Hacking Your Student Loans

Adam Carroll on Student Loans 

Every month you make that dreaded student loan payment, a reminder of the fun you had during your “four year break from reality” that was college. It’s the price that millions of graduates (and millions that didn’t graduate) are paying to pursue that prized slip of paper that allegedly is “the ticket to a good life”. Or is it? Spending 15-20 years of your life paying off these debts at a few hundred dollars a month is frustrating and may be distracting you from your true calling.

However, the good life is not that far off if you understand how to hack the student loan system. Each factoid below is followed by one or more hacks that can help you get rid of that student loan debt once and for all!

Factoid: INTEREST IS FRONT-LOADED AND ACCRUES DAILY
HACK: Make advance payments to principal

Most students don’t realize it, but as soon as the money you’ve borrowed is disbursed, the interest begins accruing (on non-subsidized loans). That is why the amount you owe is so much larger than what you remember borrowing – it includes ALL of the interest from while you were in school.

A recent graduate was frustrated that of the $250 payment they sent in, only $90 of it was applied to his principal balance. In reality, less than ½ of all of your payments for the first few years go to pay down principal, the rest goes just to cover interest.

Because the interest accrues daily, lowering your principal balance is paramount to shortening both the length of your loan AND the amount you pay in interest. Interest is calculated based on the following equation:

Interest rate × current principal balance ÷ number of days in the year = daily interest

By sending in additional payments, you lower the current principal balance, thereby lowering the daily interest charged. If you’re in a position to send extra money with your payments, make sure you do the following:

  1. Make absolutely certain that your advance payments are being applied to the principal of your loans AND NOT applied to future payments. Student loan servicers are notorious for doing what is in their best interest, not yours. Therefore, they will apply any extra amount you send in towards offsetting when your next payment will be due. You will more than likely have to call the servicer directly and make sure they apply the payment you send in where you want it. Tell them it is to be applied to principal reduction.
  2. When sending in additional payments, direct the servicer to apply the additional principal to either the loan with the highest interest rate or the loan with the smallest loan balance (just pick one). By paying down the loan with the highest interest rate, you’re automatically charged less in interest because of the above equation. Keep reading to find out why you’d choose the smallest balance.

Factoid: CONSOLIDATION ISN’T ALWAYS A GREAT OPTION
HACK: Payoff smallest balances first & attack each one individually

Consolidation is great if you’re able to lower your interest rate substantially. Lowering the interest rate will obviously lower the overall amount you’re paying over time. However, as the name suggests, when you consolidate, you’re taking all of your separate loans and putting them together into one big loan that can never ever be adjusted again.

By NOT consolidating, you can direct additional payments to one loan at a time and knock them each out sequentially, relatively quickly. Here’s why that’s important:

Let’s say you owe $40,000 total and your payment is $300 a month. You more than likely have some smaller loan balances that are part of the overall payment you’re sending in. If the loan balance on one of the smaller loans is $1,000 for instance, and you’re on a 15 or 20 year payback schedule, the amount of your payment that’s going to principal might only be $8-12 per month (on that loan). But, if you have an additional $200 a month that you’re throwing towards your payment, you could have that one student loan knocked out in 5 months or less.

What would you rather toast a piece of bread with – a flashlight or a laser beam? When you blast away one debt at a time, you’re taking a laser beam to each individual debt. Pay the minimums on every other loan except the one you have your sights on. It creates a tremendous emotional win each time you get to cross one off the list!

Factoid: 17% OF STUDENT LOAN BORROWERS ARE STILL PAYING BACK IN THEIR 50’S
HACK: Use real estate to wipe away debts in your mid-20’s

If buying a home is in your future, consider a strategy that will help you build cash flow, equity, AND knock out your student loans. Here’s how:

Duplexes can be purchased using an FHA loan when the person buying it is also living there as their primary residence. This requires 3.5% down on the purchase. Consider finding a duplex that may require a bit of fix-up work so that you can get it at a great deal. Contact a realtor and let them know that you’re looking for a duplex to buy owner-occupied that’s below market because of it’s condition, knowing that you’re going to put in some elbow grease to fix it up.

If you buy it under market value, you’re walking in with a bit of equity. By renting one side of the duplex and the other room in the side where you reside, you’ll create some cash flow (probably enough to offset the mortgage payment). What you would normally spend in rent/mortgage is freed up to blast away debt!

But it gets better. Assuming you bought the house right and it’s grown in value over the year, you can get the place re-appraised after 9-12 months and borrow from the equity in your home to pay off some of the debt. By using a cash-out refinance, you’ll transfer some of the equity from your duplex into paying off the loans. Because mortgage interest is deductible, is generally at a lower interest rate, and is amortized over 30 years, the result on your finances is positive – lower overall payments, more interest deduction, and less interest paid.

Factoid: STUDENT LOANS ARE NON-BANKRUPTABLE
HACK: Other debt is…

This hack comes with a caveat: it is purely an observation, NOT a recommendation!

After several years of paying back his nearly $300,000 in student loan debt, a dentist applied for every credit card that was available to him and did cash advances on each one pulling out well over $250k. With the money he… you guessed it, paid off his student loan debt and then promptly declared bankruptcy.

In the last decade, the bankruptcy laws changed protecting creditors from borrowers declaring bankruptcy and wiping out student loans. Everything else is still fair game. So, technically, while you can’t bankrupt student loans, there are other loans that could be bankrupted.

Why you shouldn’t do it: It screws up your credit for a solid 7 years. Forget buying a home with a decent interest rate, plan on driving the same car for awhile… and, there’s the moral issue of you DID borrow the money in the first place.

The bottom line is there are ways around, over, and through student loan debt. It requires the borrowers to be pro-active, to live on less, to accept responsibility for taking care of their debt, and a great deal of perseverance!