With federally held student loans in a payment pause with 0% interest until 9/30/2020, our stance has been to NOT pay on/accelerate your loans at this time. Why? In our current environment, it is time to get defensive with your finances and stay cash heavy.
Here are some thoughts on why you shouldn’t be making your student loan payments right now.
Defense Against Income/Job Loss
There is uncertainty in the job market right now, even for seemingly secure jobs. If income drops or you lose income altogether, you’ll be relying on your emergency savings to weather the storm. Paying extra on a debt that’s not costing you anything right now will not help you if you need that money back – more frankly: you can’t get it back once you’ve paid it.
To Be More Strategic
Since you’re not required to make your student loan payments right now, put what would have been your student loan payment into savings in case you need it (maybe even earn something on it if you have a higher yield savings account!).
If you don’t need it and our world starts to resume back to normal, you can still take advantage of the 0% interest benefit in September by making a lump-sum payment of what you saved before interest kicks back in to achieve the same thing: having more of your payment go towards principal.
A few things to note however:
- Your payment will go 100% to principal only AFTER all accrued interest is paid
- You wouldn’t want to make payments at all if you are pursuing a forgiveness timeline
Defense Against Wasting Money
If you are pursuing PSLF or the longer term 20 to 25 year forgiveness on an IDR plan, you do not get extra credit for making payments right now in any way. As long as you were in repayment as of March 13, 2020, these months of payment-pause due to the CARES Act COUNT towards your forgiveness timeline, so don’t make payments that won’t be serving you in any way!
If your loans were in forbearance/deferment before March 13, 2020, you’re not out of luck. Studentaid.gov just clarified that you can re-enter “repayment” under your IDR plan keeping your payments suspended AND have these months still count towards forgiveness by either calling your servicer or go to: https://studentaid.gov/app/ibrInstructions.action and either recalculate your payment, apply for an IDR plan, or switch IDR plans.
Language from studentaid.gov:
NEW: If I enter IDR during the administrative forbearance, will my payments automatically remain suspended? Will those months count toward IDR forgiveness?
Yes, your payments will remain suspended; and yes, the months will count toward IDR forgiveness.
Prioritizing Other Financial Obligations
Other financial obligations may take priority over this 0% interest debt. Let’s dive into those below.
What to do with the money you’re not putting towards student loans – Here’s my priority order list:
1. ABSOLUTELY #1 before anything else – make sure you have your emergency fund established.
I find this to be a commonly underrated part of one’s financial picture. Six to 12 months of living expenses should be on the sideline in savings. This is your 1st line of defense if your financial situation changes or something unexpected comes up that’s not budgeted for in your monthly cash flow. If you’re a business owner, you may need 12 months or more.
Living expenses are absolutely necessary and are definite even if you experienced a job/income loss, such as rent/mortgage, utilities, food, insurance premiums, healthcare, transportation, and debt obligations.
Now is a great time to audit your spending habits. Ask yourself these questions:
What are you not using? What subscriptions have you forgotten about? Is it time to “cut the cord” on cable, or other expenses? What are things you spend money on that don’t really bring you joy or serve a defined purpose? Have you been spending beyond your means? Is saving for your future an afterthought or are you proactively saving each month? What are your financial goals and how are you helping yourself achieve them?
Take this time to start thinking about these things and having these conversations with your spouse/financial planner/friend/accountability partner.
Once this emergency fund is in a good place, move on to the next step.
2. Pay off credit card debt.
Credit card debt is the most expensive debt to carry. Pay these off in full every single month. I’m not against credit cards – they can be great financial instruments to leverage i.e. cash back, travel points, free or reduced memberships/subscriptions, etc.
BUT those perks can quickly become NOT worth it if you let the cards leverage you.
For example: If you have a $5,000 credit card balance at a 29.99% interest rate (normal), you are paying $125/mo in interest alone.
If you didn’t spend anything more on this card & you pay $200/mo towards it to pay it off, it would take you more than 3 years to be credit-card-debt-free and you would have paid $2,943 in interest on top of your $5k balance. Yikes!
Pay those credit cards off!
3. Make sure you are saving for your longer-term future.
Start with contributing 5% or more to your retirement account. If your employer has a matching opportunity, even better! Take advantage all the way up to the match.
Also start with a minimum of $100 a month into a non-retirement account. For those of you who are pursuing longer-term IDR forgiveness, this is your “tax bomb” account.
Why would I suggest prioritizing saving over paying off all your other debts first? It comes down to the fact that your financial independence comes down to YOU and your savings rate.
There’s a balance between paying off debts and saving, and that balance is even more important when this debt is a lower interest, non-asset backed debt. Focusing a large amount of your available cash flow on student loans doesn’t return anything to you or build equity and typically student loan interest rates are below long-term market return averages.
Be productive with the rest of your cash
So compound interest & time value of money are a big part of why saving now is a priority, but also simply building the habit of savings is key. Just do it! Your future self will thank you.
Those three things above are key for protecting you during this strange time PLUS will help you start building good financial habits asap. From there, to be productive with extra cash here is a list of other things you can do with money not going towards student loans:
Accelerate other debts with an interest rate
Interest rates higher than 5-7% should be prioritized (after savings is in a good place) and paid down more efficiently.
Put more into savings
What are your short/intermediate-term financial goals? If you haven’t already, start making a plan to save for those things now.
Increase retirement savings
We prioritized savings above but 5% towards retirement and $100/mo towards your non-retirement investment account will likely not be enough to reach your goal of retiring/being financially independent in X amount of years, or at age X. This may be a good time to start interviewing a financial planner.
We recommend working with a Certified Financial Planner (CFP®). If you want a place to start, you can book a free introductory call with our referral partner Buckingham Wealth Management. In the meantime, here’s an ideal cash-flow breakdown that could serve as a good rule of thumb for what parameters to stay within based off of one’s household gross income:
- 45-50% of gross income on discretionary spending (housing, eating out, groceries, gas, entertainment, etc. – things you can control the costs of for the most part)
- 20-30% of gross income goes to taxes
- 7-12% or less goes to insurance (auto, health, life, disability, homeowners/renters, etc.)
This mathematically makes a savings rate of at the very least 8% the standard. Ideally your savings rate is 15-20% or more – that’s money going towards building an asset i.e. investing, retirement, home equity, business equity, ect.
Increase your savings into your non-retirement/tax-bomb account
This savings bucket can be versatile. This can be a great place for intermediate or long-term savings goals with its market participation & it being liquid or easily accessible.
Accelerate your private student loans
It’s important to not neglect savings to do this, that’s why it’s prioritized above, but this could be a good place to focus on next. To help reduce the cost over time of your private student loans, consider looking into refinancing to lower your interest rate and adjust your payment terms. I’d suggest applying through our cash back refinancing links.
Accelerate your federal student loans IF your plan is to pay these off
Like mentioned above, now could be a good time to make your dollars go further since interest is down to 0% until 9/30. Just don’t do it until September to preserve your options with that cash as long as possible.
Start saving for your children’s education
This is lower on the totem pole if your finances aren’t in order yet, but if everything is on track – saving for your child’s education could be a good spot for extra money to go.
Set up a “vacation” savings account/fund
We’ll all need a vacation after this craziness… ha!
If you’re unsure about your repayment strategy and what you should be focusing on Schedule a consult. We’re here to help!