In what order should I decrease my loan debt?

Question

I currently have federal student loans, and a personal loan I took out for college. Below are my percentages for each. I am wondering which loans I should start paying off first to ultimately not waste any more money in the long run. My federal ones are on grace period until 11/2018. And my personal loan is currently set for pay off in 4 years.

1. Federal Student Loans (on grace period until 11/2018) Currently as stands. 10 Years $123 a month.

   a. Direct Subsidized $4,500 4.290%

   b. Direct Unsubsidized $1,865.62 4.290%

   c. Direct Subsidized $3,141.69 3.760%

   d. Direct Subsidized $2,267.00 4.450%

   e. Direct Unsubsidized $165.45 4.450%

2. Personal Loan (around $435 a month for 4 years)

   a. $20,000 3.735%

Answer 1

I'm going to assume by now you are familiar with the two most common methods, Avalanche (highest rate first) and Snowball (lowest amount first). Avalanche should always be mathematically the correct answer, so that's what I typically recommend. Without running the numbers I would guess that the difference in your case will be minimal. There is one advantage of debt snowball that I don't hear mentioned very often though, and that is that your minimum payments are decreasing. This means that after at least one loan is paid off, if you ever have an emergency come up that depletes your emergency fund and then some, in this really bad month you could at least have the option of pausing the snowball and making the smaller minimum payments. This option is not guaranteed to be available with Avalanche.

Answer 2

Some comments:

1. All the interest rates are close, so there's no obvious choice on that score. That leads me to ask: do you have any CC debt? If so, that is what you need to hit first.
2. Do you have an Emergency Fund? With debt, a $1,000 fund is a good baseline while you're paying the debt.
3. Live below your means. (Which doesn't mean "be a miser").
4. If you can pay extra on individual Student Loans, I'd try and knock off the unsubsidized ones first, since they have the highest rates.
5. If you can't, hit the $20K personal loan first.

Answer 3

So, there are a few ways to tackle this.

Which you choose generally depends on the kinda financial philosophies you subscribe to.

TL;DR: Who do you trust?

Method #1: By Interest Rate

• Tackling the higher interest rate loans first is almost always the way to go, as you'll free up more money to pay towards lower interest debts or loans. And faster (source).
• Interest rates are pretty close across all of the debts you've listed, so you might want to jump to Method #2.

Method #2: By Total

• The second option is basically 'Debt Snowball: Redux' (source).

• This method sees you sorting your debts from low to high, and paying off the smallest loans first.

• The method behind the madness here is that, with these smaller debts falling by the wayside faster, you'll free up more and more cash which you can use to gain momentum as you roll into increasingly higher / larger amounts.

Other Things To Note

• Is the 'Grace Period' really a grace period, or will the interest be charged retroactively as soon as it ends? If so, get on these. ASAP.

• If the 'Grace Period' is a true grace period, take this opportunity to pump some serious cash into these debts and wipe them ASAP. The sooner they're gone, the less you'll walk out of the grace period with, the less interest you'll pay.

• No-brainer, but try and cut costs as much as you can. I know, I know, it's obvious. But maybe you don't need that Spotify subscription? Or the 4K Netflix sub?

• Deduct repayments from your taxes! No, really. It's important (source).

Answer 4

There are debates surrounding the order in which to pay off loans, one is the debt snowball (DS) (smallest to largest) the other is the highest interest first (HIF). Obviously the highest interest first is the most efficient, mathematically. However, the debt snowball method has merit as personal finance is so rooted in behavior, and by extension, psychology. So much so, that often times DSers may outperform HIFers despite mathematical disadvantages.

If your loans were not in deferment, the first choice would be easy pay off 1.e. first. Both methods would agree. However, they are in deferment so you have a choice to make now.

Do you intend to go crazy and pay these off ASAP or keep them around and pay them off when you have extra cash? If the ASAP way, then use the debt snowball. If you don't mind having 32k in debt, then use the HIF method. Do you want to be out of debt in 24 months or are you okay with still having 30k in debt at that time? A good barometer on where you stand is if you are willing to give up your weekends to work a second job. If the answer is yes, then the DS method is right for you.

The one thing that is clear, on 11/1, make loan 1.e. go away.

Also many people have trouble directing extra principle payments to their student loans or even specific loans. You may want to do a few small practice transaction on how to work the interface and how much trouble it is to do what you want.

Edit: As Matt points out in the comments, loan 1.e. may be accruing interest despite being in defferment. If that is the case, pay it off today!

Answer 5

As these are student loans and some are still in their grace period, I am going to assume you are relatively young starting your first real job without any other major debts (e.g., car or home), reasonable living expenses (e.g., no young children), and no savings.

If that is the cases, given all the loans are relatively small with reasonable interest rates, I would not be in a rush to pay any of them off. I would focus on making sure you have (1) a reasonable emergency fund (maybe 6 months of living expenses in a relatively liquid and conservative investment), (2) are able to fully capture any matching retirement benefits (e.g., a 401k match), and (3) maximize any tax advantaged retirement accounts. Once that is all taken care of and if there is still money left over, I would consider investing the extra money over paying off the loans. This will allow you to save towards a down payment on a home

Answer 6

1. Avalanche and Snowball agree. "e. Direct Unsubsidized $165.45 4.450%" is both the smallest loan (Snowball) and the highest interest rate (Avalanche). So pay this off first.

2. Avalanche would pay off "d. Direct Subsidized $2,267.00 4.450%" second while Snowball would pay off "b. Direct Unsubsidized $1,865.62 4.290%". If you aren't paying interest on the subsidized loan yet, then Avalanche would also pay off "b".

3. Same two possibilities but reversed. Avalanche: "b. Direct Unsubsidized $1,865.62 4.290%"; Snowball: "d. Direct Subsidized $2,267.00 4.450%".

4. At this point, both methods have paid off the same three loans. Avalanche would pay the highest rate remaining: "a. Direct Subsidized $4,500 4.290%". Snowball would pay the smallest balance remaining: "c. Direct Subsidized $3,141.69 3.760%".

5. Again, same two possibilities but reversed. Avalanche: "c. Direct Subsidized $3,141.69 3.760%"; Snowball: "a. Direct Subsidized $4,500 4.290%".

6. In both methods, you would pay off the personal loan last. It has the lowest interest rate (Avalanche last) and the largest balance (Snowball last). And as commented, it is the only loan easily dischargeable in bankruptcy.

I believe (but am not certain) that subsidized loans don't charge interest during the grace period. I believe that that is the subsidy. The government pays your interest for that time.

I believe that for the unsubsidized loans, the interest accrues during the grace period. You just don't have to make payments. You should pay off the unsubsidized loans as soon as possible.

Why choose Avalanche or Snowball? Avalanche is slightly cheaper. It has you paying the least interest. Snowball is more flexible and more emotionally satisfying. In the beginning, it has you paying off loans quicker. If you have trouble with financial discipline, Snowball is easier to follow because of that sense of accomplishment.

In this particular situation, the difference between the two approaches is negligible. Both pay off the same loan first. Both pay off the same three loans before the other three loans. And both put the personal loan last.

The only real argument against these orders is the possibility that you'll have intermittent income. If you have no money to make loan payments, student loans (at least subsidized ones) allow you to pause payments due to hardship. The personal loan does not have that option. There is an argument that you pay off the personal loan first so as to avoid bankruptcy. Of course, you might still prefer to pay it off last, because it might be worth clearing it in bankruptcy.