Why the First Year After Graduation Matters in Your Student Loan Repayment
For most college students, it’s necessary to take on debt to pay for a degree. However, as soon as you get out of school, the reality of those loans kicks in, and you’ll need to start considering your repayment options.
Your first years after graduation are a critical time for determining the overall impact that your student loans will have on the next few decades of your life. The mathematics of compounding interest can quickly turn large student loans into massive ones. In addition, your actions will impact your credit, determining your eventual ability to lower your interest rate or qualify for other types of funding, such as a mortgage.
While it’s helpful to reduce college debt while you’re in school, the decisions you make about student loan payment can dramatically affect your financial future. If you’ve just graduated, here are the seven key considerations for student debt repayment.
1. Can You Increase Monthly Payments to Spend Less Overall
Many financial advisors recommend consumers tackle student debt head on. When you put all your financial liquidity into paying off your loans, you could ultimately end up paying less.
In one example, Money Under 30 showed that increasing payments above the minimum could reduce the interest by 70 percent.
In the sample scenario, a student’s minimum monthly payment was $330 for a $50,000 student loan that had a 5 percent APR and a 20-year term. With the standard repayment plan, total spending would be $79,072, which is nearly $30,000 in interest on top of the loan’s principal.
Increasing monthly payments to $730 per month means that the loan would be paid off in seven years instead of 20, and the total paid in interest would be $8,802.
2. Can You Use Investments to Offset Interest Costs?
In some situations, it could be financially beneficial to maintain a loan balance, keeping payments at their minimum amount, while investing the additional funds. This would only be to your benefit if your investments’ average annual return is higher than your loan’s APR.
Using the same student loan scenario as above, an investment that results in 7 percent average annual return could result in more total wealth accumulation than paying off a loan with 5 percent APR.
While investments do carry risk, 20 years of spending $730 per month split between the minimum loan payments and investments could result in a total accumulated wealth of $209,586.
If the entire monthly amount of $730 were directed to paying off your loans before switching to investments, the total wealth accumulation would be $191,495 after 20 years. That’s $18,091 less.
3. Can You Consolidate?
If you have several federal loans, consolidation allows you to bundle the debt together. The result is a debt simplification with a single monthly payment. Typically, consolidation allows you to lower your total monthly payments by extending the term up to 30 years.
Loan consolidation can have complex implications based on the type of loans you have. For example, after consolidation, loan benefits could include a fixed interest rate or access to a loan forgiveness program for public service workers. However, it could also mean an increase in your principal balance, an increase in the total amount of interest you’ll pay, and a loss of some loan benefits. A financial advisor or student loan specialist can help you decide if consolidation is right for your situation.
4. Can You Lower Monthly Payments?
After graduation, you may make some career choices that aren't immediately profitable. For example, many fellowships, internships, and residency programs can help you grow your career, even if they don’t grow your bank account. Rather than getting behind on payments, which can result in late fees, a better option is to lower minimum monthly payments.
The Department of Education explains that there are forbearance options where you’re only responsible for paying the interest that your federal student loan accrues. There are also longer-term solutions to lowering payments, such as an income-driven repayment plan where your monthly minimums are a percentage of your earnings.
5. Can You Defer Your Student Loans?
After you graduate, it can take some time before you’re able to secure a full-time job.
Student loans issued by the federal government typically offer a grace period of six months before the loan servicer requires monthly payments. However, additional situations may qualify for longer deferments.
Deferment options may be available if you’re a current student, unemployed, experiencing economic hardship, serving in the military, or in another approved situation.
6. Can You Lower Your Interest Rate?
Having a lower interest rate can add up to big savings over the term of your loan. In the same example as above, a $50,000 loan with a 20-year term, reducing the interest rate from 5 percent to 4 percent means that you’d pay 22 percent less in interest.
Your lender may offer options to lower your interest rate if you sign up for automatic payments, pay your bill on time for several consecutive years, or refinance.
7. Are You Thinking Long Term?
Do you still want to be making student loan payments 25 years from now? Getting on track with your debt repayment can help you work toward financial freedom.
By making consistent and on-time payments, you’ll be helping your credit score, which can help your ability to qualify for future loans or grad school funding.
After you’re done with student loan payments, you could use your extra money to launch a startup, to make a large purchase such as a car or mortgage, or to build wealth with a high-interest investment account.
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