Pay off your student debt

You have to spend less than you earn. If you have $20,000 of student loans you have to spend $20,000 less than you earn plus an additional amount for interest. If you have a high interest rate (anything over 10%) this is an *emergency*. Debt that compounds at 10% or greater will double in seven years or less, left unchecked. Got $20,000 in debt and an interest rate of 15%? That’ll be $80,000 in 10 years.

If your student debt is an emergency you get it under control in three steps. If you have a credit card

1. Figure out the exact amount of money you need to pay for food (more than $10 a day is far too much), shelter (more than $500 a month is too much), and only those things which you need to keep your job (I figure a cell phone plan? If you spend more than $40 per month you’re getting robbed.) The rest of the money gets sent as a payment toward your debt the same day.
2. Sell everything you no long want. Be tough.
3. Sell everything else if you could repurchase it for no more than 2x what you are selling it for, and you don’t need it to survive. Got a couch that you could Craigslist for $400?  Could you get a similar used couch for $800? Put it on Craigslist tonight.

This should pay down your high interest debt quickly. Of course *any* debt over 10% is a disaster, not just student loan debt. See if it is possible to refinance the debt at a lower rate as well.

If you don’t have a credit card also make sure that you save two months of expenses before making extra payments on a student loan. If you have to give it to someone trustworthy to hold because you can’t control your spending, do it.

If your student debt is between 4% and 10% you should pay it off as soon as you reasonably can. This isn’t a disaster, you don’t have to sell your couch. Keep your expenses to a minimum but don’t weep over every coffee you spend money on. Make sure that your payments to your student loans are more than the minimum. Preferably as much more as you can handle.  This is just about one of the best investments (besides going to college in the first place, college is usually a great decision, even with loans) that you can make.  All in all put aside no less than 30% of your income towards this.

If your student debt is less than 4% basically don’t worry about it.  

 

…What?

You need to make your payments, but 4% is long run inflation.  It’s certainly debatable whether your better off paying off the loan or making some other investment.  That other investment probably shouldn’t be sit it in a bank account, but if you aren’t contributing the maximum to your IRA or 401k you could completely reasonably fully fund those before wiping out your student loan.

 

But why?

Perceptive debtors may notice that there is a huge difference between how I think you should treat high interest debt (Sell the furniture, Never eat out, asceticism-good) and low interest debt (who cares?).  

That’s simple because of how interest rates work. When someone says that a thing has exponential growth they often just mean it as a stand-in for really fast, and that’s kind of true and kind of false. Exponential growth can start fast or slow, but at some point it can always get out of control. Anything with compounding interest grows exponentially.

To get an idea of how fast a balance will grow, a quick useful estimate is the rule of 72. If you divide 72 by the interest rate you get the number of years it takes for a balance to double for a given interest rate. For example, if you have $2000 and it is growing at 12% interest it will take 6 years to become $4000. This works for any balance. If you have $150,000 growing at 12% it will take 6 years to be $300,000.  This is why it is important to start saving for retirement early. Even $10,000 saved at 8% interest doubles every 9 years, after 45 years (5 doublings) you end up with $320,000.

This is also why it’s important to squash high interest rate debts fast. Left unchecked they can get out of control. That’s also why it can be worth it to sell your $400 couch today even if you will have to spend $800 to buy it back later. Of course, how much later matters, as well as how high the interest rate is, but have a graph:

Above the line means it’s worth selling the couch, below the line it’s worth keeping the couch. You’ll notice for low interest rates its basically never worth it. You’ll notice that for 10% interest the graph the turning point is 8 years. If you can your loan paid off faster you don’t have to sell your couch. If it will take longer, start taking pictures of the thing.

Quick tips and tricks

• Always make your student loan payments on the same day, preferably a good amount of time before the due date, and check before the due date that the payment processed. Sometimes if you make multiple payments during, like, October, it’s easy to get confused next month and think that you’ve already paid for November. Most missed payment stories I’ve heard are some version of this. It pays to be organized.
• If you’ve set up automatic payments make sure to check every month that the payment went through. The benefit of automatic payments is that most of the time you will be fine if you forget one month, after all the system makes the payment for you, it isn’t an excuse to check-out from the process entirely.