Newbie question about student loan debt

[wifeytini]

Hello! I joined this forum because I love learning about money and I am currently trying to pay down my student loan debt. Also, I have a question about paying down my student loans. I would so appreciate some feedback!

Right now, two of my student loans are in repayment (the rest are still in a grace period). They are Sallie Mae loans, one (which I'll call Loan A) is $10,680 with an interest rate of 8.75%. The second (Loan B) is $1,874 with an interest rate of 9.682% (I know, super high). Since these loans are currently in repayment and they also have the highest interest rates out of all my other loans, my husband and I are trying to pay as much down on these as possible before my other (federal) loans go into repayment (about five months from now). The monthly payments on these loans are $197 and $56, respectively. This does not include the interest that accrues from month to month.

Every month we budget $350 total toward paying off these loans. My question is this -- how can I use this $350 to our advantage? Should we pay the minimum on Loan A and sink the rest of the money into Loan B? Since Loan B has a lower principal, should we pay the minimum on that and sink the rest into Loan A? Our principal payments on Loan A, for some reason, have been advanced until August, so it would be possible for us to stop paying money on them alltogether (although interest would still accrue). With that said, should we stop paying Loan A for the time being and focus on paying off Loan B in full? Or should I just split the $350 between the two loans? Which makes more financial sense??

I'd so appreciate your help on this one. I'm not really a math person and so I've just been putting $175 down on each loan, every month, regardless of whether or not I am using my money to its full advantage. Could anyone please tell me what is the best solution -- or, in mathematical terms, what will cost me the least in the long run??

Thank you so much in advance!!

[clintdavis]

I would pay only the minimum on Loan A, and pay everything extra yo0u can toward Loan B. From what you describe, you should be able to pay Loan B off very quickly and be done with it forever. Then, you can take all of your extra money, your extra $350 PLUS the $56 min. payment of Loan B, and use that to attack Loan A. This will also free up more of your money to go toward the other loan's minimum payments as the grace period ends.

When all of your loans reach the repayment period, you will want to list all of your debts from smallest balance to largest balance. Pay only the minimum monthly payment on all of them except the smallest balance. Throw every extra penny you can at the smallest balance and eliminate it as quickly as possible. Then take everything you had been throwing at that debt, and begin to put it toward the next smallest balance. This allows you to create financial momentum so that you can pay off your debts as quickly as possible.

This is the basic Debt Snowball plan that has been around for decades. It's the plan that my wife and I used to pay off $50,000 of debt in about 16 months.

Thanks for sharing with us!

In Freedom,

Clint

[jpg7n16]

Could anyone please tell me what is the best solution -- or, in mathematical terms, what will cost me the least in the long run??

In mathematical terms, you will always do best to put the maximum amount possible each month towards the highest tax adjusted interest rate.

So if you have $350, it is better to use it to eliminate $350 of 9% debt, than 175 of 9% debt, and 175 of 8% debt.

Since the 9% debt costs 0.09/year per dollar, for each dollar you are able to remove, you save 9 cents/year. This is better than saving 8 cents/year. (duh )

Doing some quick math - Putting all $350 to 8% debt would save 28/year (350*.08). Paying 175 on each would save 29.75/year (175*.09 + 175*.08). 350 paying off 9% debt would save 31.50/year (350*.09).

So using this quick example, you can see that the higher the amount that goes to the higher interest rate, the more money is saved on interest.


I tend to think of it like, 'well what gets me the most bang for my buck? saving 9 cents? or saving 5 cents?'

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But before I tell you what I'd do, keep in mind that student loan interest is deductible regardless of if you itemize or not, meaning that you get to save taxes on the interest you pay.

So take your $10,680 loan: over the course of the year, if you paid nothing on it, you would get charged 8.75% interest which you can then deduct.

$10,680 * 8.75% = 934.50 interest paid

But because you can deduct this you get a tax refund reducing the cost of your borrowing. At the 25% bracket, that deduction saves 934.50*25% = $233.63 - reducing the true cost of that debt to 934.50 interest - 233.63 additional tax refund = 700.87 true cost of the debt

700.87 / 10,680 = 6.56% - this would be your tax adjusted interest rate


The shorthand version is to take the interest cost times (1 - tax rate): {using 25% bracket}

8.75% * (1 - .25) = 8.75% * .75 = 6.56%
and 9.682% * .75 = 7.2615%

Once you have adjusted the true cost of the debt, are they still your highest interest rates?

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So back to practical real life implications:

You should reorder your debts by the tax adjusted interest rate.

Then, pay the maximum possible on the highest rate debt, and the minimum possible on every other debt.


In your unique situation, you want to pay the minimum possible on Loan A, while paying as much as you possibly can on Loan B. Since you have a unique opportunity to legally pay $0 on loan A with no negative impact on credit, and no fees to do so - the minimum possible would be $0.

So, yes - it would actually benefit you to not pay anything on the 8.75% loan, and pay the entire $350/month towards the 9.682% loan - until it's paid off.

[debtfreeme]

Aim to get rid of debt b before the others end their deferments.

[Frugal]

Try to get rid of the debt with the highest interest rate first. If you can unload this debt soon, you will save money in the long run on interest. Interest also runs the danger of capitalizing to very high levels, if it has a high interest rate.

[tan fish]

I'm locked into a payment plan with the feds where I pay about $280 a month, which is withdrawn automatically from my checking account on the 7th of the month or the closest business day if the 7th is a weekend. Because interest grows daily, much of my payment (like 30% or so) on the 7th goes towards paying off interest which has accumulated, and the rest (70%) is applied to the principal. Then what I do is make an additional payment on the 8th, before much interest has accumulated, and about 97% of it is applied to the principal.

Moral of the story is, if you have enough cash to make an extra payment a month, try and schedule that extra payment as soon as possible after your initial payment so the majority of it can be applied to your principal.