Dear College Graduates,
Most of you will walk away from your education with more than a diploma. Around 68% of you graduating with a bachelor’s degree are carrying $30,000 in student loan debt. For graduate students, that number is closer to $100,000. While it’s often tempting (and, an admirable financial planning goal) to focus on getting that debt paid off, there is more to allocating those initial paychecks.
Fund First: Your 401(k) and Emergency Reserves
In last week’s post, we shared a couple of examples on the importance of getting started early when it comes to both short and long term savings. This topic is so important, we’re going to give you a couple more reasons to believe us.
Saving for the short term can often mean saving for the unexpected. Have you ever had a surprise car repair, or medical bill? The Federal Reserve’s annual economic well-being survey tells us that nearly half of Americans do not have enough money to cover a $400 emergency expense. Instead, we put it on a credit card, borrow from family or friends, or simply don’t pay it. An emergency reserve can be crucial to help you avoid the credit card trap mentioned below. Typically, you want to save enough to cover 3-6 months of fixed expenses.
Saving for the long term takes advantage of your youth, and in many cases, your 401(k) matching program. Many employers offer to match a portion of the money an employee elects to invest in a company 401(k) plan. For example: if your employer offers to match 100% of the first 3% you invest in your 401(k), it may make more sense to invest in your 401(k) than to pay down a loan at 4% to 7% interest. A $100 401(k) contribution would earn you a $100 match, whereas paying down an extra $100 on a 4% loan will save you $.04 per year. Sure, you may have to wait awhile to be vested in that match, but saving for your retirement is a long term strategy.
Pay Off Second: Credit Card Debt
This one is simple. DO NOT CHARGE MORE THAN YOU CAN PAY OFF IN THE MONTH IT’S DUE. In today’s modern society, having a credit card is essential. The trap comes when you charge more than you can pay off in the current month. Those balances add up very quickly and with the high interest rates that credit cards charge, they can be very difficult to pay off.
If you have an 18.9% credit card with a $1,000 balance and only make the monthly minimum payment of $25, it would take you just under 10 years to pay it off. In the end, you will have paid about $1,035 in interest alone. Ouch.
If you already have credit card debt along with student loans, after maximizing your employer 401(k) match, focus on paying the highest interest debt first. On your remaining debt, make the minimum payments. Once the highest interest debt is paid, move on to the next one.
Pay Down Third: Student Loan Debt
If you have student loan debt, you’re likely familiar with the difference between private loans (aka unsubsidized) and federal loans (aka subsidized).
Private loans often start out lower to entice borrowers, but increase exponentially over a short period of time. Lenders of private loans are more likely to hold their borrowers’ feet to the fire, requiring quicker repayment at higher rates, even bringing on lawsuits for missed repayment in some cases. Those drawbacks aside, sometimes private loans are the only option for students. If you’re one of them, focus your repayment efforts on these private loans first.
Federal lenders on the other hand allow consolidation and are keen to work with their borrowers, adjusting payment requirements if needed. Consolidating your federal student loan debt both simplifies your financial picture and locks in your interest rate. At a time when interest rate increases are highly anticipated, this is a good move to do sooner than later. Click here to get the consolidation process started.
Whatever you do, don’t stick your head under a rock. Remember, student loan debt is a ‘death till you part’ arrangement – even bankruptcy won’t rid you of the financial burden (with very few exceptions).
If you’re wondering whether or not your student loan debt may be eligible for the Public Service Loan Forgiveness program, click here to read our overview on it.
All Along the Way: Protect Your Credit
I tell my clients that the two most important things they can care for during their life are their teeth and their credit – two things that have the ability to make your life heaven or hellish. Continue to pay your debts on time. Make efforts to use credit wisely. Avoid having opening too many lines of credit at once. Oh, and floss. (For more ideas on how to start building good credit, click here.)
Wrapping it Up
Just like the secret to fitness and health is diet and exercise, the secret to becoming financially independent isn’t really a secret at all. It’s simple: live on less than you earn, and invest the difference.
Legend has it that Einstein once said, “compound interest is the 8th wonder of the world.” I say it is both a tool and a weapon. It can help your money earn more money, but it can also be a weapon to make you poor when you have too much debt.