Mythbusting: Student Loans
I created the Financial Gym with the intention of giving clients of all asset shapes and sizes a place to come to get financially fit and live a better life; and four years later, I realize that probably the greatest service that my financial trainer team and I give our clients is financial literacy as we break through financial confusion and give our clients a stronger understanding of their financial choices and how they impact their lives.
In an effort to educate our clients, we realize that we’re frequently doing myth busting when it comes to financial topics, so we thought we should share some of our favorite mythbusters to you in this new series. First up, we’re busting student loan debt; and there are two big myths we see here at the gym regarding student loans:
Myth 1: You need to repay them ASAP
Myth 2: You need to refinance your loans to a lower rate
I know what you’re thinking, “Shannon, these are smart money moves to make, how could they be myths?” And you would be right, but the reality is that not all financial information applies to all people’s financial lives and if it doesn’t, it lends itself to being more of a myth than a hard fact.
Let’s talk about repaying student loans as soon as possible. In an ideal world, you would pay down your student loans as soon as possible to avoid paying interest over a greater period of time. The problem with student loan debt, though versus other debt like credit cards or mortgages, is that once you pay it down, you cannot borrow from it again unless you go back to school. So the cash that you use to pay down the loans is gone and no longer available to you for your other life goals.
We see clients prioritize student loan debt repayment above all other financial goals and this frequently gets them into other financial problems. For example, they don’t have enough money saved in an emergency savings account and as it usually happens, an emergency arises like a job loss, an unexpected move or a healthcare scare and now they have to use a credit card to pay for this emergency. Most credit card interest rates range from 14.99% to 24.99% while most student loan debt interest rates range from 4.00% to 10.99%, so you move from lower interest rate debt to higher interest rate debt because you didn’t have the cash you needed because you used it to pay down your student loan debt.
A best financial fitness practice before prioritizing student loan debt repayment is to make sure that you have a fully funded emergency savings account which would comprise six months of monthly expenses, so if you pay $2,000 a month in monthly expenses, you should have $12,000 saved before you prioritize the student loans. Yes, you will pay interest over this period of time, but consider the interest you are paying as a fee for the flexibility to use your cash as you need it and avoid higher interest down the road.
Student loan refinancing is another financial move that sounds like a good idea, it makes sense to move from paying higher interest rate debt to lower interest rate debt; however, what most people don’t realize is that the student loan refinancing option is all via private loans. There are two primary types of student loan debt, federal loans and private loans. Federal loans are issued under the umbrella of the US government and they offer various types of repayment options and flexibility over the course of paying them back. Private loans are issued from banks or financial institutions and have very strict and limited repayment options.
A lower interest rate sounds good; however, what we’re more concerned about for our clients is the loss of repayment flexibility. The average person is going to take a little over ten years to repay their student loan debt and a lot can happen over ten years, you could lose your job, start a new job, become disabled, marry and have children, etc.; and all of these life changes would grant you relief in your student loan repayment plan if they are federal loans. However, despite any of these major life changes, your private loans would still need to be paid off in the same manner.
Student loan debt whether it’s federal or private is not dischargeable via the bankruptcy courts and knowing that anything can happen in your life between now and final repayment, it’s best to pay some extra interest knowing that your buying flexibility over that period of time.
Student loan debt is not fun for anyone to manage through, but before you make any final decisions around it, make sure you’re not falling prey to any myths surrounding student loan debt and that you have the most financial flexibility for your life journey.