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Here’s Our Best Advice on Paying Off Student Loans

By Alex Stried

When I decided to go to grad school, I knew I was going to have to take out student loans to pay for it. But I didn’t want my debt to define my life or my finances for years and years after graduation.

Here’s Our Best Advice on Paying Off Student Loans

I wasn’t alone. In fact, the student debt crisis disproportionately affects women. Overall, we earn 57% of bachelor’s degrees but hold nearly two-thirds of all student loan debt in the US, which means our loan balances tend to be bigger. And then — thanks to factors like the gender pay gap — it takes us an average of two years longer to pay them off. And for Black and Latinx women, who have bigger gender pay gaps to begin with, student loan debt is a particular problem.

No wonder one of the most common questions we get at Ellevest is “What comes first, paying off student loans or investing?” A lot of people think that those things are mutually exclusive. But it isn’t really that simple, and waiting to invest until your loans are completely paid off might not be best for your bottom line. (Especially because every day you wait to invest could cost you about $100.*)

Deciding what comes first

Having debt can be really uncomfortable, but not all debt is created equal. Student loans can be part of a healthy financial plan if you graduated from school and increased that earnings potential (congratulations!). Plus, interest on student loans is tax-deductible up to the IRS-set limit.

So when you’re trying to prioritize debt vs investing, our advice is typically to go in this order:

  1. If you have a 401(k) employer match, invest enough to max it out

  2. Pay off any loans with an interest rate over 5%

  3. Save for emergencies

  4. Invest toward your goals

Maxing out your 401(k) employer match

There are some people in the world of personal finance who would tell you to pay off all your debt before you invest at all, even if you’re missing out on your employer’s 401(k) match. At Ellevest, we politely — but pretty strongly — disagree.

With the most commonly offered employer match, if you put 6% of your salary into your 401(k), your employer will match 50% of it — meaning they’ll put in 3%. That’s literally free money. And 50% is a lot higher than the average interest rate on student loans, so you’d earn much more via that match than you’d be paying in interest.

That’s why we usually recommend investing enough to get your full employer match before you focus on debt.

Looking at the interest rates on your loans

Most people’s student debt is made up of a number of smaller loans that all have different interest rates. Mine definitely was. Start by listing out all your individual loans and putting them in order from highest interest rate to lowest. (You can find your interest by logging into your loan provider’s website or checking your monthly statements.)

At Ellevest, we usually say that if the interest rate on a loan is more than 10%, you really should focus on paying it off ASAP. If it’s between 5–10%, we still recommend paying it off quickly, but if you want to save for emergencies or invest a bit too, you could — it’s up to you.

That’s the boat I was in. The interest rates on my loans were over 5%, so I wanted to pay them off. I still decided to invest part of my salary into my 401(k) so that I could get every penny of my employer match — sure, it took up some of the money I could have used to pay off my debt, but the opportunity cost was too high not to get that free money. And then I used any extra cash I had to pay down those higher-interest loans.

Later, once you’re clear of those higher-rate loans, consider paying just the minimum payments on any loans with an under-5% interest rate and using the other wiggle room in your budget to move along to the next money moves to financial control, like building up your emergency fund and investing in a low-cost, diversified investment portfolio — because annual long-term investing returns have historically been higher than 5%.

Tackling your student loans

OK, so once you’ve decided whether to contribute to your 401(k) and made a list of loans with interest rates over 5% that you want to pay off, what next?

Make a plan for paying them off

There are two common approaches — the debt avalanche and the debt snowball. Here’s the CliffsNotes version of the difference between them: With the debt avalanche method, you focus on paying off the loans with the highest interest rates first. With the debt snowball method, you focus on paying off the loans with the highest balances first.

Both approaches are valid. We’re partial to the debt avalanche here at Ellevest because it typically means you’ll pay less in interest overall. That’s the approach I used. But the debt snowball can be more motivating. Here’s an explainer on the debt avalanche vs the debt snowball and how to decide which one’s right for you.

Pay more than the minimum, if you can

Depending on your income and the balance on your loans, you may or may not be able to afford to pay more than the minimum payments due. But if you can swing extra payments, we really recommend it.

Making the minimum payment keeps you from defaulting and pays down the interest, but it doesn’t do much more than that. Bigger payments, particularly on your high-interest loans, are what will actually help you make a dent in the principal … and save a lot of money in the long run.

If you do this, specify to your lender that you want the extra payment to be applied to the principal on a certain loan. Otherwise, they might spread it out evenly among all your loans, or else apply it toward future payments. That’s not the worst thing, but if you wanted to follow the debt avalanche or snowball methods, it wouldn’t align with your plan.

If you can’t pay more than the minimums right now, that’s OK too. The minimums are designed to pay off your loans by the end of your repayment plan. So you’ll end up paying more in interest overall, but the loans will eventually be gone. Still, see if you can make moves to bump up your income or pare down your expenses — and then try increasing the amount you’re paying toward your loans a little bit each month.

And if something happens where you can’t pay the minimums, you have a couple of options (at least for federal loans). You can apply for deferment or forbearance — which let you temporarily stop making payments, or pay less, for income reasons. Or you can switch repayment plans (from a standard plan to an income-driven plan, for example), which will usually extend the time you’re paying back your loans. These are useful options when you really, really need them — but if you use them too often, that’s how the interest on your loans can start to get out of control. So they’re a better option than defaulting, but we recommend them as a last option before you do.

Beware of lifestyle creep

If you get a raise or a bonus, consider putting that money directly toward loan repayment instead taking on new expenses or spending it on a purchase. If you were able to make things work with the money you’ve had, you can probably continue to do so.

I also used any extra cash I had — like tax refunds, birthday money, etc. — to pay down my loans.

Plus, leaving school doesn’t have to mean you leave the budget-conscious-student mindset behind. We aren’t going to tell you to stop spending money on yourself and the things that matter to you, but sticking to a pared-down lifestyle now can help you avoid uncomfortable adjustments later if you realize your debt and spending are too high.

For most people, the biggest single opportunity to keep costs down is with housing. If you can keep your housing costs low, you’ll have more flexibility in the rest of your budget for saving, paying off debt, and investing. Once I graduated, I set a limit on how much I was willing to spend on rent in New York City and ended up sharing a room with my best friend. It wasn’t the big-city living arrangement from the movies, but I did manage to pay an extra $600 toward my loans each month while having a great time. I’m not saying you have to do that, too, but making concessions now — getting roommates, settling for a smaller and cheaper room, or living in a less stylish neighborhood — can really help.

Lower your rates

A lot of lenders will reduce your interest rate by 0.25% if you enroll in an automatic payment program. That may not sound like a big discount, but every little bit helps. Also, auto-pay makes it easier to make all your payments on time and avoid late fees.

If you’re making payments by their due date — and have been for a while — you might also call and ask for a lower rate. I used to call my lender every six months, pointing out that I used auto-pay, paid on time, and (whenever possible) made more than the minimum payments. It took several tries, but I finally got my rates lowered by 1%.

Student loan refinancing or consolidation are other options to look into. If you qualify for student loan refinancing, your new lender would give you one big loan to replace all your old, individual loans at a new (usually lower) interest rate. This can really help you save money. (FYI, though: If you refinance federal loans, you lose a lot of benefits — like those deferment, forbearance, and income-based repayment options we mentioned above.)

Loan consolidation is similar, except instead of getting a lower interest rate, your new lender would just take the average of all your old interest rates. That could help you keep track of everything if today you have a lot of different loans with a lot of different payment due dates.

Here’s another article with more info about ways to lower your rates.

Get relief

And finally, if you work in public service, you might qualify for federal and state student loan forgiveness programs, which offer partial and full forgiveness on student loans over the course of several years. The program applies to qualifying loans for government and non-profit employees, teachers, lawyers, and doctors who meet certain criteria.

Student loans can be daunting. They were for me. And, until we get some sort of relief program to help ease the student loan crisis, it might take a good amount of time and effort to get rid of them. But they don’t have to take over your entire financial future — smart planning and hard work can get you there.

I made it out. And you will, too.


Disclosures

Source Ellevest. To calculate “about $100,” we compared the wealth outcomes for a woman who begins investing at age 30 with one who began investing at age 40 after having saved in a bank for 10 years. Both women begin with an $85,000 salary at age 30 and all salaries were projected using a women-specific salary curve from Morningstar Investment Management LLC, a registered investment adviser and subsidiary of Morningstar, Inc., which includes the impact of inflation. We assume savings of 20% of salary each year. The bank savings account assumes an average annual yield of 1% and a 22% tax rate on the interest earned, with no account fees. The investment account assumes an investment with Ellevest using a low-cost diversified portfolio of ETFs beginning at 91% equity and gradually becoming more conservative during the last 20 years, settling at 56% equity by the end of the 50-year horizon. These results are determined using a Monte Carlo simulation—a forward-looking, computer-based calculation in which we run portfolios and savings rates through hundreds of different economic scenarios to determine a range of possible outcomes. The results reflect a 70% likelihood of achieving the amounts shown or better, and include the impact of Ellevest fees, inflation, and taxes on interest, dividends, and realized capital gains. We divided the calculated cost of waiting 10 years to invest, $341,181, by 3,650 (the number of days in 10 years).

The results presented are hypothetical, and do not reflect actual investment results, the performance of any Ellevest product, or any account of any Ellevest client, which may vary materially from the results portrayed for various reasons.

© 2019 Ellevest, Inc. All Rights Reserved.

* Source Ellevest. To calculate “about $100,” we compared the wealth outcomes for a woman who begins investing at age 30 with one who began investing at age 40 after having saved in a bank for 10 years. Both women begin with an $85,000 salary at age 30 and all salaries were projected using a women-specific salary curve from Morningstar Investment Management LLC, a registered investment adviser and subsidiary of Morningstar, Inc., which includes the impact of inflation. We assume savings of 20% of salary each year. The bank savings account assumes an average annual yield of 1% and a 22% tax rate on the interest earned, with no account fees. The investment account assumes an investment with Ellevest using a low-cost diversified portfolio of ETFs beginning at 91% equity and gradually becoming more conservative during the last 20 years, settling at 56% equity by the end of the 50-year horizon. These results are determined using a Monte Carlo simulation—a forward-looking, computer-based calculation in which we run portfolios and savings rates through hundreds of different economic scenarios to determine a range of possible outcomes. The results reflect a 70% likelihood of achieving the amounts shown or better, and include the impact of Ellevest fees, inflation, and taxes on interest, dividends, and realized capital gains. We divided the calculated cost of waiting 10 years to invest, $341,181, by 3,650 (the number of days in 10 years).

The results presented are hypothetical, and do not reflect actual investment results, the performance of any Ellevest product, or any account of any Ellevest client, which may vary materially from the results portrayed for various reasons.

The information provided should not be relied upon as investment advice or recommendations, does not constitute a solicitation to buy or sell securities and should not be considered specific legal, investment or tax advice.

The information provided does not take into account the specific objectives, financial situation or particular needs of any specific person.

Investing entails risk including the possible loss of principal and there is no assurance that the investment will provide positive performance over any period of time.

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Alex Stried

Alex is the Chief Product Officer at Ellevest. She researches and identifies what’s most important to our clients to deliver the best experience possible.