Sometimes the numbers seem to say one thing, but real life screams something else.
That’s the case when I talk to young people with lots and lots of college debt to pay off.
The voices in their head say something like this:
I have a LOT of student debt. But I know I also need to start saving for the future. Maybe I should probably pay off these debts first, because I won't earn enough interest to make up for the interest I’m paying. Or…is it better to pay more than the required amount and then start saving, or to pay the required amount and save at the same time? Ugh…I hate word problems…
Depending on what kind of student loans you have, you may have an interest rate as low as 3.4% (for a federally subsidized Stafford loan) or a rate more than double that. Student loans generally have pay back periods of between 10 and 25 years.
If you were to pay back an $85,000 student loan with a 5% interest rate, it would take you $898 per month to pay it off in ten years. If you stretch it out to 25 years, the monthly payments reduce to $494.
If you lived in a vacuum in which the only two things you could ever spend money on were savings or pay extra towards debt, the answer is easy – pay more towards the debt.
But guess what, you college educated person you…life is not that simple and you do not, in fact, live in a vacuum. You live in real life.
And in real life, young people buy cars, buy houses, get married, have babies, have emergencies…the list gets pretty long of things that require more money than you’ve got on hand – in other words, things that may require you to borrow even more money.
Savings and debt tend to mirror one another. The more you have of one, the less you tend to have of another. Therefore, the more savings you have, the less you tend to get into (more) debt. And not only more of it, but more expensive debt.
I suggest a young person pay what they must towards student loans – the minimum payment required. Then focus all your savings efforts on building up an emergency fund of six months of living expenses, then building up a car fund with enough to pay cash for your next car. For most young people starting from scratch, that can be a ten year process.
Once your savings are built up to proper levels, only then do you want to direct the extra dollars towards paying down your education debt.
Because one of the lessons most often learned in the school of hard knocks is that when (not if) the unexpected happens, cash is king.
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