Student loans, credit history and debt repayment strategy

1. Why is it so important for students and graduates to make debt repayment a priority as they build credit history?

Credit history, by nature, measures consumer’s ability to repay debts and their demonstrated responsibility in repaying debts. A person’s consumer history (numerically represented by individual Credit Score) is then used when approving credit (credit cards, home loans, store cards, car loans, etc.). Credit history is also critical when renting an apartment, applying for utilities, cable TV, or even a cell phone plan. Everywhere we turn our personal credit history is being verified in order to access basic services, so it’s critical we behave in such a way that helps us establish and maintain a positive credit history.

Many young people should remember that a negative credit history will cost them money. This could be in the form of higher interest rates on a car loans, credit cards, or even home loans. Acquiring a habit of paying debts on time, every time, is critical in order to save money long term.

2. What are the benefits of paying of small balance debts first?  Large balance debts?

When looking at debt repayment, paying off small balance debts first has the power to create quicker emotional wins for an individual. Since debt repayment, for most of us, is a marathon and not a sprint, it requires long-term commitment and stamina. Being able to celebrate quick wins along the way will help us stay encouraged to keep going.

Being able to experience quick wins, especially for recent graduates who are also trying to find work and establish themselves in their new out-of-school reality, can be critical to help them stay out of debt.

3. Which debt would benefit a student/grad most to get rid of first (consumer debt, student loans, etc)?

This answer has to be prefaced with one very important fact regarding student loans: Student loans are the only type of debt that, in most cases, cannot be dismissed even though bankruptcy.

Student loan interest rates range from 3% – 6.8%, so compared to other consumer debt, like credit cards for example, it tends to be lower. Student loan balances, however, tend to be higher (averaging $26,500 – $27,500) than a typical credit card or even car loan.  Assuming that recent graduates have various debt balances including student loans, car loans and credit card loans, I would suggest tackling the lowest balance debt first to help them score quick wins and then roll that payment over to the next smallest balance, which in turn will accelerate their debt pay off. It’s critical that no new debt is incurred in order to keep the debt roll down method working to the max.

4. What are some examples of different debt payoff methods students/grads can use?

The best debt pay off method includes having a written spending plan (budget) where every single dollar is assigned to a specific spending category and the student is committed to stick to those boundaries. Commitment to live within their means will make or break someone’s debt repayment.

Choosing to pay smallest balance first versus highest interest rate debt should be considered in light of recent grad’s cash flow and emotional stamina (do I need frequent encouragement or am I successful in sticking to long term goals?).

The debt roll down is a very common and effective strategy to eliminate debt fast. Once one debt is eliminated, instead of absorbing that payment amount into the monthly cash flow, it should be reassigned to the next debt payment, and then to the next one.

5. How can a student/grad’s financial circumstances affect which method they use to eliminate debt?

Positive cash flow is critical when it comes to graduate’s ability to eliminate debt. When there is comfortable room in your monthly cash flow, stick to, or accelerate, your debt roll down.

When cash flow is an issue there may be a need to create more breathing room in your monthly budget as well as a need to create emergency savings (savings is key to overcoming the debt cycle.) In that case, once you pay off one debt, consider taking that payment amount and open up a savings account where you can start building an emergency fund. Having that extra cash set aside will not only help you emotionally, but it will also give you that extra cash support in case something unexpected comes up (car problems, broken appliance etc.).

6. For students/grads paying down federal student loan debt, is it wise to look into any repayment plans they may be eligible for?

Depending on student’s financial situation, there are payment options available but should ONLY be considered under several financial circumstances since both the Graduate Repayment Plan (payments can be extended up to 10 years) and Extended Repayment Plan (payments may be extended up to 25 years) offer lower payments on the front end but higher pay off amounts in the long run. Any way you slice it, in order to pay the least in the long run you should stick to your original payment option, plus pay extra if possible.

7. If grads have private student loans, where should those fall on the list of debt priorities?

Private student loans should have a high repayment priority on students list for various reasons. These loans are often subject to a variable interest rates, which means rates could go up since they are tied directly to an index. Private loans usually require a co-signer which puts the person who co-signed in a position of liability in case student is not able to make the payments. To protect the co-signer the student should repay the loan as soon as possible. Unlike with federal student loans, private loans carry much steeper penalty for missed payments and defaulting on your private student loan will almost immediately impact the credit history. Lastly, in case of student’s death, the co-signer is obligated to repay the loan.