Should you pay off your student loans quickly?
Wed Sep 5, 9:39 pm
Feeling trapped under a mountain of student loan debt?
Joe Mihalic did. So a year ago, the 29-year old Harvard Business School graduate aimed to wipe out his $90,000 debt. He was earning just over $100,000 as a product line manager at a technology company in Austin, Texas, but was spending too much. He stopped eating out, rented two rooms in his house, sold his motorcycle and cashed out a retirement account. He paid off his loan in just seven months.
"My stress level is so much lower," says Mihalic, who blogged about his experience at NoMoreHarvardDebt.com and wrote an e-book.
It's a feeling many will envy. Student loan borrowers owe nearly $25,000 on average. Paying back the minimum means it can take years to make a significant dent. But is it smart to pay off student loans as aggressively as Mihalic?
It depends on whether you have other types of debt. Student loans tend to have low interest rates, usually below 9 percent. It's best to pay off higher interest rate debt first, such as car loans and credit card debt, says Alexa von Tobel, founder and CEO of financial management site LearnVest.com.
You need to also think about your future before throwing extra money at student loans. Fund your retirement accounts because you can earn a higher rate of return in the stock market. Also, make sure you have an emergency fund to cover about six to eight months of expenses.
Mihalic was motivated to pay off his loans quickly after being passed over for a promised promotion. He wanted to tell his bosses that he would look for another job, but realized he wouldn't be able to make student loan or mortage payments if it backfired.
"I wanted to send a strong message to the company, but I couldn't afford to," Mihalic says. "It was a shocking realization."
Soon came another shock. Although Mihalic had paid $1,057 a month for nearly two years, the more than $22,000 in payments only lowered his debt to $90,700 from the original balance of $101,000. That's when he revved up his payments.
Here's what you should consider if you want to do the same.
SCRUTINIZE SPENDING: Don't try to keep up with how much your friends are spending. "Turn off Facebook," Mihalic says. "All you're seeing is their new car or new shoes. You don't see that they are drowning in debt."
Mihalic was spending $1,300 a month on movies, weekend getaways and eating out before slashing those costs. He stopped taking dates to restaurants. Instead they would go hiking or have a picnic. For nights with friends, he avoided a big bar tab by bringing a flask.
"Some girls sort of turned their noses up," Mihalic says. "But I started avoiding those women. I don't want to work until I'm 65."
Another place to cut costs is on cable TV, says von Tobel. That can free up an extra $100 a month to put towards your student loans.
She also recommends taking a closer look at services that take money out of your checking account automatically every month. Cancel gym memberships you're not using or subscriptions to magazines you're not reading.
Sell any spare vehicles you own, like a second car or a motorcycle. Keep only what you need in order to get to work. You'll get some extra cash, but you'll also save on maintenance, gas and insurance costs.
PAY OFF PRIVATE STUDENT LOANS FIRST: Those loans have higher interest rates than federal ones. Many private loans have variable rates, meaning that their interest rates could jump in the next several years, says Zac Bissonnette, author of "How to Be Richer, Smarter and Better Looking than Your Parents."
DON'T CASH OUT RETIREMENT ACCOUNTS: Mihalic withdrew $12,235 from his individual retirement account. But after paying early withdrawal penalties and taxes, he only received a check for $7,953. Mihalic recognizes that it didn't make sense financially, but emotionally it provided more motivation to carry out his plan.
Tapping your retirement account should be an absolute last resort. Mihalic might be able to rebuild his balance because of his high salary, but he still had to pay the steep penalty and is missing the potential compounded earnings of his entire original balance.
Mihalic also stopped contributing to his 401(k), another mistake, especially if your employer is matching your contributions. Always take advantage of an employer match. Don't ever give up free money.
GET A ROOMMATE: If you don't own a home, renting a place with a roommate will help keep housing costs down, says Lauren Lyons Cole, a certified financial planner.
Mihalic rented out two rooms in the three-bedroom house he owns. He hated losing his privacy, but says it was an easy way to bring in more money.
Mihalic has no regrets about the sacrifices he made during the seven months. He's now replenishing his retirement accounts and continues to cut costs. But he's not getting any more roommates. The last one moved out in August.
No longer burdened by student loans, Mihalic plans to use the extra money to start a business one day, or take time off work and travel.
"I've built up a 12 month nest egg," he says. "I can pay my mortgage, fuel, groceries all for the next 12 months."
Such rapid repayment may not be feasible in your situation. But even so, the key bit of advice to take away from Mihalic's story is to put together a plan. Even if you only set aside an extra $10 a week toward your loan, that helps.
Joseph Pisani can be reached at http://twitter.com/josephpisani