Do you know how long it is going to take to pay off your student loans? Honestly, have you ever done the math based on your balance, interest rate, and current payment to know the actual months remaining? Or do you just pay them and assume they should be gone soon? Or even worse, are you sitting there saying, “I heard that all student loans are going to be forgiven, so who cares?”
I guess you can say I always took it for granted that everyone was on the “proper payment” path with their student loans. However, after working with many young professionals and their families, I am starting to think the student loan epidemic is worse than I expected. I never use the word “bubble,” but it is starting to scare me.
- Student loan debt is the second highest consumer debt category; the only category higher is mortgage debt.
- Current student loan debt = $1,400,000,000,000 (that is $1.4 trillion, with a “t”)
- Pennsylvania has the second highest average student loan debt at $34,798. New Hampshire takes the 1st place trophy (although, you don’t want to win that tournament…).
Examples have been my thing as of late, so I just wanted to walk through some debt amounts, interest rates, and their actual payoff dates based on some fictional characters. For simplicity, we will use one loan balance and one weighted interest rate. I would challenge you to take some time and find the weighted average of your student loan interest rates. Again, something I took for granted, however, many have no idea what this number is. Many quote their lowest rate or what they have heard in the past.
Here is an example of weighted average using three loans:
You would be surprised by how many would see this chart and assume their total rate is, “somewhere in the 5% range.” The weighted rate is coming in hot at 7.23%! There is a huge difference between 5% and 7%.
Miss Suzy Dentist
Suzy was lucky enough to have no undergrad loans and only took out loans during medical school. Suzy built up $300,000 in loans over her medical school years. Her weighted average was 7.0% on her loans. She heard of Public Service Loan Forgiveness (PSLF) and assumed she was good to go based on what her friends told her. The problem was that Suzy was in the private sector, meaning no PSLF. The only forgiveness option she would have is traditional forgiveness in 20-25 years. The only way to get these payments to go away in 20 years would be to use an income-based repayment plan. The problem with an income-based repayment plan is you are going to have negative amortization which leads to your debt balance increasing for 20 years. So in 20 years, Suzy’s loan balance could be drastically higher, and any debt forgiveness is fully taxable. Income-based repayment plans can also become an issue depending on Suzy’s income and growth. For fun, let’s assume the balance only accumulated to $500,000 and that was forgiven in 20 years. Suzy would be ecstatic that all that debt was forgiven, yay!!! Until her tax bill from the IRS arrives, do you know what the tax bill on $500,000 of additional income is? For simple math 20% = $100,000 – I can almost promise that is going to be nowhere close to her tax bill. Heck, the federal rate at that amount is 39.6% = $198,000. Safe to say that not many have $200,000 laying around to pay Uncle Sam.
So back to our original problem, $300,000 in loans at 7%. What is needed to pay this amount off in 5 years, 10 years, 15 years, or 20 years?
- 5 Years= $5,940 per month
- 10 Years= $3,483 per month
- 15 Years= $2,696 per month
- 20 Years= $2,326 per month
Yes, this is simplified in numerous ways, but it should start to give you an idea of what is needed to pay off your loans in real time frames (before you turn 50...hopefully). Also, I kept the 7% rate throughout, you should be able to get lower rates for 5 or 10 years, maybe 15 years, depending on your financial history.
Okay, Suzy had a large loan balance and a significant interest rate. While that loan amount might seem crazy, that is commonplace for young medical professionals and attorneys.
Mr. Joe Engineer
Joe earned an engineering degree from the best university in the country, Penn State (We Are!). Okay, that is a biased opinion, but they do have a solid engineering program. Joe had $50,000 in undergrad loans with a weighted interest rate of 6.125%. Joe was smart and consolidated into a Federal Direct loan to make life easier.
Joe is good with numbers (engineer bias) and assumed the “standard repayment” was standard. However, he didn’t realize that with his loan balance he just signed up for 25 years of repayment! So when Joe got his first bill in the mail for $326, he thought to himself, this isn’t so bad! Not realizing his loans would not be paid off until his 50th birthday.
$50,000 in loans at 6.125% with a standard repayment (25 years). What is needed to pay this amount off in 5 years, 10 years, 15 years, or 20 years?
- 5 Years= $970 per month
- 10 Years= $558 per month
- 15 Years= $425 per month
- 20 Years= $362 per month
Now, these numbers don’t seem too bad compared to Miss Suzy, but you have to put them into context. Joe’s current 25-year plan is $644 less than the 5-year payoff period ($326 vs. $970), that is nearly 3x his current repayment amount!
Let’s use a percentage breakdown and assume Joe’s salary out of college is $65,000 as an engineer. On a 5-year payoff, $11,640 per year would be going to pay for Joe’s student loans. That is 18% of Joe’s gross income going to pay for student loans! If you want to know why millennials are still renting (or living with their parents) and not buying homes, here is why. It is nearly impossible to save for a down payment when 20% of your gross income is going to student loan repayment.
Yes, you could say I am being aggressive with a 5-year repayment, but even a 10-year repayment is still 10.3% of Joe’s gross income.
Mrs. Sam Mommy
Sam is a stay at home Mommy (shout-out to all the awesome Mom’s out there!), or Chief Family Officer (CFO), and got her degree in liberal arts. She went to a local state school, so it kept her loans balance down. She has a $15,000 loan balance with a weighted interest rate of 5.625%. Like Joe, she consolidated all her loans to a Federal Direct loan and opted for standard repayment because $124 per month was feasible based on their household income.
However, the standard repayment for a $15,000 loan balance is 15 years. So what would it take for Sam to pay off her loans in 5 or 10 years? We won’t use 15 years since we know that answer (hint: it is $124/m).
- 5 Years= $287 per month
- 10 Years= $164 per month
I tried to keep these examples simple and make the stories relatable to what I see a lot regarding student loans. I didn’t talk about the details of Public Service Loan Forgiveness or the different types of income-based repayment plans. They are all imperative, but the details are very specific to the client. So for this post, I wanted to take the big picture view.
Again, I challenge you to take a few minutes to crunch some numbers to get your weighted interest rate and then see how long it is going to take to pay off your loans with your current payment amount. I think all too many underestimate their interest rate and also assume their student loans are going to be paid off sooner. But in reality, it is the opposite, and there are some who are going to be paying their loans much longer than they ever imagined.
- For ANY tax and/or legal notes above, I am not an accountant/CPA or an attorney. Please be sure to consult an accountant/CPA or an attorney before implementing. This blog does not constitute tax advice or legal advice.
- Advisory Services and Financial Planning offered through Vicus Capital, Inc., a Federally Registered Investment Advisor. Registered Representative offering securities through Cetera Advisor Networks LLC, member FINRA/SIPC. Cetera is under separate ownership from any other named entity.