I was helping a friend this past week on her student loans. My student loans had been on cruise control. Helping her caused me to become curious on my own loans. When I checked my latest statement, my variable interest rate was 7.42%! I had assumed the low rates would stay for longer. With the Fed raising interest rates, variable rates shot higher. Variable loans include home loans (ARM’s), auto loans, student loans, and credit card loans. The amount of payments is almost equal to the amount of interest.
As of November, interest was 89% of our total payments. Without a doubt, interest rates will go higher. There will a come a month where interest is more than our payment, increasing our balance! That’s the wrong way to go.
What are our options?
- The first thing is to stabilize the interest rate by switching to fixed. I plan to call our private student loan company and switch to a fixed rate loan. When I checked SoFi, the best rate for 15 years was 8.11%. That’s horrible, but better than increasing my loan balance every month. Consumer Advocate has possible companies to refinance with. Be prepared for a hit to your credit score. It may make sense to boost it first before applying for a new loan. Many places will allow you to check your credit score for free.
- Be careful if you are switching from public government loans to private loans. You’ll lose quite a few benefits. See Studentaid.gov for Repayment plans and Debt Relief pages first. President Biden has announced 10,000 in student debt relief for public loans and 20,000 for Pell grant loans. That is fighting its way through the courts, as Republicans are mad normal people get a break.
- If you do re-finance, make sure to keep the term as low as possible. There is no point making 5 years of payments on a 20 year loan, and refinancing into another 20 year loan. Choose a 15 year loan, which should have slightly lower interest rates and higher payments to keep on track.
- Once the interest rate is stabilized, it’s time to pay it off. Save up multiple payments at a time above the minimum, then make a one time payment. This ensures more goes to principal than interest, minimizing your lifetime total payments. I argue for paying off your higher interest rate balance first, if you have multiple loans like us. Many successfully argue using the snowball method, to pay off the smallest loan first, and taking the saved payments for the next one. Once our Model 3 is paid off, we’ll employ this strategy on high-rate loans.
- You can consider a low interest balance transfer for a credit card. Don’t take out more than 20% of your credit card limit (we did 100% foolishly) because it will be a big drag on your credit score. Make sure to pay down the balance transfer in full within the time period given. You do not want the added stress of paying off the balance transfer at punitive interest rates or finding another balance transfer.
- An advanced strategy is getting a universal life insurance policy, saving up the money in the contract, and devastating your student loans with a big cash payment, via a universal life insurance policy loan. Any growth is tax-free, as long as the policy doesn’t lapse. Policy loans have favorable rates. Make sure the policy has at least 30% cash remaining to cover any policy fees. There are lots of universal life policies out there. Talk to a dedicated life insurance professional on how they can help.
- I do NOT recommend a 401k loan. Here’s a guide from Investopedia on 401k loans and when they make sense. Here’s a simple example. You have 50,000 dollars in your 401k. You borrow 50% to pay off your variable student loans. Your 401k balance is now 25,000 dollars, with a fixed repayment plan out of your paycheck. If you leave the company before the loan is paid off, guess what, you immediately owe the money. We’ve had this happen before. Not pleasant. Your 401k net worth goes from $50,000 to $0 ($25,000 401k balance, $25,000 401k loan, and $25,000 in cash is immediately spent on high-interest debt). Not a great idea to build wealth.
To summarize, stop the bleeding, review your options, and set up a goal to pay off your debt. If you are in a difficult spot, talk to your loan provider on what options you have to pay down your debt. Proactively reach out to them and let them know your financial difficulties. It’s in their best interest to help you rather than writing off the whole loan or going through collection agencies.
President Biden and his team have made it easier to discharge student loans in bankruptcy, as a last consideration. See this Forbes piece for more details.
The key thing is take action! Don’t delay! If your plan is awful, start and you’ll find a way to make a better plan.
Have a happy Thanksgiving.
Sincerely yours,
smilingdad
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smilingdad 