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up vote 12 down vote favorite

I have more loans than these but I am wondering how to handle these three (all with the same bank):

3%, last payment ~$36, current balance $6153, original amount $5500, payoff balance $6170
2.5%, last payment ~$30, current balance $5200, original amount $5250, payoff balance $5200
8.75%, last payment ~$9, current balance $940, original amount $3000, payoff balance $950

I have very little idea how to understand all this, but even though I am making the minimum payments each month, I feel like these loans just aren't moving despite starting to pay them off a couple years ago. I plugged an extra $2k toward the last loan a while back because the interest rate on that thing scares me.

But in general I have no idea what to really make of these numbers (I suck with finance) nor how long it'll take to pay off at this rate. How much more should I pay each month and how do I know how much shorter it'll take to pay off/how much money I'd save in the long run?

Thank you.

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2  
Minimum payments are designed to maximize the amount the bank makes on your loan. Even a 50% increase in the payment amount will add up significantly in savings over the long term. – user4127 Jun 20 '12 at 20:44
One thing you appear to be missing is that one of the "ways to wealth" is by letting your money make money for you, a return on your money (interest, but also dividends, other investments). These days, it is very hard in the U.S. to get a "decent" guaranteed return of, say 3% return--to get that would be great. What you need to deeply get is that credit debt is NEGATIVE RETURN where you guarantee a negative 3% or whatever you have. By paying these off, you will at least be back to a neutral position and then can climb to wealth eventually. – Chelonian Jun 21 '12 at 3:29

4 Answers

up vote 8 down vote accepted

Paying the minimum balance on a loan can be DEVASTATING and is highly UN-RECOMMENDED. It is important you understand your loan and the terms associated with it.

Loans are given for a period of time but if you pay the minimum it does NOT mean you will pay it all off by the end. When paying a loan money is applied to the interest first and any extra amount is then applied to the principle.

Here's an example: If I have a $12 loan for 1 year. The interest is 100%. My minimum payment each month is $1. If I pay that minimum only I will be stuck paying $12 at the end of the loan. Why you ask? because each month I'm being charged $1 interest and the payment I am making is only going towards that interest. However if I paid $2 instead now $1 goes to the principal (the original $12 I borrowed). This means that next month I will only be charged interest on $11 dollars instead of $12.

You need to know how much is going towards the interest of your loan and how much is going towards the principle you can speak with your bank about this and they will help you understand. In many cases they actually provide you with the numbers on your statment with examples of how long it would take to payoff your loan with minimum only and how long it would take if you added an extra x amount each month.

I recommend using the Snowball Method to pay of your debt. It's simple and effective.

How much you should add to each monthly payment depends on how much you can afford to add.

Here are some calculators you can play around with:

CNN Money

Bank Rate Calc

Edit: So with the additional information you provided we can estimate that you have about 2200 free cash flow each month(that's your cash after you pay all your bills).

We can put away 500 each month for a rainy day fund, just to be safe.(job loss, accidents, or anything we can't predict)

So assuming that is all your expenses including the money you spend on entertainment. That leaves you with $1700 you can add on to your loan payments. So you can pay off your third loan in 1 month. Then add the remaining balance to the 2nd loan. With this income it should take you less then a year to pay off all your loans.

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My problem isn't with motivation really -- I am just wondering how much extra I should pay. – AgainstASicilian Jun 20 '12 at 15:00
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@AgainstASicilian As much as you can afford. If you live with your parents or someone supports you then set a budget for the expenses you have and pay the rest towards your loans. So if you can add another $100 each month, do it. If you can add another $1000 then add that. Its difficult for me to give you an exact amount because I do not know anything about your expenses or your income and unless your investing that money with better returns its worth it to just pay it off asap. – Kirill Fuchs Jun 20 '12 at 15:08
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@AgainstASicilian put money into your choice of savings vehicle weather its a savings account, a stock protfolio, bonds, gold, or checking account. If your asking whats a good way to invest your money, that deserves its own question on SE :). – Kirill Fuchs Jun 20 '12 at 16:27
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"Loans are given for a period of time but if you pay the minimum it does NOT mean you will pay it all off by the end." - ? For a credit card, perhaps, but the student loan, like a mortgage, has a fixed payment schedule. The minimum is what will pay it over its term. "can be DEVASTATING and is highly UN-RECOMMENDED" - if high interest/high balance, agreed. $11K at 3% is neither. If he is starting out and on a tight budget, planning for a future, I'd leave the two low rate loans in place, perhaps for the full term. – JoeTaxpayer Jun 20 '12 at 19:56
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Don't listen to anybody except JoeTaxpayer - the snowball method makes no sense in terms of saving the most money. If, for some reason, you feel there is a psychological victory in reducing a balance to 0 and this means enough to you that you want to pay for it by spending more on interest than you have to, well, it's your money. Otherwise, highest interest first, to the extent possible. It's that simple, unless there are other differences in the loans, such as the fact that student loans are still due after bankruptcy, or if some are variable rate. In which case, use your judgement. – psr Jun 20 '12 at 20:17
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up vote 10 down vote

First to actually answer the question "how long at these rates/payments?"-

  • $6153 3%, $36/mo = 223 months remain
  • $5200 2.5%, $30/mo = 215 months remain
  • $940 8.75%, $9/mo = 197 months remain

These is nothing magic or nefarious about what the bank is doing. They add accrued interest and take your payment off the new total.

I'd make higher payments to the 8.75% debt until it's gone, $100/mo extra and be done. The first debt, if you bump it to $50 will be paid in 147 months, at $75/mo, 92 months. Everything you pay above the minimum goes right to the principal balance and gets you closer to paying it off.

The debt snowball is not the ideal way to pay off your debt. Say I have one 24% credit card the bank was nice enough to give me a $20,000 line of credit on. I also have 20 cards each with $1000 in credit, all at 6%. The snowball dictates that the smallest debt be paid first, so while I pay the minimum on the 24% card, the 6% cards get paid off one by one, but I'm supposed to feel good about the process, as I reduce the number of cards every few months. The correct way to line up debt is to pay off the (tax adjusted) highest rate first, as an extra $100 to the 24% card saves you $2/mo vs 50 cents/mo for the 6% cards. I wrote an article discussing the Debt Snowball which links to a calculator where you can see the difference in methods. I note that if the difference from lowest to highest rate is small, the Snowball method will only cost you a small amount more. If, by coincidence, the balances are close, the difference will also be small.

The above aside, it's the rest of your situation that will tell you the right path for you. For example, a matched 401(k) deposit should take priority over most debt repayment. The $11,000 might be better conserved for a house downpayment as that $66/mo is student loan and won't count as the housing debt, rather "other debt" and part of the higher ratio when qualifying for the mortgage. If you already have taken this into account, by all means, pay off the 8.75% debt asap, then start paying off the 3% faster. Keep in mind, this is likely the lowest rate debt one can have and once paid off, you can't withdraw it again. So it's important to consider the big picture first.

(Are you depositing to a retirement account? Is it a 401(k) and are you getting any matching from the company?)

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I just paid off the 8.75% to get it over with. It also happens to be my highest-interest loan and lowest loan amount. I have a couple other government loans that are much larger but have lower interest rate. I understand the utility effect of the snowball method but I am really concerned with rational optimization of payoff, but I'm not too good with finance. Do you have a few sample equations that I could look at to understand how to make sense of my numbers in particular? Online calculators tend to shoehorn me into frameworks I don't know all the info for – AgainstASicilian Jun 20 '12 at 16:02
Yes I am depositing 3% into a 401k, company matching. The account's not particularly huge as I have only been working here for a couple years. – AgainstASicilian Jun 20 '12 at 16:04
See the calculator in the article I linked to. If you don't care for it, a custom spreadsheet is the best way to view it all. – JoeTaxpayer Jun 20 '12 at 16:05
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The debt snowball is not about efficiency it is about setting goals and accomplishing them. If you try to take on the biggest debt first you are more likely to give up before accomplishing your goal. If you had the basic willpower to accomplish the big goal you probably would not have gotten into a position where the snowball was needed. (no judgement I fell in to that pit myself before) But moving the finish line closer gives achievable goals that can help you build that willpower. It is the difference between a diet to lose weight and changing how you live. – user4127 Jun 20 '12 at 20:42
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@psr - It is a one step at a time program that is about changing behavior. The idea is that you can learn to take increasingly larger steps with confidence. You change the way you live. For someone used to living in constant debt they need to learn to change. Change is hard, and one of the hardest parts is believing in your self that you can do it. So those small victories early on do have an impact. But just like losing weight or quitting smoking if you do not truly commit to doing it no system in the world will save you. – user4127 Jun 21 '12 at 12:56
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up vote 2 down vote

The first loan looks like it did not have its interest subsidized while you were in school, so interest was accruing eventhough you didn't have to start making payments on it yet.

With the $73 payment you made, the bank is allocating the funds in a pre-determined split that is in their best interest - NOT yours! While you do need to pay them down (and eventually off), at the current rate it will take ~169 months (with no more interest accruing) to do so. Most likely, with interest continuing to accrue, you're looking more in the neighborhood of 17 years, rather than 14 (these are back-of-the-envelope numbers).

The payoff balance listed is the current principle plus interest that will accrue before the next processing date - so it is usually a little higher than the "actual" balance, because the interest is accruing daily (albeit in very small percentages (1/365 of the loan's percentage)).

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Yeah, these are private loans so they were not subsidized while in school – AgainstASicilian Jun 20 '12 at 14:41
What would you recommend in terms of how much additional to pay, if any? Any general strategies? – AgainstASicilian Jun 20 '12 at 14:42
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@AgainstASicilian - personally, I follow the "debt snowball" method that Dave Ramsey describes (others have similar thoughts): pick the lowest balance debt, and pay it off (while not missing minimums elsewhere) - everytime you pay off a balance, it's a little victory. Then, take the amount you had been paying to the lowest, and add it to the payment on the next lowest, and so on. With student loans in particular, my wife and I pay a fixed dollar amount every month while we focus on other debts - more than the minimum, but nothing extravagant... yet :) – warren Jun 20 '12 at 14:49
up vote 1 down vote

If you want to pay them off as quickly as possible, pay the minimum payment on the larger two and dump as much as you can into the one with the 8.75% interest. Then, even though it has a slightly lower interest rate, I would attack the one with the next smallest balance after that, while continuing to make the minimum payment on the one with the largest balance.

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I just bit the bullet and dumped a grand into the 8.75% loan to pay it off. I am going to feel sick. LOL. Do you recommend paying more than the minimum on one loan or more than the minimum on many loans across the board? – AgainstASicilian Jun 20 '12 at 15:50
If the goal is to pay them off quickly, I would stick to paying the minimum on the larger and continue to attack the smaller of the two. Also, if you are looking for good long term advice on getting out of debt and staying out of debt, check out the book "The Total Money Makeover" by Dave Ramsey. Don't worry, it's not a get-rich quick scheme. It's about doing the right things with your money, like budgeting, having an emergency fund, getting out of debt. – Kevin Jun 20 '12 at 16:08
Sounds like a good idea. My financial goals have largely been 1. To have enough of a slush fund to absorb the variance of risky events like injuries or losing my job for whatever reason, and 2. Have enough to pay off the minimum debts every month no matter what. I am worried, though, about not having enough to raise a child or afford a house. Feels like I am throwing money out the window on rent and loans which is why I want to pay this stuff off ASAP. – AgainstASicilian Jun 20 '12 at 16:10
Don't know what all debt you have, but if this is it, and you do have 1700 month that you can attack this debt, I would stick $1000 in a savings account to use for any emergency like car breaking down, then use that money and get rid of this debt in less than a year. Then build that emergency fund up to 3-6 months living expenses. You could easily do that in 18 months or so and be better off financially the a large majority of people. – Kevin Jun 20 '12 at 16:17
Only debt is the student loans, mainly. I have a credit card but I only use it once a month and pay it off immediately. Other than that, just rent, insurance, phone, food, etc, the basics. No car or anything like that. – AgainstASicilian Jun 20 '12 at 16:24

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