A Young Lawyer’s Financial Guide | Part 5: Student Loan Debt Payment

Kitch's Corner:

A Young Lawyer's Financial Guide

Part 5: Student Loan Debt Payment

Law students face the burden of student loan debt every year. According to an ABA report, around 90% of recent law school graduates have an average of $130,000 in outstanding loans – with many owing much more. Left unmanaged, this substantial amount of debt can lead to disastrous effects on a young lawyer’s life, such as anxiety, depression, and financial hardships. To be clear, there is no one-size-fits-all when it comes to paying off student loans, but everyone needs to have a good plan prepared before they begin their career. In this article, I will walk you through some of the most important things to consider when devising a strategy for paying your loans.

Devise a Unique Repayment Plan

The most common questions regarding student loan repayments tend to be: how much should I pay and how quickly should I pay it? Unfortunately, there is no perfect answer to these questions because everyone’s approach to paying student loans needs to be tailored to their unique circumstances. Some of the most important factors that you need to consider when making this decision are:

1) what are your short-term and long-term career goals?

2) how much money do you plan to make after graduating from law school?

3) do you believe that your income will gradually increase or decrease over time? and

4) are you willing to make lower monthly payments so that you can enjoy a higher quality of life?

If you haven’t already, I’d urge you to review my previous article about how to create a budget (particularly, the discussion about opportunity costs) because it is essential to have a personalized plan that accurately reflects your entire financial picture. This plan needs to include your yearly income (plus any additional money earned from bonuses, etc.), important expenses (rent, food, etc.), and other miscellaneous things (investments, etc.). Remember, life is unpredictable, so you may want to consider leaving aside some “emergency fund” money to take care of unexpected expenses. Once you have these figures (or at least an estimate) listed, you can start to think about loan terms, monthly payments, and the right plan for you. Another great tool that you can use to help evaluate your loan repayment options is the Loan Repayment Simulator that the Department of Education offers.

Know Everything About Your Loans

The first, and most important step is to learn everything about your loans. You need to identify exactly how much you owe, what is the interest rate on each loan, to whom do you owe (whether private or federal loans), what are the minimum monthly payments, and what are the grace periods on the loans. When reviewing your loan’s interest rate, make sure that you know whether it is a fixed or variable rate. The former simply means that the stated rate will not change while the latter means the rate may fluctuate with the market – in other words if you have a variable loan, you could be forced to pay more if interest rates increase. It might be helpful to get a credit report from a site such as Credit Karma to ensure you’ve accounted for every loan that you have. Also, make sure that you review the eligibility requirements for loan deferment and forbearances. This first step can be extremely time-consuming so it’s important to get this done early.

To emphasize how important this step is, note that accidentally missing your loan payments due to poor management can have severe real-world repercussions. Just a single missed payment can significantly lower your credit score. If you miss multiple payments or end up in default, then you may no longer be eligible for deferments or forbearances – depending on the circumstances, you could end up having your wages garnished or be required to pay the entire loan balance all at once. A good way to ensure that you never miss a bill is to set up automatic payments and have the money taken straight from your account. To be extra careful, you could open a checking account that is only used for loan repayment and deposit the payment amount each month.

Repayment Plan Options

Generally, federal student loans can have some unique advantages over private loans. Unlike private loans, the terms and conditions of federal loans are set by law and allow for flexible repayment options, fixed (and lower) interest rates, and postponement options. On the other hand, the terms and conditions of private loans depend on the borrower. With that said, in certain circumstances, you may be able to negotiate slightly different terms before you start paying your private loans, and in some cases, a private borrower may allow for a postponement if you are unable to make payments. Both federal and private loans will have standard loan terms (for example a 10-year term at 5% interest) but if you require flexibility, federal loans offer an array of income-driven repayment plans, which will calculate your monthly payments based on a percentage of your household income. These plans are great options for lower-income earners.

Other federal loan payment options include Graduated Repayment Plans, which start with lower payments and then gradually increase during the term of your loan – this is a great option for someone that expects to earn more money over time. For those who are planning to do Public Service work, you should speak to your program coordinator (and possibly a loan counselor) about eligibility before you begin paying your loans. Some of the federal repayment plans can disqualify someone from being eligible for forgiveness.

Student Loan Repayment Strategies

Make Extra Monthly Payments:

When thinking about paying down on your loans, if you’re able to, you should consider making extra payments every month on top of your minimum required amount. This is a great strategy that will lower the overall amount of interest that you will pay during the life of the loan and will also accelerate your path to being debt-free. You can use a loan repayment calculator to see how much you will end up saving. If you have multiple loans and you are unable to make extra payments on all of them, then you could use either the “Debt Snowball” or “Debt Avalanche” method.

The Debt Snowball method argues that you should start by making additional payments to the smallest debts while making minimum payments to the larger ones. Once you knock out the smallest one, you continue to the next smallest one. This method has been lauded by Dave Ramsey because it is easy to follow, helps you with consistency and to build momentum by getting quick wins. The downside, however, is that by tackling the smallest debt first you may pay more overall since you continue to incur interest from the more expensive portion of your debt.

The Debt Avalanche method is the opposite. Instead of paying the smallest first, you begin by tackling the largest debt. Mathematically, this means that you will pay less interest over time and that your loans will be paid off quicker. However, you need to be consistent and cannot miss any of those additional payments. Also, since you will be making much larger payments at the beginning, you’ll need to make sure that you have a constant stream of discretionary income.

Pay more with “extra income”

In this strategy, we are talking about using money that is not necessarily a part of your monthly income, for paying down on debt. For example, tax refunds, bonuses, or cash gifts (birthdays, weddings, etc.) all count as extra income. You can use all (or a percentage) of these funds to pay down your loan principal.

Refinancing & Consolidating

Though most borrowers are aware of these terms it can be very difficult to tell the difference – especially since they are used interchangeably. Simply put, refinancing is when you take out a new loan to pay down your current loans and consolidation is when you combine multiple loans into one. The advantages and disadvantages of each method will depend on the type of loans that you have – and in many cases, a consolidation will be a refinancing as well.

Federal student loan consolidation: the federal government allows you to consolidate most of your federal student loans into one new loan, which has a different interest rate (usually the weighted average of your old loans’ rates). The main advantage of doing this is the convenience of only having one bill to keep track of, and the consolidation usually lowers your monthly payment amount. However, note that this is because the repayment term gets extended, so you pay more interest over a longer period. Only federal loans are eligible to be consolidated by the government. You can go here to learn more about federal loan consolidation.

Private student loan Consolidation & Refinancing: In the context of private student loans, the words refinancing, and consolidation are effectively the same. When you consolidate or refinance through a private lender, that lender will pay off your current debt and then issue you a new loan with a different interest rate and repayment schedule. Refinancing is a great option for someone that has high-interest private student loans and can obtain a significantly lower interest rate and better terms. Moreover, this has become an even more attractive option in recent years because of record-low interest rates in the U.S. Depending on the repayment term, you might end up paying more over the life of the loan. Also, to be approved for a refinancing (and get the most favorable terms), you will need to have a good credit score or a co-signer.

Be extremely careful if you are thinking about refinancing a federal loan through a private lender. If you decide to do this, then you’ll lose all the unique benefits discussed above that federal student loans have to offer. You’ll also no longer be eligible for loan forgiveness or cancellation programs. Before you decide to refinance, I would suggest that you do a detailed comparison between the terms of your current loans and the terms of the refinanced loan. To learn more about private loan refinancing, you can head over to SoFi (a student loan refinancing specialist) and review your options. You can also go here for a list of other student loan refinance companies. Please be aware that student loan refinancing scams are rampant, so make sure that you only contact a reputable company. If you are heading into private practice, check with your employer’s benefits coordinator to see if they partner with any student loan refinancing companies. They will usually offer better rates.

Conclusion

The most important factor for tackling your student loan repayment is to formulate a plan that works for you. The specifics of this plan will be different for everyone, and many might need to have multiple scenarios baked into that plan. With so many options available, there is simply no clear answer regarding the most effective strategy, but one thing is for sure: the worst option of them all is to have no plan. As a law student, make sure that you take advantage of the resources at your disposal that can help you learn more about which repayment option fits your specific circumstances. This includes going to your loan counselor if one is available, reviewing student loan information on the ABA’s website, asking your future employer about loan assistance benefits, and drafting a budget that includes your monthly payments. Though the burden of student debt is significant, with the right planning and discipline, it is manageable. If you stick to the plan that you’ve made, then you will be on your way to being free and clear of debt and can use those additional funds for the things that really matter in your life.

*Note that interest on student loans from federal agencies has been suspended until Jan. 31, 2022