Senioritis is beginning to take hold as the class of 2012 prepares to graduate in May. This year, I’ll be graduating from my MBA program, but there is a cloud lurking over my head – student loans. Recently, several of my classmates have asked about what they should do about paying off their student loans after graduation. In this article, I’m going to share my student loan story and tell you how I am planning to start paying off student loans later this year.
My Student Loan Story
After earning my undergraduate degrees in English and Economics at Hendrix College in Conway, Arkansas, I graduated with a very few student loans. I was lucky, and had a family that started saving early for my college education and was willing to cover most of the bill for my undergraduate degree. I had a great job lined up in New York, my education was covered and I had the world of opportunity ahead of me. Paying off student loans wasn’t a problem back then.
Today, I am in a completely different position. When I decided to start my MBA program at Georgetown in 2009, I had a great job that paid well. Today defray some of the costs, I decided to go to school part-time and keep my job. My goal was to pay for my entire MBA by the time I graduated. I considered universities that offer online degree programs that would fit better with my working schedule, but I could not pass up the opportunity to go to a prestigious school like Georgetown. Eventually things changed, and I made a tough decision to resign from my career to pursue my dreams of starting a company.
So on June 8, 2010, I handed in my resignation to Citi, and started a new chapter of my life. It was a perfect time for me to take the risk-I was single with no kids and had my MBA program to fall back on. Ever since I was a kid, I wanted to be an entrepreneur. Inspired by my stepfather who has run an electric company in Little Rock, Arkansas successfully for 35 years, I realize the benefits of becoming a small business owner. Thanks to my old man’s hard work, integrity and street smarts, he has helped create a lot of jobs while providing a wonderful life for my Mom and brother Guy (who is my favorite artist). What I didn’t account for before I left my job was that running a successful company is one of the most challenging things I’ve ever done.
Like many startup companies, things didn’t go as planned. To keep up my cash flow, I did some consulting work on the side. Then one day I went back to the drawing board, tossed around some ideas in my head and set out on a path to take my passion for financial education online. 12 months later, YoBucko was born. While YoBucko has been one of the best experiences of my life, it has been nearly 15 months and we are just now starting to get some traction. In the meantime, I’ve taken out student loans to bridge the gap and cover my educational expenses.
So when I graduate this year, I will have a Georgetown MBA and $120,000 in student loan debt. From an outsider’s perspective, it may seem hypocritical. What financial expert would recommend quitting their job, taking out loans and putting everything on the line for a dream? Well, this one. If you have a great idea, have a plan for changing the world and have the ability to repay the money you borrow, I say go for it. But planning is key.
Creating a Plan for Paying Off Student Loans
If you are graduating this year and had to borrow money to finance your education, you may be thinking about paying off student loans. A few things you may want to think about include how much you owe, how much you will have to repay each month, what student loan repayment options are available. Finally, you may want to consider consolidating your student loans as well. Here are a few things to consider as you begin planning:
Step 1: Determine your Total Outstanding Student Loan Debt
Before you start paying off student loans, you’ll need to calculate how much money you owe on all of your student loans combined. To make it easier, we’ve put together a student loan worksheet that will help you add up your loans and keep track of them. Feel free to download our a student loan worksheet and share it with people you know who may need a little help paying off student loans.
Step 2: Calculate your Expected Monthly Student Loan Payments
Next, you’ll want to figure out how much your student loans will cost you each month. This can be a time-consuming process if you don’t have the right tools. Fortunately, you came to the right place. To calculate your monthly loan repayments check out our student loan repayment calculator. Once you have the monthly repayment amount for each student loan, add them up and arrive at a total monthly payment.
Step 3: Consider your Student Loan Repayment Options
There are multiple ways to repay your student loans. While it is pretty straight-forward with private loans, there are some caveats with federal student loans that may give borrowers more flexibility. Today, there are five options available for repaying federal student loans. They are:
- Standard Repayment – With the standard student loan repayment plan, you’ll pay a fixed amount each month until your loans are paid in full. Your monthly payments will be at least $50, and you get up to 10 years to repay your loans.
- Extended Repayment – If you have more than $30,000 in student loan debt, you may want to consider this option. Extended repayment allows you to extend your student loan payments out over 25 years. You can do this in one of two ways: fixed or graduated payments. Fixed payments are the same amount each month for 25 years. Graduated payments, on the other hand, start low and increase every two years. This may be a better option if your income is low and you need to reduce your monthly payments up from. But remember, the longer it takes you to pay your loan, the more you pay in interest in the long run.
- Graduated Repayment – As highlighted above, this plan starts out with lower monthly payments that increase every two years. Unlike the extended repayment option though, you only get 10 years to repay under the graduated payment option. Graduated repayment would be best for someone who doesn’t have a lot of student loans and expects their income to increase steadily over the 10 year period following graduation.
- Income-Contingent Repayment – Under this plan, your monthly payments are determined based on your adjusted gross income (“AGI”), family size and the total amount of your direct loan. If you are married, your spouse’s income is included in the AGI calculation. Also, your payment is calculated as the lesser of 1.) How much you would pay if you repaid in 12 years * Income % factor, or 2.) 20% of your monthly discretionary income. The Income Percentage Factor is based on a calculation by the government. I’ll spare you the details for now. The maximum repayment amount under this this plan is 25 years. If you still haven’t repaid in 25 years, your loans are forgiven but you get taxed on the amount that is forgiven like it is income.
- Income-Based Repayment – Similar to the Income-Contingent repayment plan, the income-based repayment (“IBR”) plan bases your monthly repayment amount on your income. It’s actually a pretty good option for people who are struggling to get on their feet post-graduation and are not making enough money to pay the full amount on their student loans. For a full description of income based repayment plans, click here.
Step 4: Consider Student Loan Consolidation
Student loan consolidation is an option for people who have multiple student loans and are trying to reduce the amount of paperwork they have to deal with by packaging all of their loans into one loan. If you have private student loans, you can also consolidate your loans, but you will not be able to consolidate your private loans with the Department of Education. If, however, your loans are all with the Department of Education, which mine are, then here are some of the benefits of consolidating your student loans:
- Less Paperwork – Rather than dealing with 10 loans, you can just pay one lender with one monthly payment. This alone can help a lot of people avoid missing payments or getting frustrated with the loan repayment process.
- Flexible Repayment Options – Unlike private lenders, the federal government has more flexible repayment options for people who are facing financial hardship. This is very helpful if something bad happens and you find yourself in a tough financial situation. After all, you don’t want to hurt credit history.
- No Fees – When you consolidate your federal student loans with the Department of Education, there are no fees. That’s not the case if you consolidate with a private lender.
- More Deferment Options – When you consolidate, you may qualify for renewed deferment benefits. If you’ve already exhausted your options on your current loans, you may get a renewal on those options when you consolidate.
- Reduced Monthly Payments – While this is not always this case, often times consolidating your student loans into one will actually reduce the interest rate you pay on your student loan. Why? Because they take the average interest rate on all your current loans and set one fixed-rate that you have to pay each month. You can calculate your average interest rate using our free student loan worksheet.
Step 5: Create a Budget and Stick to It
One of the keys to success when paying off student loans or any other type of debt is to create a budget and stick to it. If you account for your student loan payments in your budget and try to keep your total debt and housing payments below 36% of your gross income, you are heading in the right direction. If you need a little help creating a budget, we’ve put together a budget and cash flow worksheet to help you out.
My Strategy for Paying Off Student Loans
When I graduate, I’ve determined that it would make the most sense for me to consolidate my student loans with the Department of Education and take advantage of the Income Based Repayment program. Why? Because there aren’t any fees to consolidate my federal student loans, it would lower my overall monthly payments, it would minimize the amount of paperwork, and it will allow me to minimize my payments in the first few years. As a small business owner, I’ve taken a lower-income so I could continue to invest money in my business. As a result, my Adjusted Gross Income is low relative to where I will be in a few years. To minimize the amount of money I have to pay back on my student loans after graduation, I will probably use the IBR program. This may change, but I’ll continue to keep you updated throughout the process.