The average payoff date for student loans is 10 years from the first payment. For those in income-based repayment programs, it can be as long as 25 years until the final payment is made. And here we are advocating for a payment time of just five years – why?
The simple answer is it will save you a ton of money, cost less than you expect, and help you prepare to tackle every other financial milestone you wish to achieve by providing you with the financial discipline needed to succeed.
What If I Stick to the 10-Year Payment Program?
Assuming you are just starting your repayment journey, take a look at the amount of money you are paying in interest and compare it to the amount going toward the principal. This handy calculator will help you figure out the amortization schedule if you are not yet through with school.
Let’s say you have $50,000 in student loans and a 6% interest rate; your payment will be $555.10. The first payment will have $250 going toward interest and $305.10 going toward the principal. Every month you will pay $1.53 less in interest, with the extra going toward the principal.
When it is all said and done, you will have paid $16,612.30 in total interest for your loan. In other words, you will be paying roughly 32% of the principal back as interest.
What Will It Cost to Pay It Off in 5 Years?
Assuming the same $50,000 and 6% interest, your monthly payment will be $966.64, or $411.54 more per month (an increase of only 74%). However, all of that extra is going toward paying down the principal. You will still start off paying $250 per month in interest, but each payment will see the total interest charge go down by $3.58.
This is more than double the rate of decrease you would see with a traditional 10-year repayment schedule. The total amount of interest you will pay is $7,998.40, or about half of the interest you would pay on the 10-year note.
Remember that interest isn’t a nifty perk or item you can collect. It is a fee for being able to pay back debt more slowly. By cutting the time in half, you will be negating the amount of interest you have to pay considerably.
But What About the Interest Tax Deduction?
Paying more than the minimum every month, and, therefore, less in interest overall may seem counterproductive considering the tax benefits that come with student loan interest payments. However, on closer examination, the benefit matters vastly less than the amount you will be able to save by cutting your payment time in half.
The faults with the deduction are twofold: The first is that you can only deduct a maximum of $2,500 per year, and the second is that the deduction is toward your taxable income rather than the amount of tax itself.
That means, assuming you are in the 24% tax bracket and qualify for the maximum deduction, you will only see your taxes decrease by $600. This amount will decrease every year, as less and less of the total payment goes toward interest. As such, you should consider the tax break a nice, small gesture from the federal government rather than something to base serious financial decisions around.
How Do I Get Enough Cash to Do This?
You may be wondering, “How in the world am I going to afford this?” Well, there are many ways to free up or create cash that can be used to handle this. Here are some of the most common ways college students and graduates can save money every day.
Cut Down on Expenses
Take a hard look at your finances to determine what you can cut. Do you need to be eating out every day for lunch? Bringing a packed lunch to work can easily net you over $170 per month – and more if you go out for dinner or breakfast, as well.
Another common savings is on entertainment packages you barely use. For instance, do you need to have 150 cable channels and high-speed internet access if you are living by yourself? Downgrade to just the local channels and slightly slower internet to save a ton of money every month.
The list of things you can cut goes on, from paying for a top-tier phone to having your car waxed and shined every month.
Change How You Commute to Work
If you live in an area that is friendly to bikers and your job isn’t too far away, consider saving gas and maintenance money by biking to work when it is nice out. Or use a gas-friendly alternative like a moped if the distance is just a tad too far. By cutting your gas tank bill by just $15 per week, you will be saving an additional $780 per year that you can put toward your student loan payment.
Downsize Your Apartment
If you live by yourself, do you really need that second bedroom as an office? Or can you get by with using your laptop on the couch? Cut down on the clutter and see if you really need the extra space.
Moving into a more efficiently designed apartment for a couple of years may mean less entertaining space, but it can add up to hundreds of dollars going toward paying off your student loans.
Remember, your goal should be to maximize your life while minimizing your expenses. Take a long look at your possessions and see if you can put them into multiple uses. As with using the living room as an at-home office space, you will be amazed at how easy it is to “double-up” on the usability of your household furniture.
Add a Freelance “Gig”
Do you have a passion that you do in the evenings or on weekends? See if you can turn it into a small gig that brings in cash you can use to pay down your student loans. With more than 35% of the American workforce now freelancing, it is becoming commonplace for people to turn their favorite hobbies into a resource for paying down debt, building savings, and providing stability when the traditional job market isn’t cutting it.
Consider a “Soft” 5-Year Plan
Just because you are willing to pay off your student loans in five years doesn’t mean that you need to consolidate them into a single five-year note. Students with the financial resources should stick with a 10- or 15-year payment plan and then make extra payments whenever possible.
This gives the graduate the ability to “slow down” payments to the lower monthly payment during crunch times – like when you are forced to suddenly rely on your freelancing income for a couple of months.
You will still receive all the benefits of paying your note off in five years, regardless of whether you need to “go back” a couple of months during year three.
While saving money for the sole purpose of paying down your student loans faster can be enticing, there is one exception that you mustn’t overlook: You need to have a sizable amount in savings to cover periods of unemployment and emergencies. Do not let saving on interest keep you from making regular contributions to your savings account – you never know when you will need to dip into your buffer.
Learn More With CollegeFinance Today
At CollegeFinance, it is our mission to provide college students (and graduates) like yourself with the information needed to make proper financial decisions. Our team of experienced financial experts has spent years working with people from around the world, discovering tidbits that can help you choose the right way forward.
From filling out your Free Application for Federal Student Aid (FAFSA) to figuring out what loan repayment program will work best for you, our team is ready to provide you with the information you need today.