Goodbye High Interest Debt, and Good Riddance.
There has been a giant smile on my face all week because I just reached a HUGE milestone in my journey to becoming debt free. On July 28th, I paid the final $3,815 balance due on the high interest portion – originally totaling $61,800 when borrowed – of my student loans, less than two years since I started repaying them.
All in all, I paid off $67,000 of student loan principal and interest in 1 year and 8 months.
This accelerated timeline saved me $23,600 in interest!
Why did I pay this giant chunk of my loans off so quickly? Well, once I fired up my loan amortization calculator to run the numbers, I realized that I would be paying over $25k in interest if I paid off these particular high interest loans over their initially prescribed 10 year repayment plans. Since I was already in nearly $100,000 of debt, it felt absolutely insane to pay an additional $25,000 – one quarter of the original debt – on top of that! Therefore, I made it my goal to pay as little interest as possible on the student debt I had incurred. In the end, I paid about $5,200 in pure interest towards my high interest loans after my repayment period began.1 How did I avoid paying $23k in interest? Read on.
Pursue a Goal & Make a Plan
My highest priority was paying as little money as possible in order to be free of these student loans forever. This meant I would have to figure out ways to decrease the amount of interest I paid. My strategy was two-fold:
Decreasing the interest rates so interest wouldn’t accumulate so quickly, and
Paying the loans off quickly so interest didn’t have time to accumulate.
I like to think of these strategies as a double-edged weapon – you can cut something down so much quicker if both sides of your tool are sharp.
Additionally, I set a timeline for myself. Timelines are a measurable aspect of planning that really help motivate me to achieve a goal. I just found a page in my Financial Planning notebook (yes, I’m a total nerd) that defined my payoff timeline as having my high interest loans paid off by halfway through September 2018 (under 3 years from the start of repayment in November 2015), if I made payments of $1,782.25 per month. This is oddly specific, I know, but there were a lot of calculations and projections involved. I am so proud that I blew my original timeline completely out of the water – by more than a year!
How did I do it so quickly? I made it my mission to pay my high interest loans off in under three years – I was fully committed to saving money and gaining freedom by paying off my student loans and becoming debt free earlier. So, each time I realized I could put more money towards my student loans, and that doing so would shorten the timeline, I inched the end-date sooner and sooner. Eventually, I was paying more than $2,500 a month to these loans, and my payoff date had moved to more than a year earlier than I had originally planned. Below, I’ll outline some of the ways I was able to put so much money towards my student loans.
I made it my mission to pay my high interest loans off in under three years – I was fully committed to saving money and gaining freedom by paying off my student loans and becoming debt free earlier.
Define High Interest Loans
When my student loans came out of their “grace period” and into repayment in November 2015, I had already filled out a spreadsheet that laid out the amount borrowed and the interest rates of my loans, which totaled $84,900. With accrued interest, they had ballooned to $94,400 while I was in college, and grew with even more interest during my 6-month post-graduation grace period. Since I obviously couldn’t pay the full amount off right away, I had to prioritize which loans I would focus on first.
In order to save the most money on interest, I decided to pay off my high interest loans first. These loans, with an initial total balance of $61,800, had interest rates of 6.41%, 6.80%, 7.21% and 7.90%. The remaining $23,100 of loans had low interest rates in the range of 3.40% to 4.66%. I considered my interest rates above 6.4% to be “high interest” because I compared the interest rates to the rate of returns I could reasonably expect from stock market investments, which is generally thought to be between 6% and 7%. Since using your money to pay off your loans is a direct return on investment (ROI) in the amount of the loan’s interest rate, paying off loans with interest rates between 6.4% and 7.9% gave me a similar, if not better, ROI than investing that money in the stock market.
Decrease Interest Rates
Interest Rebates
There are two different types of interest rebates I took advantage of: Upfront Rebates and Auto-Debit Discounts. Upfront rebates are offered when you first take out the loan, and are then given back to you once you make a certain amount of on-time minimum payments towards the loan during the repayment period. These are typically small rebates – I think I saved less than $100 total from them even though my loan balance approached $100k.
Auto-debit discounts are where the real savings lie. I recommend signing up for auto-debit on all of your loans, regardless of their interest rates, because most student loan servicers will offer a rebate if you sign up for auto-debit. This means the servicer will automatically deduct the minimum payment from your checking account each month. In order to maintain this discount, you have to have enough money in your account each month for them to withdraw the minimum payment. To ensure this was the case, I did the following three steps:
I set up a new bank account to serve as my auto-debit account. This way, I was able to segregate this money so it couldn’t be spent on anything else, and I never had a chance of overdrawing my checking account with an auto-debit that I forgot was coming.
I direct-deposited half of my monthly minimum payment into my account from my paycheck – since I got paid bi-weekly this meant each month the full minimum payment was going into my account.
I kept an amount equal to three months of the minimum payment in the auto-debit account at all times, for extra peace of mind. This “buffer” ensured that if something happened with my direct deposit, cash flow, or life circumstances, I would have three months to get back on my feet and start paying my minimum payments again without losing my auto-debit discount or going into default on my loans. I highly recommend you do this – it really saved me in October 2016 when I had an unexpected 2-week hospital stay and subsequent 1 month recovery from a sudden, unexpected, and serious illness. Very suddenly, I was out of work – and therefore out of a paycheck – for a month. This meant my direct deposit was no longer providing for my minimum payments. I was also physically unable (and it didn’t even cross my mind) to login to a computer and transfer money over to the auto-debit account. In the end, it took two months of minimum payments coming from my auto-debit account buffer before my direct deposit kicked back in and I was able to transfer money over to the account to replenish the three-month buffer. Through it all, I was able to maintain my current status on my loan payments and keep the auto-debit discount.
Commonly, the discount will decrease your interest rate by 0.25%. That doesn’t sound like a lot, but when you owe tens of thousands of dollars, this can make an enormous difference. For example, I ran the numbers for my high interest loans – over 10 years, the 0.25% interest rate reduction would have saved me $1,000 in interest. I can think of plenty of things to do with $1,000 that are a hell of a lot more fun than paying student loan interest! The impact of the auto-debit discount is further magnified when it is paired with refinancing.
Refinancing
I set my sights on dropping those high interest rates of 6.41%, 6.80%, 7.21% and 7.90% – effectively looking to chop them in half. My best option for this was refinancing – where you borrow money from a different entity (such as a bank) at a lower interest rate, then use that money to pay off the original high interest loan, then pay back the balance at the lower interest rate. I shopped around interest rates with different banks and eventually found that with my limited credit history, I couldn’t lower it my interest rates as much as I had hoped. However, my parents have amazing credit and were willing to help me refinance the high interest Parent PLUS loans that they had co-signed for me when I entered college. With their assistance, I was able to refinance $56,000 of the high interest loans with TD bank. This refinancing chopped my interest rate to 4.94% over a 10-year term.
Utilizing the auto-debit discount, I dropped the interest rate to 4.69%. This interest rate was now only 0.03% higher than the 4.66% interest rate I had originally deemed “low interest”! One important caveat that I made sure I checked before I went through with the refinancing was that there was no “early payment” penalty. This penalty is when a bank charges you a fee if you pay off the loan faster than the term you agreed upon, such as 10 years. I chose the 10-year term, rather than the 6-year term because the interest rate was lower, and there was no early payment penalty either way. Boo-yah! Though I regret using TD bank to refinance my loans, because making additional principal payments was a complete hassle and they did math that was just plain wrong multiple times, I am still really happy I refinanced my loans. By reducing my interest rates by more than 2%, I saved approximately $1,400 in interest in just the one year and eight months that it took to pay off the $56,000 balance.
Pay Loans Quickly
Prioritize High Interest Student Loans
Now that I knew which loans I considered to be high interest, I focused solely in paying those loans off. This is called the Avalanche method, one of two widely known methods for paying down debt. These are the Avalanche and Snowball methods, a la Dave Ramsey of Total Money Makeover fame (it’s probably a book your parents read back in the day). The Avalanche method will save you the most money in the long run because you focus on paying your debts from highest interest first to lowest interest last. The Snowball method, on the other hand, is more focused on keeping you motivated with quick wins, because using this method you pay the lowest balance loans first in order to get rid of them completely. Personally, the one HUGE win at the end of the debt payoff was enough motivation to make me stick to an aggressive high interest debt payoff plan, so I chose the Avalanche method.
In practice, this meant I needed to decrease the amount I was paying towards my low interest loans as much as possible. I did this by applying for income based repayments on my low interest loans, which lowered the minimum payment based on my income. Then, I only paid the minimum payment on these loans – I didn’t make any additional payments to the 3.40% – 4.66% interest loans in the past two years. This allowed me to reserve all of my extra money for large principal payments to the high interest loans.
Divert Savings Towards Student Loans
One of my first repayment actions in November 2015 was to knock out two 6.8% loans that had a starting balance of $4,800 and had gained approximately $200 of interest. Wiping out $5,000 of my debt felt soooo good, especially knowing that I had just dodged $1,600 in interest on those loans. Then, I paid what I could – about $2,000 – of the high interest Parent PLUS loans, with a starting balance of $57,000. These had also gained interest since graduation, so in October I had paid an additional $2,300 in interest towards the Parent PLUS loans.1
Where did I get the $9,300? Well, I emptied my savings… almost. I decided I would keep a $500 emergency fund, but divert the rest of my savings towards paying off 2+ loans right away. After a lot of debate about whether or not to make it $1,000, I settled on a $500 emergency fund because that would cover all of my bills (including discretionary spending) for one month, or my necessary expenses (not including discretionary expenses) for several months. This was possible because I lived with my parents and therefore had very few living expenses besides fuel for my commute to work. I wouldn’t recommend that everyone use all of their savings for paying off student loans – everyone has different circumstances and risk tolerances to consider.
Make Large and Frequent Principal Payments
Did you know that part of your minimum payment each month goes towards your interest? In fact, when you’re first paying off high balance loans, almost all of your minimum payment is probably being applied to interest. And that interest keeps accruing each and every month! That makes it really hard to pay down your debt quickly using minimum payments. Making additional payments to principal, the core chunk of borrowed money that is accruing the interest, is what will decrease the amount of interest you pay over the life of the loan.
The larger and more frequent these principal payments are, the quicker you pay off the loan, and the less interest it accrues overall. Over the 20 months that I paid the $56,000 high interest refinanced loan, my average monthly principal payment was $2,350! That’s on top of a $585 minimum payment. Of course, in some months I paid $2,000, some months I paid $0, and one month I made a principal payment of $12,600! How did I find the money to make these large principal payments?
1. Defer Saving and Investing
I spent a lot of time debating whether I should save an emergency fund and/or invest while paying off my high interest student loans. However, my singular focus on using all of my “extra” money to pay off my student loans greatly accelerated my payoff timeline and massively increased my net worth (though it is still negative, thanks to my low interest loans). I had originally decided to save for various goals, but ended up using this money for student loans anyway. The only investing I did over the past two years was contributing a small percentage of my income to my 401k that my company will match.
Now that I’m done paying off my high interest student loans, I can use the $2,500+ per month that I was spending on minimum and principal payments to instead reach my saving and investing goals, and I’m less than 2 years “behind”. It will only take me 4 months, that’s until December 2017, to save a $10,000 emergency fund, which is enough to cover my current monthly expenses for one year. After December 2017, I plan to begin investing. As I mentioned above, my ROI on paying off my high interest loans, with a weighted average interest rate of 7%, matched or may have actually exceeded the 7% expected market returns on stock investments. Therefore, my net worth was affected equally (in a positive way) by paying off the student loans as it would have been by investing. On top of that, I now have the freedom and peace of mind that comes with ridding myself of $67,000 of debt!
2. Reduce Discretionary Spending
I made a conscious choice when I created my plan to pay off debt to reduce my necessary expenses as much as possible. This worked for me because I had the option to live rent free. Not everyone has the option to cut that necessary expense out completely. However, everyone can reduce their discretionary spending to save more money for paying down debt. I never had extravagant discretionary expenses to begin with, but I decided I would be more conscious of how I was spending my money.
To create a framework for this, I made a Spending Plan. This plan laid out all the categories in which I wanted to spend my money, prioritized based on my goals and my values. Because one of my largest goals for the past two years was to pay off my high interest debt, that was by far the largest “expense” category. Everything else I limited to a certain allocation each month, though I definitely didn’t deprive myself. I budgeted plenty for fun, dining out, and experiences/trips. Then, I stuck to my Spending Plan and took all of my additional money beyond that and put it towards my student loans.
3. Make More Money
I don’t make an astronomical amount of money – in 2015 and 2016, I made a little under $50k per year and in 2017 I am making a little over $50k per year before taxes – but I managed to pay off $67,000 in less than 2 years. I made more money than just my typical salary in a multitude of ways. I had a part-time job on top of my full-time job in 2015 to 2016. My holiday bonuses in December 2015 and 2016 went right to my student loans. So did the additional income from getting a raise with my promotion at work in March 2017, for all of the months following. I get paid straight-time overtime at work, and I work anywhere from 2 to 15 hours of overtime a week. You guessed it – that extra income goes straight to my student loans.
I also use a Discover rewards credit card which has made me almost $200 since February 2016. I consider this income since you can apply rewards directly to your credit card balance. I opened a bank account with a promotional offer earlier in the year, and was rewarded with a $200 bonus. June was 3 paycheck month (since I get paid bi-weekly), which is how I scraped together $3,815 for my final payment, even though I was normally stretching myself just to make a $2,585 payment each month. You get the idea – there are a lot of ways to make extra money if you’re trying.
Overall Savings
I used my savings to pay off $9,300 of high interest loans when my repayment period began in November 2015. Then, I refinanced the remaining $56,000 of high interest loans, which reduced the interest rate by more than 2%. By making large principal payments towards the refinanced loan, I saved an immense amount of money that I would have paid in interest over 10 years.
What would I have paid over 10 years?
Had I paid off these high interest loans at their original terms of 10 years, interest rates of 6.41-7.90%, and total starting balance of $57,000, it would have cost a total of approximately $80,700!
Even after refinancing, if I paid off the $56,000 refinanced portion of the loan over 10 years at 4.69% (the refinanced rate after the auto-debit discount was applied), it would have cost me $70,300.
What did I actually end up paying?
Only $58,700.
What were my total savings?
That’s $11,600 in interest savings compared to paying the refinanced loan over 10 years, and $22,000 in interest savings compared to paying the original loans over 10 years!!! Add in the $1,600 I saved by paying off the two 6.8% loans with a starting balance of $4,800 at the beginning of my repayment period, and that’s $23,600 of interest savings!
In the end, I paid off the original $61,800 of high interest student loans in 1 year and 8 months, spending a total of about $67,000. Of this total, $5,200 was paid to pure interest. By paying off these high interest loans in less than two years, and by refinancing a large portion of the loans to a much lower interest rate, I saved $23,600 in interest that I otherwise would have paid over the 10-year term of the original high interest loans.
I crushed $67,000 in just over a year and a half.
Cheers to that.
Notes:
1. This amount does not include any pre-capitalization interest that was paid prior to my graduation in May 2015.
Photo Credit:
1. Photo by Lesly B. Juarez (https://unsplash.com/@jblesly)
2. Photo by Yutacar (https://unsplash.com/@yutacar)
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