Is a small student loan payment wise or foolish?

The new Pay As You Earn program will lower monthly student loan payments big time. And the government is selling that concept as a way to make student loans more affordable.

I talked about the new Pay As You Earn in my post The new Pay As You Earn student loan repayment program – A blessing or a curse? Part 1.

PAYE is a big change being introduced by the government to lower monthly payments for new student loan borrowers. It also promises forgiveness of the debt after 20 years if the low monthly payments do not fully pay off the loan.

Here’s the important question to ask yourself. “Is a low monthly payment on a student loan smart?

Let’s look at a quick example from my email inbox this morning.

I got an email from my credit card provider that reminded me my payment is due next week. It said my balance was $6,050.33. It also said my payment due was only $61.00. Should I pay the full amount due or pay the low monthly payment on the balance?

The answer is I should (and I will) pay the entire balance next week. I’ll pay it off in full. (That’s what I do every month.) Thanks but no thanks on the offer to pay $61.00. That would just keep me in debt and cost me more money over time – not less.

(As a side note, I use the card a good bit for business related travel which is why the balance this month is high. Although I did buy some furniture last month too – ouch!)

The Government Says Lower Monthly Payments Save You Money

If you go to barackobama.com/education-calculator you will find a page that advertises the new Pay As You Earn program. The page was put up during the 2012 presidential election campaign (and was still up as I wrote this).

As I have mentioned before, I am not picking on President Obama or Democrats or Republicans. They all say very similar things when it comes to student loans in general. My focus is on the facts and the reality of student loans, not on what any political party has to say about them.

The page has a pretty slick online calculator so you can plug in your expected income, your expected student debt after college, your family size and it shows you your “savings” under the new PAYE plan.

I plugged in an example to see what it showed.

On the left side of the calculator I plugged in a $30,000 annual income. I plugged in $25,000 of student debt (a little below the average). And I plugged in a family size of one.

On the right it tells me the good news. My monthly “Payment under Obama” is only $110 per month rather than the $288 under the standard 10-year repayment plan. My “Annual Savings” is $2,128.

So the government is saying that lower monthly payments are smart. They saved me money.

Using that logic, in my credit card bill due this month, if I only pay the $61 minimum payment I would save $5,989.33.

Low Monthly Payments Keep You in Debt

Common sense says that the lower the monthly payment you make on an outstanding debt the longer you stay in debt. And the more interest you pay over time. That’s not saving money, that’s pissing money away.

Be careful when a lender tries to entice you into staying in debt by making low monthly payments.

And the government is the lender when it comes to student loans (over 90% of all student loans now are made by the federal government).

This isn’t about Democrats or Republicans.

It’s about making wise decisions with your money.