The Sherpa Mailbag: Consolidation, Big Payments, PAYE and Strategy

This morning I acquired an email from a reader who wanted input on repayment strategy. ?Specifically, she wanted advice on creating a one time payment and whether she should consolidate. ?Her situation is really as follows:

  • Approximately 100k in federal student loan debt
  • 5 loans at various interest rates (5.4% to 7.9%)
  • Eligible for the PAYE plan
  • Unsure of her income next year
  • Loans still in deferment
  • 15k in the bank

First, you should note that each loan situation is different and what works well with one person may not be what works perfect for another person. ?This situation is worth sharing because lots of people may find themselves in similar circumstances, and it will hopefully inspire ideas. ?In this circumstance, there are a variety of inquiries to answer.

What related to the cash in the bank?

This cash is likely earning hardly any interest and applying it immediately towards an education loan might be worth hundreds of dollars within a few months. ?However, any income uncertainty should be taken into account here. ?If you don’t have long term employment secured, keeping a sizable nest egg for emergencies could prove to be a very smart decision. ?There is also lots of middle ground. ?$10,000 could be put on the greatest interest education loan while the rest remains for any day you need it.

How would you decide? ?It comes to the math. ?Leaving money in your money costs you money. ?This is often known as opportunity cost. ?By keeping that money inside your banking account, you will pay extra interest during the time it sits within the account. ?For those who have a $15,000 loan and you’re simply paying $100 monthly in interest on that loan, the price of keeping that money in the bank is $100 monthly.

To find your best bet, perform the math for many large payments that may be made. ?Find out how much it is you to keep those funds inside your account for the year, then check out a few different values in between all and absolutely nothing. ?You need to find your personal sweet spot. ?Your sweet spot is the lump sum payment that?knocks out a bunch of monthly interest, but still leaves you having a large enough nest egg to feel at ease.

Should you consolidate?

The trouble with consolidating federal loans is that it doesn’t actually lower your interest rates. ?Instead of having 5 smaller loans, you have one large loan with the interest rate calculated because the weighted average. ?If you are only likely to be making minimum payments for that life of the loan it does not matter. ?However, if you plan on aggressively paying down your financial troubles, you will pay less in the long run if you do not consolidate. ?This is because you are able to pay off the highest interest rate loans first and then pay off the a low interest rate stuff last. ?If you consolidate, you’ve just got a medium rate of interest.

There are also private lenders which will consolidate your federal loans, and potentially decrease your interest rate. ?However, there are dangers associated with going this route. ?In so doing, you’d permanently lose the advantages of the government loan, like the repayment plans and education loan forgiveness.

For a more detailed explanation, take a look at our article on making the government student loan consolidation decision.

Am I on the right repayment plan?

If you are subscribed to the PAYE plan, the reply is likely yes. ?When you have numerous loans and debts, you should find the minimum payment on all of them. ?Keeping the loans current with no forbearance or deferment is critical, but you don’t want to pay any more than the minimum. ?Then pick one loan to repay. ?It can be your highest interest rate loan or the smallest loan. ?The key part is that you simply select one loan and attack it relentlessly. ?Once credit is paid off, pick the next loan to attack and repeat.

The right repayment plan would be the one which allows you to pay as little as possible in your current loans. ?This frees up more money to attack your target loan. ?Keep knocking off your target loans and before very long, you’ll be debt free.