It’s well documented that the cost to attend college, both for undergrad and graduate level studies, gets more and more expensive every year. So it shouldn’t be a surprise that 62% of seniors graduating with a Bachelor’s degree have student loan debt and today's graduate students are 3 times more likely to borrow for school than students in 1995. And U.S. students are carrying a hefty debt load.
The average balances for student debt are:
- Those with Bachelor’s degrees: $36,635
- Those with Master’s degrees: $71,287
- Those with PhD’s: $159,625
- Those with MD’s: $215,900
So if you’re in the majority of college attendees with debt, how do you prioritize paying off your loans and saving for your future? Are they mutually exclusive or can you work on both goals simultaneously? The answer will depend on your budget and the nature of your debt.
Step 1: List your income and expenses
The first step to improving your financial picture will be to get a handle on the details. Open a spreadsheet, list all of your monthly income, total it, then list all of your expenses and when listing your debt, use the minimum payment amount. Now total your expenses, then subtract your total income from your total expenses.
Our goal for this exercise is to increase the difference between your income and expenses and then decide whether you should put that money toward savings and retirement or paying off debt.
Step 2: Prioritize your expenses
In order to grow that bottomline number (i.e. your output), we need to address the specific line items (i.e. the inputs). First, we’ll tackle the expenses. Go line by line and categorize each number as either fixed or flexible. A fixed expense is an expense that is the same each month, like your minimum car payment. A flexible expense is something you have control over such as groceries. Sort the expenses so that all of the fixed expenses are grouped together and the flexible expenses are grouped together. This will help you visually see what you can change.
Then, prioritize your debt. Next to each debt line item such as student loans, credit cards, car payment, etc., list the interest rate. You want to at least make the minimum payment on all debt, but pay down the higher interest rate debt faster than the others. Most student loan debt carries low interest rates compared to revolving debt like credit cards.
Step 3: Are there any places you can cut?
Common places to cut back are: groceries, eating out, gym memberships, alcohol and cigarettes, or entertainment. If you have holes in your shoes, by all means, buy new shoes. But you don’t have to buy the most expensive shoes. You could also start shopping at a cheaper grocery store, cut back on eating out, or trade an expensive gym membership for a workout app.
Another way to cut down on expenses is to refinance your student debt to a lower interest rate or single monthly payment. You can also see if you’re eligible for an income based payment plan or loan forgiveness.
Step 4: Do you have any opportunities to increase your income?
Are you due for a raise? Could you change companies and increase your income? Is there a certification or continuing education course that could increase your earning potential? Could you start a side gig? Typically increasing the income number is a little more difficult than decreasing your expenses but if there’s a way to earn more money in the short term without incurring more debt, that’s something to consider as well.
Step 5: How to allocate your leftover cash
The first goal is to pay for all of your expenses, including making the minimum payments on all of your debt. Once you can do that, the next decision is: do you pay down your debt faster or do you save your money? To make this decision, you have to flush out which will be the most beneficial. Here are things to consider:
What are the interest rates you’re paying on your debt? The average annual return for the stock market is 10%. If any debt you have carries an interest rate higher than 10%, you should pay that down first.
Are you leaving any money on the table? If your employer offers matching for 401k or Health Savings Account (HSA) contributions, that’s free money. So if you can, you’ll want to maximize that matching by contributing up to the employer-matched limit.
What will maximize your tax savings? Contributions to retirement accounts like IRAs, 401ks, and HSAs are tax-deductible. You know what else is tax-deductible? The interest you pay on your student loan. So as long as the debt doesn’t carry a large interest rate, it might be better to prioritize retirement savings over paying your debt down faster.
Are you close to hitting a limit? For example, if you’re really close to paying off your student debt (or any debt), it might make sense to just get it paid off immediately and then turn your focus to saving. Conversely, if you’re close to maxing out your employer’s contribution matching, it might make sense to allocate your money there.
What causes you more stress: debt or lack of savings? You might be comfortable with a monthly payment that’s built into your budget, but the thought of not having a rainy day fund gives you anxiety. Or you might physically feel the weight of debt hanging over your head on a daily basis. Stress is an intangible factor but should be considered when deciding how to allocate your money.
As an added benefit, your employer may even offer access to financial wellness benefits like financial counseling and loan repayment assistance, so be sure to ask about those.
Going through the exercise of deciding how to prioritize your debt and allocate your money might take a little time, but it’s important to ensure financial stability. It can also give you a sense of relief to know where you are in your financial journey and which levers you can pull to better your position. It’s also an exercise you want to do on a yearly basis. If you have questions or want professional advice on how to manage your money, you may want to reach out to a financial advisor.
Disclaimer: the content presented in this article are for informational purposes only, and is not, and must not be considered tax, investment, legal, accounting or financial planning advice, nor a recommendation as to a specific course of action. Investors should consult all available information, including fund prospectuses, and consult with appropriate tax, investment, accounting, legal, and accounting professionals, as appropriate, before making any investment or utilizing any financial planning strategy.