Thursday, June 14, 2012

Student Loans: How the refined college grad handles them

Student Loans: How the refined college grad handles them

Student loans can make or break graduate life after college. Student loans can be a source of constant worry and strife or seldom thought about. This post will go into what student loans are, how they work and how to manage them.

Four amazing years have come to a close. The books are sold or donated, final grades are in, the beer soaked rug is removed from the fraternity house and the first job is already lined up. One of the top comments of recent college graduates is: Now I will have Money! No more Ramen and Milwaukee’s Best Light (Ice for the real men). Now it will be all about Miller lite and steak (a ton of steak). There is one thing the typical college graduate is not thinking about that can come back to haunt them. Six months from graduation student loan bills will start arriving (if not enrolled in a graduate program). These are some of the most important bills a college graduate will have.   
The refined grad knows there are two main types of student loans private and federal. These loans are structured in similar ways and have similar payment terms. They are VASTLY different in the interest rates they hold though.

Private Loans

Private student loans are a special kind of hell. I know sounds it sounds extreme but they really are. Here is a quick list of the hellish features of these loans.

The college graduate cannot default on the loans. Yes even if down the road the college graduate declares bankruptcy, the loans are still there. OUCH!!! Kick them while they are down.
The loan’s interest kicks in when the loan was signed not when the grad gets out of school. This Means that all that interest has been compounding for as much as four and a half years.
The interest rates vary wildly based on the applicant and co-signer. The interest or (APR) can range anywhere from the low-3% to mid-10%. The interest really can add up quickly. Many college grads do not understand the power of compounding interest. See the table below for the thought process of many grads.

Not too bad right? Only eight years and four months to pay off the entire loan at only $250 a month. WRONG! Even though most graduates know that their private loans hold high interest rates they willfully ignore them; out of sight out of mind sort of thing. Here is a chart that is a closer representation of reality.

In this more accurate example the college grad paid $250 a month for an extra four years and 3 months. In dollar terms this is $12,750 more than with no interest. Whhhhaaa??! Refined college graduates know the power of compounding interest. The effects are even greater when the grad starts with more debt or a higher interest rate.

What can be done? The refined college grad knows that loan’s with high interest rates should be paid as quickly as possible. Even a little extra money towards the monthly payment can make hundreds and even thousands dollars of difference. Here is a chart to help illustrate this. 

For $450 a month the same loan with the same interest rate are paid off in less than half the time. This is $50 less than double of the original $250 monthly payment. Most college grads would think paying double per month and pay it in half the time. However this is not the case with the power of compounding interest. Paying double the amount will pay off the loan in less than half the time. Even if the college grad cannot pay $450 a month they understand that paying the most possible per month on private loans is highly important.  

Many college grads get very angry at the banks that issue these loans or the government that “does not protect the consumer”. The refined college graduate knows that this is the largest load of crap ever. All of the college grads that can be seen on Youtube and the TV that hold signs saying ‘6 years of college $120k in debt, no job’ are idiots. The refined college graduate treats their life like a business; managing debt to assets and always ensuring there is steady cash flow. Okay, so what does that even mean? SNL said it best “don’t buy shit you can’t afford”. Every college grad needs to evaluate what the payoff of a college education will be. Many “experts” will tell you this is impossible because the college grad does not know what job or what salary (if any) they will receive upon graduation. This is false, there are multiple metrics that any college grad can use to determine if college will pay off in a reasonable amount of time.

  • How much private debt does the college grad plan to take on? If it is more $60k the college grad may want to rethink their choices (yes it is a choice). There are exceptions to this for college students who are in majors that typically lead to high paying starting jobs.

  • What is the college student majoring in? If they plan on being a career social worker or geography major they should take on much less debt than engineering or accounting majors.

  • What are the college students grades like? Often a student’s grades and college involvement directly correlate into what kind of first job they will get.

Federal Loans

Federal loans are a completely different story. The current interest rate is at 3.4% and it appears that rates will remain low in the future. Both Democrats and Republicans agree that rates should be kept low for students (I know completely shocking; they do agree on something). The only thing the parties do not agree on with this policy is how to pay for the loans. Even with the disagreement on payment it is unlikely that congress will allow the current low rates to expire. If for some reason they could not come to an agreement the rate would double to 6.8%. If the interest rates did double the refined college grad would pay these loans like he/she pays private loans.

The refined grad takes a leaf out of the Ric Edelman book The Truth About Money and like a mortgage in the book only pays the minimum each month. This may sound insane to most college grads but the refined college grad knows this can be a really good move. Here is why paying the minimum on a low interest loan and putting the rest that the grad saves into investments will increase wealth faster than paying off low interest debt as quickly as possible. The refined grad knows that keeping control of his/her money is the most important thing.  

Here is an example of how the typical college graduate will pay off loans and invest.

Not too shabby. After just 5 years the college grad is debt free and at just over 10 years the grad has over $30,000.00 saved up.

Now let’s look at how the refined college grad handles low interest student debt.

Amazing by paying near the minimum each month and investing the rest the refined college grad comes out with more than $8,000 more than a regular college grad. This is the true power of the college grad keeping control of their money. Here are a few reasons why the college grad should allocate their money this way instead of paying off all debt first.

The college grad ends up with more cash at the end. As long as the gains/dividends remain higher than the loans interest rate the college grad is building wealth. Many will make the argument that with such high volatility in the markets there is no point in investing. This kind of attitude will never allow the college grad to ever build wealth. There will be more posts on investing in the future.

Here are some reasons to pay off a federal loan like this.

  • The college grad keeps control of their money. Life happens; having money saved up instead of dumping it into loan payments will allow the college grad to have flexibility if needed.

  • Consistent long term credit history building. Having a good credit score is highly important for refined college grads. At some point they will want that house with the backyard.

  • Learning about investing early. Having a grasp on investing is essential to building wealth.

The refined college graduate knows how to handle federal student loans. They plan with spreadsheets and budgets and STICKS TO THEM.

The refined college graduate uses debt to their advantage and understands the difference between private and federal loans. The refined college graduate reads about current events on student loans. Doing a little bit of research and planning can help the college graduate achieve both short and long term financial goals. 

Email with questions. 


  1. Otis, perhaps a link to a google docs version of your spreadsheet for us readers to plug in our own numbers?

    In my case I have 6.8% on federal and 7.25-7.50 on private so maximum pays are the only way, savings will come later.

  2. Awesome idea! We will get on that right away!

    Good call, Pay those loans off ASAP. Those interest rates are really high.

    Stay Refined.....Otis