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In my opinion, this post is extremely important based on the amount of conflicting information out there when it comes to paying off your student loans. “Pay off the largest balance first”, “the smallest balance first”, “the highest interest rate”, etc.
I can’t tell you the one-size-fits-all plan, because it doesn’t exist when it comes to student loan repayment. However, I do want to explain the meaning behind these different ideas to help you decide which method is best for your situation.
- Paying off the highest interest rate first – while this seems to make the most sense since you will end up paying more in interest on these loans, it may not work for everyone. If you are someone who has just started paying more than your minimum payments, or if you get bored easily, you may want to focus on the method below.
- Paying off the lowest balance first – paying off the smallest debt first gives you what many call “quick wins.” This is a great idea if you are someone who needs that kind of motivation early on, or gets bored easily. After you pay off the smallest loan, you would then use a debt snowball to pay off the rest in ascending order. Typically, you will end up paying more in interest this way, but if you are someone who might give up on paying extra on loans if you don’t see progress right away, then this additional cost in interest is worth the price.
- Paying off your private student loans before your federal loans – this is definitely something to consider when you make your list of which debts will get paid first. Typically, private student loans have variable interest rates, meaning if the economy hits another bump (which is probable in the next few years), your interest rates could jump a lot higher than their current price. Of course, the other side of that is they could go down if we see the economy bouncing back.
Federal student loans typically have a fixed interest rate. The plus side to that is you can be sure exactly what rate you will be paying until the loans are paid in full. The down side is that your interest rate could be higher than your private loan is offering.
However, federal loans also offer better repayment plans so if you do end up in hard times. You can opt to do an income-based repayment plan which will coincide with your current income. I wouldn’t advise using this plan for more than a year or so until you get back on your feet. Your payments will continue to rise and it could take you longer to pay the balance off.
With both options, you can typically find a good consolidation or refinancing plan with partners like SoFi or CommonBond.
You can see there are a lot of options and ideas to consider when deciding which loan to pay off first. This definitely comes down to personal preference and will come down to what will ultimately get you to stick to the plan.
I am using what I call “Chenell’s modified snowball.” Clever, eh? Here it is:
Student Loan 1 – $1350 – Unsubsidized federal student loan @ 6% interest rate
Student Loan 2 – $8000 – Private Student Loan @ 4.5% interest rate
Student Loan 3 – $6500 – Subsidized federal student loan @ 6% interest rate
Student Loan 4 – $42,000 – Private Student Loan @ 3% interest rate
These aren’t my current totals, but were approximately what I had started with. You can see that I paid off the lowest balance federal loan first. The 6% interest was too high for me to not attack it first. Also, it was a small loan and I knew I could get rid of it quickly and be able to throw the extra money I would have used to pay that loan towards my others.
Why not pay off both 6% interest loans first?
Well, the other one is subsidized and since I have recently gone back to graduate school, it is deferred AND interest does not accrue while I am in school. It really is only accruing interest 5-6 months out of the year when I’m not attending school, so technically the interest rate is about 3% or lower. Also, it’s fixed interest rate and that peace of mind is nice for me to have.
I will be making payments on the loan for the months I’m not in school so the interest doesn’t make the loan grow anymore. Loan #1 is now paid off, and I have been taking the extra money that would have been going towards those payments, and am working on paying off loan #2.
If all goes as planned, I will have the next loan paid off by October of this year, loan #3 paid off by June of 2015, and I will have paid off student loan #4 by September of 2017.
Please keep in mind I am also paying off all of the other debts I have while this is going on (you can see all of my debts here). It can get pretty confusing and there is a lot of math (pretty basic stuff though) involved to figure out which method of repayment is best for you. But once you figure it out, it is such a relief to know exactly when you will be out of debt, and how much attention each debt will be receiving in a specific month.
I hope this helps you at least get started thinking about how you want to pay off your debts. Just remember how you will feel once these are paid off, and you are no longer slave to the lender. I can’t wait to have that weight lifted off of my back, and that is definitely what is keeping me going. Please leave your comments and questions below and I will be sure to answer as soon as I can. Don’t forget to subscribe to the blog to receive the most current updates via email!
Photo by 401(K) 2013