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.
Pay off Your Pesky College Loans
Normally, I would approach all debt in the same general manner. I use a basic formula to help people get out of debt as fast as possible. Since this is a book geared towards college graduates, I decided to emphasize college loans separately. If the only debt you have is your college loans, you are quite fortunate for several reasons. Not having any credit card debt is perhaps your greatest achievement in college, next to your degree of course. It took me over five years to pay off my credit card debt after I graduated, mainly because I kept adding to it in the beginning. Another reason college loans are a preferable form of debt is their tax deductibility. Notice I said a preferable form of debt, not good debt. In other words, if you are going to have debt, college loans are one of the better types of debt, but ideally you do not want to have any debt at this stage in your life, if at all possible.
Another significant advantage of college debt is that some employers (in some instances this includes the federal government) offer tuition forgiveness programs. When you are looking for a job, this is certainly a benefit to consider. If one job will pay you $2,000 less than another one, but offers to reimburse $5,000 worth of tuition per year, it may still be a better deal, depending on the restrictions. Also, be careful of the wording, because there are also tuition reimbursements programs. Tuition forgiveness programs pay for the tuition from the degree you have already earned. In other words, it will help you retire your current college loans. Tuition reimbursement programs reimburse you for any new expenses you incur as you pursue a new degree, or take additional classes. In other words, it will help you as you continue taking new courses. Both of these programs normally require a type of commitment on your part to remain with the company for a certain length of time, such as three years.
Let’s talk about the tax benefits for a moment. If you pay $250 per month for your loan payment and $30 of that is for interest, you can only deduct the $30 interest portion, not the whole $250. We’ll get into taxes more in a later chapter, but a deduction means your taxable income is reduced by the amount of your deduction, not your tax amount. Essentially your $250 payment (in this example) results in a $30 deduction on your taxes, which saves you about $5 from your total tax bill. Now you can see why I call it preferable debt, but not good. You spent $250 this month and saved $5 in taxes. If that makes you want to hang on to your college debt for as long as possible, you really should considering contacting your college math department and demanding a refund.
The best way to handle your college loans is to do everything you can to minimize the interest rate, as mentioned earlier. Such things as automatic withdraw from your checking account and making your payments on time may help. Take advantage of any employer reimbursements, but only if you understand and can agree to the terms and conditions. Use a part or all of any bonuses you receive to pay off your tuition. Nothing helps make a debt disappear faster than a nice big chunky payment that goes directly towards the principal. If you are able to use any of the ideas earlier in this book to save money every month, use a portion of your savings to add an extra amount to your loan payments. Finally, as you get raises at work, pocket half of the raise, but use the other half to pay down your loans.
If you have other debt to payoff, you may want to hold off on the strategies in the last paragraph (except for minimizing the interest rate and using programs offered by your employer). It may be in your best interest to follow the strategies below and pay off other debt, such as credit cards or car loans before you really tackle your student debt.
Pay off Your Car Loans and Credit Card Debts
I wanted to discuss college loans separately since they have so many unique features and benefits. I also figured many of you have college loans of your own. Regardless of whether you do or do not have college loans, most people will have some type of debt to contend with at some point in their lives. Some have car loans, others have credit cards, and some have just a little bit of everything. No matter how big of a hole you dig yourself into, it is almost always possible to work your way back out in a relatively short time period.
What do I mean by relatively short time period? Well, that depends on how you look at it. If you have $2,000 worth of credit card debt and no loans, you should be done in a matter of months. If you are starting out with $40,000 in student loans and $5,000 in credit card debt, we may be talking about four or five years. Sure that may seem like a long time, but look at your numbers again. Paying off $45,000 in less than six years is quite incredible for someone just starting out.
Conventional wisdom says you should begin by paying off your highest interest rate debt first. I am by no means conventional. In my experience with people, immediate gratification goes a long way. In other words, I recommend paying off the debt that can be paid off the fastest. In some cases this will be the smallest debt, in other cases it will not. Here is how you figure out which debt to pay off first.
List all of your debts. Write down your monthly payment beside each of your debts. Now, divide the debt by the monthly payment (that should be the big number divided by the small number). Write down the answers beside each debt. The smallest answer is the one that will be paid off first (See Figure 10-1). You should focus all of your resources onto this debt. What I mean is that any extra money you pay towards your debt should be directed towards this one. Pay only the minimum on the rest of your debts.
Once the first debt is paid off, take the amount you had been paying each month and add that to the next debt on the list and so on. By the time you get to the last debt, you will be paying the same amount per month as you always had, but it will all be going towards one debt. Using this strategy will knock years off the life of your debt.
To make things go even faster, we are going to look at ways to add to the minimum monthly payments. One of the reasons we discussed stretching your paycheck earlier was to find extra money each month to add towards your debt payments. I know that was a bit sneaky, but that’s how I operate. Don’t worry; I’m not going to force you to sit in the dark with no television for the next four years eating nothing but rice and Ramen noodles (that’s what college was for). It only takes a little bit to go a long way. If you can add just a few dollars a month to your payments, you will be thanking yourself again and again a few short years from now.
Next week we will discuss how to live completely debt free by age 30… and why you should want to.
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.