total of $1,400 if you include the interest charges on your credit card. If you stretch it out by paying only the minimum amount on your card, it will take more than 15 years to pay it off and you will have paid $1,300 in interest, for a total cost of $2,300. I hope you got a good deal.

By getting yourself into debt, not only do you sacrifice your future income, but you also are paying more for everything in terms of interest charges. You are essentially selling away your choices. If you have $1,000 you have many choices of what to do with that money. Once you spend it you have fewer choices. If you borrow another $1,000, you have even fewer choices, because some of your future money has been spoken for. You cannot, for instance, quit your job since you have to earn that $1,000 first. If you lose your job, you are forced to get another one immediately, even if it is not the one you want, since you have to make the payments on your debt.

In addition, you are not saving anything because you are too busy making payments. What could be worse than spending the next three years waking up at five o’clock in the morning, commuting for 30+ minutes, staying late at the office, etc. only to look back and realize all you have to show for it is a stereo that no longer works and about $790 in debt? Avoiding debt (this includes avoiding new debt if you already have some) is the first step towards reaching any financial goal. Paying off your current debt is the second.

Bill Pratt is a former credit card executive turned student-advocate. He is the author of Extra Credit: The 7 Things Every College Student Needs to Know About Credit Debt & Ca$h and The Graduate’s Guide to Life and Money. Bill speaks at colleges to educate and entertain students about real-life issues in money, leadership, and success. His goal is to help students succeed personally and financially so they can improve the lives of those around them. You can learn more at www.ExtraCreditBook.comor www.TheGraduatesGuide.com.

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