How Are You Doing on Your Budget So Far?

A monthly budget is a powerful tool for paying off your student loans.

As Dave Ramsey says, a budget is how you make your money behave! He also says that using a budget will make you feel like you got a raise. It’s true.

Erasing $20,000 in Debt in 2 Years – In New York City!

Here is a quote from a great story about getting serious, and using a budget, to get rid of your student loans.

“Just months after getting our diplomas framed, Joanna and I sat down and got serious about our finances and attacking our $20,000+ in student loan debt. While interest rates were favorable and our cumulative debt was lower than many graduates, we couldn’t stand the feeling of owing anything to anyone. Imagine our conundrum when I got my dream job offer from a storied advertising agency in New York — the most expensive city in America.

Despite a cost of living that’s 125 percent higher than the U.S. average, we were committed to paying off our debt in two years. And the craziest part of it all? We did it. (We were in Manhattan for a year and a half, and then we moved to Boston for a year.)”

Here’s another quote about how they attacked the debt.

“Instead of first budgeting out typical expense categories (food, transportation, tourist activities, etc.), we figured out how much we wanted to put toward paying down our debt each month. After subtracting that from our monthly income, we knew how much money we had remaining for all of our discretionary and leisure spending.

We created an itemized budget and then tracked our expenses like accountants from the Internal Revenue Service. Every penny of every expense was accounted for throughout each month. If we noticed that our $350 food budget was running low halfway through the month, we knew to cut back or face the wrath of beans, rice and ramen for the duration. This tracking helped ensure that our get-out-of-debt goals were walking the walk.”

Here’s the full article about how they did it. Check it out. It’s a fun and motivating story.

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Grandma Has Student Loans

One of the dangers of student loans is they can easily live a long, long life. They can hang around for a lifetime if you don’t attack them aggressively in the beginning.

A growing portion of the student loans outstanding today are to people 60 or older. There are lots of reasons for the shift. Maybe the biggest one is that if you have trouble paying your student loans back you end up using deferment, forbearance and other means to try to deal with the problem. But that usually just increases the amount you owe because the interest accrues each day and is added to the principal.

Then an older person can find themselves with an ever growing student loan balance and unable to make the payments.

Here is a quote from an article by Annamaria Andriotis, at Smartmoney.com titled Grandma’s new financial problem: college debt, about what can happen next.

“According to government data, compiled by the Treasury Department at the request of SmartMoney.com, the federal government is withholding money from a rapidly growing number of Social Security recipients who have fallen behind on federal student loans. From January through August 6, the government reduced the size of roughly 115,000 retirees’ Social Security checks on those grounds. That’s nearly double the pace of the department’s enforcement in 2011; it’s up from around 60,000 cases in all of 2007 and just 6 cases in 2000.

… This is going to catch an awful lot of people off guard and wreak havoc on their financial lives,” says Sheryl Garrett, a financial planner in Eureka Springs, Ark.”

Please give some serious thought to paying your student loans off aggressively so you have zero risk of this happening to you (or your kids).

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Small Student Loan Payments Create a Surprising Risk

One of the big risks you take on with student loans starts when you decide to pay them off slowly. By slowly I mean taking 10 or more years to pay off your student loans.

Making the smallest monthly payment you can get away with means the debt will be hanging over your head for a long, long time. You have years and years of payments (including interest) to make on those loans and you have to be constantly mindful of that obligation every single month.

  • But what happens if you get laid off?
  • What if you have a lifelong dream of starting your own business but you can’t go even a couple months without a steady income because of your debt?
  • What if you meet the love of your life and decide to become a stay at home spouse or parent?

Your student loans will handcuff you and become a constant drag on your ability to make even the most basic family and life decisions if you keep them around too long.

Freedom and Peace of Mind

Paying your student loans off quickly gives you more freedom to make decisions in your life. It puts some cushion between you and the ups and downs of life. When you don’t owe anything on your student loans you are no longer a slave to that annoying monthly payment.

You don’t have the worry that wakes you up in the middle of the night stewing about what might happen to you or your family if you lose your job or some other financial surprise pops up.

You will notice a sense of calm and confidence as you reduce the financial risk inherent in having a large student loan hanging over your head. You have more flexibility to make decisions. And flexibility will help you survive and thrive in life. That’s a great way to live.

And it starts by making a commitment to pay down your student loans as quickly as possible.

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Will You Still Have a Student Loan Balance Five Years From Now?

I received some interesting comments on my recent post titled Paying your loans off quickly has hidden benefits.

Here’s one of the comments.

“Pretty utopian point of view. I assure you, if it were as simple as “just pay off the student loans and be happy,” I would. I see blogs and articles all over linked in about paying down student loans, but the fact being ignored in every one of them is that student loans are not the only bill that has to be paid. The game isn’t how fast you can pay them off, the game is staying out of bankruptcy.”

The comment is true in that a person’s ability to pay their student loans off quickly differs. Everyone is in a little different place in life and faces different challenges at whatever phase of life they are in.

What many people ignore though is that in many cases the reason a person has so many other bills is poor decision making. When you buy into the BS that student loans should be dragged out for a long time you are buying into the same logic that compels you to become a good little “consumer”. You spend your extra money and buy more and more stuff that only makes it harder and harder to get rid of your student loans.

Here is another comment I received.

“Hmmmm….I take a contrarian view….I purposely pay my student loans off as slowly as I can because the rates on them are so low! I’m paying less than 3% on them. I graduated with significant student loan debt from my first graduate school experience (more than $80,000 in institutional loans) and I did work hard to pay the higher interest ones off early, and I was able to do that within a year or two.

Now I just have the Federal loans left on that initial grad school experience…and I’ve taken out more loans for a new program. It is my opinion that the federal student loan program is some of the cheapest money around….and it’s always worthwhile to invest in your own human capital.”

This comment speaks to my post not long ago titled Student loans and CRAP: A fun look at the amazing similarities.

In that post I provided some quotes from a super fun article that set out the two philosophies most borrowers choose.

Philosophy #1: I Can Never Be Fully Free Unless I Have No Debt

Philosophy #2: I Will Always Have Debt, So Let’s All Just Live Our Lives

Read the article here.

Which goal excites you the most? Freedom from student loans? Or freedom to keep your debt as long as you please?

They are both achievable in America! Choose wisely. :-)

Pay As You Earn can make your child dependent on the government

The new Pay As You Earn plan is likely to have an impact on your child’s financial future that goes way past its original intent.

At the core of the new plan is lowering monthly payments on student loans and promising debt forgiveness for many borrowers.

One of the larger problems with Pay As You Earn is it encourages a person to stay in debt for 20+ years. Very low monthly payments, and the promise of debt forgiveness after 20 years, will keep more young people in debt for a long, long time.

I wrote about that here.

It will have another negative consequence that nobody has talked about in the media yet.

It will create a dependency on the government that you need to carefully consider as a parent.

I’m not referring to the broader subject of government dependency and the size of government. I’ll leave that to the Democrats and Republicans to hash out. My concern here is not big-picture politics.

I’m referring to a very specific financial dependency that your child will experience if they decide to enter the Pay As You Earn plan for repaying their federal student loans.

Here’s how it will unfold.

  1. Most people choosing PAYE will be doing it for both the low monthly payment and the promise of debt forgiveness after 20 years. They will have friends and classmates who have learned how the plan works and who realize that they will not necessarily have to pay back all the money they borrow. They will end up comparing how much forgiveness they each expect.
  2. Pay As You Earn will be marketed by the government and colleges with these buzzwords made very prominent “forgive your student loans”. The promise of having your student loans forgiven will create some interesting conversations – and incentives. The person that might have paid their loans off aggressively after school might think “Well, why should I sacrifice my lifestyle after school to pay these loans off fast and get them out of my life? What if I am throwing away the chance to have my debt forgiven? Maybe I should get in the program and start living my life the way I want to (the pay all my friends are) and see if some of my student loans will be forgiven later on.”
  3. Pay As You Earn creates very small monthly payments. In many cases, the monthly payment is not even enough to cover the interest that is due for the month. That’s what called a negative amortization loan. Since the interest is not being paid in full, the combined amount due on the debt is actually going up every month, not going down. As the balance goes up each year, it will become even more important that the promised debt forgiveness happen. Your child will become more and more dependent on the government taking action as they watch their debt get bigger and bigger as each year goes by.

Once your child has committed to the smaller payments, and they have watched their balance grow every month/year, the more they need the government to come through on their promise of forgiveness. So they have to pay very close attention to the rules the government has set and hope and pray that no mistakes are made along the 20 year path to forgiveness.

Pay As You Earn says if you make all your monthly payments over a 20 year period they will forgive any balance. That’s 240 consecutive monthly payments. What happens if you miss a payment in month 71? What if you make every payment on time but there is a clerical error on their end and their system shows you did not meet all the rules? (You would be surprised how disorganized the student loan servicing side of the business is.)

There are many other rules as well. You must provide them your income tax return each year so they can see your income and set your monthly payment each year. (Just to mention one.)

Philip Lehman IV wrote in The Washington post in December 2012 about an experience he had recently in the Income-Based Repayment (IBR) program. PAYE and IBR are basically the same program. PAYE just accelerated certain provisions.

He is a doctor who racked up some large student loans in medical school. Here is a quote about his experience with one of the IBR/PAYE requirements.

“So it was when, on Aug. 16, I received a letter from Direct Loans informing that it was time to recalculate my monthly payment amount under IBR. (Direct Loans is a loan servicer, authorized through the U.S. Department of Education.) The letter notified, “If proof of your current income is not received within 90 days of the date of this letter, your repayment plan will be changed to Standard Repayment Plan, which could increase your monthly payment amount.”

On Oct. 23, I faxed last year’s tax return as proof of income and forgot about the process, until I received notice eight days later that my next month’s payment had skyrocketed 1,600 percent, from $177 to $2,916. This charge equals one standard repayment, and was only $125 less than my monthly take-home salary.

Shocked at this logarithmic rise, I called Direct Loans to ask for an explanation. The customer-service representative stated that the loan servicer had not received my forms in time and thus had to adjust my payment to the Standard Repayment rate. When I pointed out that we were having our conversation on Nov. 7, clearly within the 90-day window of the initial letter, the representative did not budge.”

What the customer-service representative was saying is he just got kicked out of the program. The promise of loan forgiveness is gone. The low monthly payments are gone.

That’s what she was saying.

Maybe he eventually got the problem fixed. But your child (and maybe you) will always be on the edge of a bureaucratic mistake like that. Your child will have large sums of debt hanging on the hope that the loan servicers and the federal government will get everything right over a 20 year period.

What if the Laws Change?

Do you think the rules and the laws around student loans are going to change over the next 20 years? Of course they will. That’s pretty much assured no matter which party is in the majority.

20 years is 10 lifetimes away for a politician. They have a hard time making decisions that have an impact six months from now. Who knows how the rules and laws will change over 20 years.

Your child would be sitting there at the mercy of politicians for 20 years wondering whether the promise of forgiveness will actually come true. I can’t think of too many things I would rather avoid than putting myself in that position. To me that is the opposite of freedom. That sounds like financial dependency well into a person’s 30s and 40’s (and maybe longer).

Are you going to encourage your child to get into the Pay As You Earn Program?

I’m not against accepting the benefits the government offers on college costs. By itself, the promise of debt forgiveness is not a huge problem in my mind. The problem is the price your child will have to pay to try to get the forgiveness. It requires staying in debt for 20 years or more on the hope that the forgiveness actually happens.

Think about this. What if your child had a group of friends and as each month or year went by they would all share with each other what their student debt balance was? Would she feel proud to show everyone her balance continuing to go up?

Or would she feel better if she could show her balance going down quickly because she was making larger monthly payments? Imagine her pride if she paid the debt off quickly.

I think this is an interesting scenario for a parent and child to consider as you evaluate whether to get into Pay As You Earn and sign up for 20+ years of debt to the government on the hope (which will turn into prayers as the years go by) of forgiveness.

The Path to Financial Freedom

The wise choice to seriously consider is to sacrifice after graduation and take the higher income and devote it all to paying the debt down within a few years. Get it out of your life quickly. Encourage your child to get that debt out of their life as fast as possible after finishing college.

That way they have their new income to put toward raising their family and saving for their children’s college education.

That’s the path to financial freedom. That’s the path away from dependency and weakness.