Dealing With Debt II

In my last three posts I focused on how to evaluate your finances in order to make the proper funding decisions concerning your education. My end goal is always the same, I want to see students graduate with the degree, but not saddled with the debt. If my example on Making Funding Decisions (Part III) demonstrated anything, it was the significant debt situation facing most college students. Even at a public in-state institution, a student has little chance to escape the need for debt unless they receive substantial inflows from scholarships and/or parental contributions. So in this post I want to suggest a way of dealing with taking on student loan debt should you take out an unsubsidized federal loan or a private loan, both of which begin accruing interest immediately. What I am suggesting is unconventional, but if you have the need to accrue debt in order to fund your education, your objective should be to reduce your final payback amount to the smallest amount possible. This trick is one means of doing so.

In case you did not read your loan paperwork, unsubsidized Stafford loans and most private loans begin accruing interest immediately. What this means is that you will owe more at the end of the first month than you originally borrowed. As each month passes, you accrue more and more interest, some of the principal and some on the interest). When you finally leave school the total due the bank is your original loan balance plus the accrued interest. Thus, your interest rate and your length of time taken to earn a degree contribute to your final amount due. The higher the interest rate and longer the length of time, the more you will owe at graduation and vice versa. In the example below, I chart the total cost for a student who is taking out the maximum amount of student loans available each year. For simplicity sake, I assume the maximum loan amount is withdrawn every January 1 with a constant interest rate for undergraduate studies of 4.29%. So the chart inflows are as follows:

Year One: $5,500

Year Two: $6,500

Year Three: $7,500

Year Four: $7,500

Year Five: $7,500

When charted, your interest accrual and the resultant total due at graduation looks as follows:

Loan Graphic One

Broken down further, your interest is as follows:

Loan Graphic Two

As you can see, a substantial amount of interest accrues over time, increasing the total amount borrowed by almost $3,000 assuming four years of loans or $4,500 assuming five years of loans. This additional interest amount has the following impact on your repayment schedule.

Loan Graphic Three

My suggestion is that you attempt to pay the interest as it accrues on your loan, leaving you with a final repayment of only the amount you have borrowed throughout your time in college. In this example, doing so would save over $1,000 over the life of the loan for your four year loan, or $1,600 over the life of a five year loan. This is accomplished with relative ease your first three years, costing roughly $20 per month your first year, $45 per month your second year, and $74 per month your third year. It is not until your fourth year where you would break a $100 per month need.

Even if you are not able to pay the accrued interest off monthly, you should attempt to make some monthly contribution while attending school. For students whose parents have limited financial means, you could ask your parents to assist with part of the interest, thus lessening your contribution, or the whole amount. In the early years of your loans, this assistance is probably manageable for most parents.

In my next post, I am going to tackle a potential problem plaguing students seeking graduate degrees: the deferment option. Once again we will see that allowing interest to accrue is not the preferable answer to student loan debt.