How to Manage and Quickly Pay Down Student Loan Debt
Key Points:
Consolidating student loans can make it easier for someone to track and manage their debt payments.
Refinancing student loan debt can potentially allow someone to lower the interest rate on their debt, particularly if they refinance federal loans with a private lender.
Making extra payments towards student loans is a great way to save money and reduce the amount of time it will take to completely pay them off.
It’s no secret that student loan debt is as high as it’s ever been in America. According to the latest studies from 2017, student loan debt nationwide totals $1.4 trillion across more than 44 million borrowers. Paying thousands of dollars each year can be daunting for recent graduates who may not get the job they want immediately after graduating, or who may have relatively low starting salaries. With 70% of graduates leaving school with an average balance of nearly $38,000, all while paying federal fixed-interest loan rates between 4.45% to 6%¹, it's easy to see why they may feel trapped by their debt.
How to Manage Student Loan Debt
Method 1: Consolidating Loans
A common strategy to manage student loan debt is to consolidate the loans with one lender. It is common for graduates to have different loans across several lenders making it difficult and overwhelming to make the different payments and manage all the due dates each month. Consolidation allows someone to group their student loans together and make a single monthly payment to one lender. Consolidating student loans can make it easier for someone to track and manage their debt payments.
Method 2: Refinancing with a Private Lender
While consolidation simplifies the process of managing student loan debt, it typically doesn’t lower the interest rate. On the other hand, refinancing student loan debt can potentially allow someone to lower the interest rate on their debt, particularly if they refinance federal loans with a private lender. Companies like SoFi and LendKey are two examples of these private lenders that can sometimes offer a lower interest rate than what someone might be paying on their federal loans. A lower interest rate can result in significant immediate and long-term savings. See Figure 1. While refinancing may seem like a no-brainer, there are some things to consider with private lenders.
Private Lenders Do Not Offer Favorable Interest Rates to Everyone
Typically, a private lender will give you a break on the interest rate if certain conditions are met. To receive the best interest rate possible, you will need to go through an underwriting process, which is simply the procedure in which the lender decides if an applicant is eligible for a loan. The lender will typically look at a few factors, such as one’s credit history, income, debt, and employment history to assess their overall risk.
Generally, the less risk someone is as a borrower, the lower their interest rate. For most newly minted graduates, it is typically best to wait at least a year or two after graduating to improve their chance of getting a lower refinance rate. This assumes the graduate uses that time to secure a job with steady income, build up their credit score, and lower any other outstanding debts they may have.
Private Lenders Do Not Offer as Much Flexibility
The major downside to refinancing one’s student loans with a private lender is that the borrower will typically no longer have access to various payment options or loan forgiveness plans. For example, federal student loans come with a variety of income-driven repayment options, which could potentially lower a borrower’s monthly payments if they qualify. These programs include income-based repayment (IBR), income-contingent repayment (ICR) and pay as you earn (PAYE). The federal government even offers a loan forgiveness plan, which is available to federal employees, teachers, and a few other professions.
How to Maximize the Benefit of a Lower Interest Rate
Securing a lower interest rate and lowering a monthly payment doesn’t mean that a borrower shouldn’t try to pay more than the new lower monthly payment. In fact, one tip we often give to clients (regardless of the type of debt they have) is to pay the same monthly amount they were paying prior to the refinance. This is because more of the payment will be applied towards principal rather than interest. (See Figure 2.) If we assume the same facts as Figure 1, but instead of paying the newly refinanced monthly amount ($1,008), the borrower continues to pay the original payment amount ($1,110), that person could save anywhere between $25,000 - $28,000 in interest and pay off their loans one to two years earlier.
Final Thoughts
Consolidating and refinancing student loans can be effective ways to manage and pay down student loan debt more quickly. Consolidating can make the process of paying down debt simpler, while refinancing at a lower interest rate can save a borrower thousands of dollars and enable them to pay off their loans earlier. It is important for graduates to keep in mind that student loan debt is not bad debt, because it represents an investment in one’s future. But if managed appropriately over time, that investment cost can be less daunting.
Sources
¹Debt.org, Students & Debt