Boring investor sites state there are two ways to pay off debt. The avalanche method is when you pay down higher interest loans/debt first. In the snowball method you pay down the loans with the lowest balances off first. This is assuming you have multiple loans/debts which I’m sure 99% of individuals do. What are the advantages of these methods?
In the avalanche method, as you might imagine, you will save money on the interest. You know how much I hate interest. My rate on my loan with FedLoan Servicing is a grand 7.37%. Basically robbery.
The snowball method could prove beneficial for a person in the fact that paying off smaller loan balances could eliminate that monthly payment or obligation. That extra money could then be used towards increasing payments on the remaining debts. There is also highly gratifying mental pleasure in paying off smaller loan balances.
Which method do I employ? I’ve decided that the snowball method works best for me. I have one huge loan with FedLoan servicing for about $490k and a smaller cookie crumb of a loan with Navient for a mere $15k. My monthly obligation for Navient is $192 a month. Thus eliminating this debt would give me that extra month toward the big kahuna. Now, this doesn’t just apply to student debts either. I do also have a car payment but this debt is a zero percent interest rate (yes, you heard me right) thus, paying this off early just doesn’t make sense. Also keep in mind that credit cards can have the worst interest rates in all of time, so take a look and really analyze your debts. How you pay off your debts can actually save you time and money as I have mentioned before in my previous blog post about biweekly payments.
Lets say you get a paycheck every two weeks, as a majority of people do. Now, if you want to save even more on your student loans I was doing some research on the amount of money you can save by making biweekly payments. This would mean you would not pay your loan bill once a month but you could pay every paycheck. For those that this is a feasible option for them, I would highly suggest reading below to see the details.
Most likely your student loan interest is calculated on a daily basis. Take your interest rate and divide it by 365 days. My rate at 7.375% is 0.020%. This is your daily interest rate. On approximately 490k (remember to move the decimal point two places to the left) brings my daily interest rate to about $98 a day. Basically, I’m spending $98 a day before the sunrise rises everyday. When I log into Fedloan servicing I can see the current accumulated interest since the last payment:
My unpaid interest is $1,284.72. this amount increases by $98 daily and the new balance is used for the new daily interest dollar amount calculation. This is the principal of daily compounding interest. Your calculated interest every day is based on the previous days increased balance.
Now lets say you pay half of your student loan payment 15 days before the due date. You are dropping the balance just that small amount so you will save that extra money of compounding interest. Over time this could save you hundreds, thousands, or tens of thousands. You will also finish paying off your loan sooner, sometimes by years. There is a calculator you can use to calculate your savings. In my half a mill student loan situation this is huge. Not to mention this money is all out of pocket money and is all savings on interest. Check out what my projected savings is:
PSLF or public service loan forgiveness inauguration in 2007 was created under President Obama’s leadership as a way to ease the student loan crisis for millions of borrowers. Basically how it works is this: A borrower will need to enter re-payment under a qualifying re-payment plan. The borrow must also work for a non-profit organization in full time status. They must then make 120 on-time payments (over ten years) under one of these plans. After all 120 payments are made, they can then have the remaining balance of their student loans forgiven or wiped out completely. The qualifying plans include:
Revised Pay As You Earn Repayment Plan (REPAYE Plan)
Pay As You Earn Repayment Plan (PAYE Plan)
Income-Based Repayment Plan (IBR Plan)
Income-Contingent Repayment Plan (ICR Plan)
The first recipients of loan forgiveness was in the fall of 2017. I am still searching for anyone who has had a balance forgiven. There are several considerations to be concerned about here. First of all, there has been government talks about cancellation of the program altogether. Obviously they did not anticipate this plan for high student loan borrowers such as myself who can potentially have hundreds of thousands of dollars forgiven. Secondly, there is also the potential that any amount forgiven will be handled by the IRS as taxable income. Lastly, there is also the potential that they will cap the forgiveness balance to $57,500.
Here’s my opinion on PSLF. It depends. The higher amount of debt you have, the more appealing the program but also the more risky. I will use my own loans to break down my points:
If I were to have have a crazy $670k completely erased, this will be subject to 25-30% in taxes. The total taxes owed at 30% will be approx. $201,000 to uncle sam. Now, if you look at how much you would have paid out of pocket to the loans over the ten years using the same calculator as above you can see that the amount you are paying might not be saving you as much as you think.
The big factor that I should also mention here is that you can clearly see that while $670,000 will be forgiven, the loan balance has gone up by $170,000. You see, at my income level and at my loan balance/interest rate entering into PAYE will actually add interest to the balance of my loan over the ten years. In other words, the monthly payments are not even covering the accrued interest! This is a scary thought if you consider the concerning considerations mentioned at the beginning of this article. For example, if I make it to year 8 and suddenly with a quick vote by congress the whole program becomes obsolete, I will not only be at square one, but I will actually be in a worse position than when I started. Total nightmare. The less risky choice would be the ICR plan which you could do the math on that.
Now which plan did I ultimately choose? I am in an Income-Based Repayment plan. The caveat is that I pay much more than what the payment book says to pay to avoid the balance of my loan going up. I am actually not working in public service so some may wonder why I am in this plan at all. This plan also will allow for forgiveness of the student loan balance after 20 years of payments even if you are not working in public service. I will hope that my loan will be paid by then but just in case… More on re-payment plans for future posts.
– Dr. J
Update 2.12.18- I did place a call to FedLoan servicing because of another question I had on my account. While I had the agent on the phone I inquired about taxation of the debt forgiven. They deny this as a taxable income at this time. Keep in mind that at the forgiveness of any student loan debt you receive a 1099-C for the IRS. You would file this along with your taxes. Apparently at this time, this form is in vain and has no meaning but I consider this as just a set up for future taxation laws. My opinion on this matter still remains pessimistic.
This is my story on being a half a million dollars in student loan debt. This financial weight is not only troublesome to our bank account but also an emotional and sometimes humorous tale. How did I get here? That deserves a blog post on its own. To be fair, I am a practicing physician and am considered a high income earner. But this is still an enormous amount of debt. I believe that there are many others in this crisis situation. I’m going to share my debt story starting with transparency. I hope that I will be able to help some, or give hope to others. This all starts with my own total transparency. I am posting below snapshots of my account balances.