Getting an education to prepare you for your field of choice is an admirable professional goal, and eventually repaying that student debt over time is an important financial goal. But having lingering student loans? Well, that isn’t anyone’s goal.
Yet for many people, repaying student loan debt is a long, tedious task. As with any loan, it generally makes sense to try to pay down your debt quickly so you avoid paying more in interest. But there are some nuances about student debt that are important to consider as you weigh paying down debt against your other financial goals (i.e. saving and investing). Here’s why that’s the case.
Growing Costs
The cost of higher education has risen consistently, meaning that it has become increasingly difficult to pay off over a short period of time. For those who have financed much of their education, monthly payments can approach the size of what they pay for rent.
As a result, the days of repaying your student debt within your first few years of professional work are long gone, and it’s important to have a thoughtful strategy for paying it down over time.
Interest Rates
Interest rates on student loans are typically higher than other debt you may have. Why is that? Think about it this way: if you borrow money to buy a car or a home, the bank (the lender) has collateral (your house or car) that can be seized if you fail to pay your debt on time. In contrast, with an educational loan, they can’t exactly take back your education if you fail to pay.
That’s why these loans are considered “unsecured” – meaning there is no physical property that can be seized and sold off to repay the lender in the case that the borrower were to default. This inherently makes the loan more risky to the lender, and therefore why your interest rate will be higher. (This is also the case for credit cards, and why rates on these forms of debt are higher than say, a car loan or a mortgage.) Of course, high interest rates are a big reason why it’s advantageous not to let loans linger forever.
Federal Loans vs. Private Loans
While all student loans are similar in that they’re unsecured, they differ based on whether they’re Federal loans from the government or private loans from a bank.
The federal government has no loan underwriting criteria in terms of the interest rate applied to each borrower, meaning that everyone pays the same rate regardless of credit history or their ability to repay the loans. As a result, people with bad credit are still able to pay for school, and people with good credit may feel their interest rate is arbitrarily high since they’re effectively subsidizing higher-risk borrowers.
That’s why there has been an emergence of private market lenders offering to refinance federal student loans. Typically, their business model has been offering refinancing options to those who have graduated from more selective schools and for those in higher paying career paths. With a private loan you’re more likely to get a lower interest rate, but you’ll also be forfeiting some of the more advantageous features of a government loan.
Specifically, one notable positive feature of federal student loans is the ability to delay monthly payments temporarily due to financial hardship. So if you were to find yourself without a job (and consequently without income), the federal government may allow you to pause your loan payments for a period of time. But note that the government must agree to do this on a case-by-case basis, meaning that you can’t just stop paying and hope they get the message.
Additionally, it’s important to be careful about any potential unintended consequences of this “not current” payment status. As a result, delaying your federal loan payments should be done purposefully and cautiously – and not unless you absolutely have to.
Making Sense of It All
Ultimately there are a lot of nuances to consider when making sense of your student loans. It’s important to discuss your particular situation with a trained financial advisor who can help you put in place the right strategy for paying down your loans while optimizing for your long-term financial health.
To discuss your options, contact Paceline today.
This blog was written by Jeremy Bohne, Principal & Founder of Paceline Wealth Management. Paceline is a fee-only investment advisor serving clients in the Boston area, and on a remote basis throughout the country. Paceline specializes in helping tech and biotech executives, physicians, and those seeking financial planning services.