# Paying Off Student Loans Early

I currently owe \$34,558.00 in student loans (\$31,000.00 principal + \$3,601.83 unpaid interest accrued so far) with an average interest rate of 4.877%. I just started working full time (\$70,000 GAI) and I can now start making payments.

I'd like to figure out the best way to pay off loans as early as possible without completely depleting my income, so I've come up with the following table (figures are based on this website http://studentloanhero.com/calculators/student-loan-prepayment-calculator/):

``````+---+-----------------+----------------+-------+
|Yrs| Monthly Payment | Interest Saved | Ratio |
+---+-----------------+----------------+-------+
| 2 | \$1,576.89       | \$7,467.49      | 4.74  |
| 3 | \$1,061.26       | \$5,530.73      | 5.21  |
| 4 | \$809.22         | \$4,893.38      | 6.05  |
| 5 | \$659.94         | \$4,799.45      | 7.27  |
| 6 | \$561.32         | \$3,882.68      | 6.92  |
| 7 | \$491.37         | \$2,952.55      | 6.01  |
| 8 | \$439.23         | \$1,570.36      | 3.58  |
| 9 | \$398.92         | \$1,051.44      | 2.64  |
+---+-----------------+----------------+-------+
``````

The first two columns give the time frame (in years) in which all loans would be paid off using the given monthly payment amount. The third column gives the amount of interest saved compared to choosing the standard 10-year repayment plan. The last column gives the ratio of Interest Saved / Monthly Payment.

My interpretation of the ratio column is that a higher ratio combines the best total interest savings amount with the lowest monthly repayment amount. In other words, I could choose to pay \$1,576.89 each month (about 42% of my take-home pay each month) for 2 years and maximize interest savings...or I could pay \$659.94 per month (about 17% of my take-home pay) for 5 years, which loses me \$2,668.04 in total but gives me a much healthier budget for other things each month.

So...

1. Do these figures look reasonably correct?
2. Am I overcomplicating this? Should I go with the 5-year plan I described, or try to pay as high a monthly payment as I can realistically afford each month?
• I'm not going to give you advise about what you should do. But I just want to remind you not to cut yourself short and overpay to the point where you have absolutely no money for bread and butter. If all you will lose is 2700 bucks due to interest in 5 years - that really isn't bad.
– JonH
Jan 18, 2016 at 20:42
• I'm curious: Did you read about the Interest Saved/Monthly Payment ratio somewhere, or did you come up with that metric on your own? Jan 18, 2016 at 21:50
• I came up with the metric on my own Jan 18, 2016 at 21:51
• JonH has a good point. It's definitely a good idea to pay this down as quickly as you reasonably can, but the key word there is reasonably. Make sure you're living decently well and that you're regularly saving some money too, so you'll have something to fall back on just in case you need it. Jan 19, 2016 at 2:27
• Don't forget that the tax deduction for student loan interest starts to phase out at \$65k/year and goes away completely above \$80k. ohe.state.mn.us/mPg.cfm?pageID=115 Jan 19, 2016 at 20:59

As you noticed, there are diminishing returns on the interest savings as you get closer to paying off the loan. Certainly, the quicker you pay off the loan, the more interest you save. However, the total interest under the normal 10 year terms is fixed at \$9178, and you can't save more interest than that. Therefore, the rate of increase of the interest savings gets smaller and smaller with each month you take off the loan period. This becomes more obvious when you look at the numbers at the far end of the scale:

• 6 months; Monthly Payment: \$5842; Total Interest: \$493; Interest Saved: \$8685; Ratio: 1.49
• 1 payment; Monthly Payment: \$34588; Total Interest: \$0; Interest Saved: \$9178; Ratio: 0.27

To go from 6 month repayment to 1 month payment, your payment amount has gone up 6 times, but the difference in interest savings is only \$493.

As for what you should do, it really depends on what your goals are. There are many people that do not like being in debt. Their goal is to become debt free as fast as possible. So if that person was comparing the 5 year plan to the 2 year plan, he might notice that the difference is \$2688 in interest, but the important difference to him is 3 years. He has a big payment for 2 years, but is completely debt free after that. The sacrificing in the budget might be tough, but after 2 years, he can do whatever he wants with that extra income.

Looking at it another way, if you go with the 5 year plan, paying less on your loan and having more room in your budget, what do you plan to do with that extra money? If you plan your budget/lifestyle with the \$1577 monthly payment, you will live more frugally, and in 2 years when the loan is done, you will have an extra \$1577 that you were not used to spending that you can do whatever you want with. If, instead, you plan your budget around the \$660 payment, you will become accustomed to spending more money, and in 5 years when the loan is finished, you will only gain \$660 in the budget.

Paying the debt as fast as possible encourages thrift.

• +1 great answer! I would only add a note that if you fall on hard times (lose the lob for any reason), the loan companies aren't going to give you any of that money back just because you need it. So it could be wise to set the monthly budget, but for the first few months pay the minimum on the debt and put all the other money directly into savings for an emergency fund; once that is at target, shift to paying the loans (while leaving your monthly budget the same). Jan 19, 2016 at 16:00
• @BrianDHall While they won't give your money back; once you're paid far enough ahead your minimum payment may go to 0. The lender behind the student loan I paid ahead on spent the entire period between when I started making large extra payments and the balance was paid off sending me "bills" for \$0.00; hoping I'd decide to slack off, keep my money, and amortize interest until I fell back onto the original repayment schedule. You still want an emergency fund ofc; but being paid ahead on your loans may reduce the size you need. Jan 19, 2016 at 20:46

The ratio is meaningless. What's important is what the rates are, and where they fall compared to other rates, both debt you owe, and return you can get.

Does your company offer a matched 401(k) deposit? If so, are you depositing to get the match? If not, that's the priority. Do you owe any credit card debt? 18% (or similar) debt is next. Next, is the question of liquidity. I'd first have 6 months expenses in the bank before paying off these loans at an accelerated pace.

Next, are you planning a home purchase any time soon? Sooner than 5 years? I wrote Student Loans and Your First Mortgage which might apply. If not, that's ok, too.

In a time when bank interest is sub .1%, paying off near 5% loans is fine, but the ratio you offer shouldn't be your guide. If the other priorities on my list are all covered, send every dime you can to pay it off. If not, don't ignore the magic of a matched 401(k) deposit, or the comfort of knowing you have money saved to get you though a busted transmission or radiator.

• +1 for eliminating credit card debt and considering the 401(k) match before focusing on this debt. Jan 19, 2016 at 3:22
• I do have 401k matching but not until I've worked for a full year. I have no credit card debt, and I am living with my parents. I'd like to pay them back for the money they contributed to my degree (and to make sure they have a good retirement). I'm not sure if I'd consider the ratio meaningless - I was trying to express a notion similar to ROI but with discretionary income as a factor. Jan 19, 2016 at 3:53
• No math or any manipulation is required to give you an ROI, it's the rate of the loan. Your chart implies some ideal thing happens at a 5 year payoff. As if the extra \$150/mo to drop to 4 years has some diminishing return, or worse, that a 9 year payoff would be bad regardless of other financial considerations. Jan 19, 2016 at 16:31

If you are making \$70,000 a year and living with your parents, I see no reason why you can't do multiple things at once. Max out your 401(k) and IRA contributions. That's \$20,000 before taxes. I'm guessing about \$10,000 in taxes on the remaining \$50,000, leaving \$40,000. Pay \$20,000 a year on your student loans and you still have \$20,000 left for actual bills.

Note that in ten years you may have kids of your own. So you want to start your retirement savings in a healthy way now so that you can compromise more later. It's easy to get used to having money, which can make it difficult when you have less. You don't want to move out and find that you are totally short.

The same thing applies when you move in with a significant other (or vice versa). Sharing rent and utilities saves you money. Use that to crank up your savings or pay off debt (or both).

It may be that this is not feasible, but I would try making it feasible first. If you take a long look at your options and it really doesn't work, that's one thing. If you don't want to make it work because you'd like to buy that shiny Porsche, that's something else. You don't really give us a good idea of how you are spending your money. Make a budget. See where the pain points are. You can always post back with another question that gives us more details so that we can suggest tradeoffs. For example, should you buy lunch at restaurants every day? Or bag your lunch most days? Even if you have to buy the groceries, bagging your lunch will be considerably cheaper.

If you aren't flush while making \$70,000 and living with your parents, when will you be flush? That strikes me as a pretty good starting salary. I wouldn't expect there to be a lot of room for big raises. Perhaps your work is different, but I wouldn't assume that it is. Save for retirement and pay off debt now so that you don't have to do so when you have more bills.

People are right when they say that you shouldn't kill yourself saving, but in your circumstances, you shouldn't have to do so. I would think that the bigger worry is that you'd get accustomed to having low bills that won't last once you move out. You can always slow down to the five year pace later if the two year pace is overwhelming. Try it, at least on paper. If it's too painful, adjust then.

• Thank you for the detailed response! I appreciate the customized hypotheticals you outlined for me. I also think 70,000 is a very good starting salary and I'm very grateful to be in this position. It's just that I've been used to almost zero income of my own as a college student, so I'm still carrying over this idea that I can't afford things. Jan 19, 2016 at 6:02
• @JoshBroadhurst If you are used to been a zero income college student try to hold on to that mindset as long as you can. It is easier to stay frugal than to tighten your belt after getting comfortable at 70k. Put as much as you can aside while it is still comfortable to live on less.
– Ukko
Jan 19, 2016 at 19:59

When I graduated, I had around \$40,000 in student loans and got a job that paid a little less than what you make. The way to get the loans paid off the fastest with the least amount of interest paid is with something called the "snowball effect" where you pay off the loan with the highest rate first. Once that is paid off, start trying to pay off the loan with the next highest rate.

What I did was allocate \$1200/month towards my student loans. My reasoning for paying a higher amount was, I had lived like a poor college student for 4 years, what was another couple of years. Then, I figured out what the minimum payment was for each of my loans. For simplicity, lets say my minimum payments ended up being \$100/month. That gave me an extra \$1100 to put towards my loan with the highest rate. After that loan was paid off, the total in minimum payments went down to, lets say \$75 so I had \$1125 that I could pay extra towards my loan that had the next highest interest rate etc.

Also note, most student loans accrue interest daily so the more often you make payments, the less interest you end up paying. For example, if you get paid twice a month, try to make a student loan payment each time you get paid as opposed to just once a month. You will end up paying less interest than if you had only made payments once a month.

I would suggest making an amortization spreadsheet to show the differences between different payment options. P=e^rt is your best friend.

Good luck!

• I like that plan a lot. And thanks for the payment frequency tip! Jan 19, 2016 at 16:51