You may be wondering, like I am, whether it is wisest to pay on my temporarily paused federal student loans or if it’s best to pay extra on my credit cards. Both can end up growing into a mountain of extra debt thanks to accrued interest. If you are in the enviable position to have some extra cash you are able to use to pay down debt, you may be wondering which debt is the best to pay off now that the student loans are not accruing interest for the next 2 months. Well, let’s check the math on that.
Over 43 million federal student loan debtors have had their payments continued to be paused yet again until January 2023. This is amazing news and a welcome relief for those struggling to make their payments, and even those who are able to make their payments but are able to save massively on not accruing any interest in deferred time. We have had two years of paused payments thanks to the economic turmoil caused by the COVID-19 pandemic. But this is the last continuation of the payment and interest pause. So how can we make the most of it?
If you are one of the lucky ones who has been able to continue to make some or all of your federal student loan payments throughout the payment pause, bravo. Job well done taking advantage of that pause to pay down your principal and save on interest. If you haven’t been able to continue paying every single month (*cough* me), please continue to follow along because I’ve still got some useful information for you as well.
But I don’t have to pay, right?
Even if you don’t have to pay, you still have to pay. That debt isn’t going to go away on its own. Well, not unless you qualified for student loan forgiveness under existing plans or the new August 2022 sweeping debt forgiveness plan. But for many of us, even if we qualified for the new debt forgiveness plan, our loan balances dropped from a migraine to a tension headache. When you owe $60k and then you get $10k in loan forgiveness that’s great and sure I’ll still take it, but I now still owe an ungodly amount of money that just seems to keep growing every year no matter if I’m making the payments or not. Why is that anyway?
Interest Capitalization. That means that any unpaid interest, either partially unpaid because you are on an interest-driven plan or wholly unpaid because you are deferred (unrelated to the 0% interest pandemic payment pause), gets added to the principal balance of your loan and then that entire new, bigger balance is charged interest. That is how people graduate with $25,000 in debt, make payments for years under an income-driven plan totalling thousands of dollars, and still owe more than they originally borrowed!
But I digress.
What do I do now?
Let’s assume that that big hairy monster of student loan debt is still right outside your house, threatening to eat up your front lawn. And now, finally, you can pay your student loan bill every month, pandemic deferral or not. Yay budgeting and frugal living!
So now what? How can you finally get some traction on shrinking this monster that makes your heart rate increase whenever you open that bill and see the balance?
First thing’s first: get off of an income-driven payment payment plan.
Unless you have worked out all the math and you can save a massive amount of money making payments under the income-driven plan and your loan is set to be forgiven under the Public Service Loan Forgiveness plan or another plan, move toward making payments in full each month.
Need another nudge to see why you should not have an income-driven payment plan? Log into your student loan portal at your federal loan servicer’s website and check what your payments would be under your current income-driven plan and under the standard repayment plan. Then look at those pages as they have a chart that will explain how many years it will take to pay off your debt and how much you will pay.
When we calculated this we learned we could save $14,000 and pay it off several years earlier by switching to the standard payment plan. Shoot, we could use that money for a new car, or a vacation, or a new air conditioning unit for our house rather than pay it to the loan servicer for interest payments.
I know I know, but the monthly payment is gonna be more than your car payment! Me too girl, me too. But hear me out. You’re gonna want to rework your budget to try to make that payment in full every month. You could be saving the price of a used car! Think of this in terms of the long game and not in the short run. A sacrifice now to make that larger payment will literally pay off in the end.
Work to move toward the plan that allows you to pay the most that you can afford on your loans. Work to tighten your budget, get a side hustle, ask for a raise, anything you can find to get some more money to throw at this debt. I am NOT saying you should not pay your other necessary bills or stop paying on other debts. That’s not gonna serve you. What I do mean is look to see if there is anywhere in your budget that you can reasonably minimize or eliminate. And/or flex your hustle muscle and get going on some side hustle that works for your and your family’s available time and energy. If you can scrimp together the money to make those payments in full, you will save a lot in the end.
But my loan is at 0% interest now. Shouldn’t I pay other debts first with higher interest?
Aye, there’s the rub. So, let’s do some math. I will use some general numbers as an example but please run these calculations yourself to determine what works best in your specific situation.
Federal student loans will be deferred for twomore months (November and December of 2022). What you calculate now may change in January 2023 when your interest kicks back in and starts accruing. Your mileage may vary.
Pre-step: Log into your federal student loan servicer’s website to get your total amount due on each loan as well as the interest rates for each loan. Do the same for your credit card. If you have more than one card or loan you can run the calculations for each to see which particular card or loan would get the most benefit from extra payments.
- Calculate the monthly interest accrued on your federal student loans (what it would be if it wasn’t deferred).
- Calculate the monthly interest accrued on your credit card.
- How much can you afford to pay extra over the next three months?
- Calculate how much that extra money would pay down the principal on your student loans. Then re-run the interest accrued calculation for your new monthly interest accrual rate.
- Calculate how much that extra money would pay down the principal on your credit card debt. Then re-run the interest accrued calculation for your new monthly interest accrual rate.
- Compare and see which one will save you the most money.
Here’s an example with links to the online calculators using average rates to help you do this.
(Note: I calculated this in October 2022 so it takes into account three months’ of payments before the end of the year. I ended up posting this in November, but the math still checks out)
Credit Card: $6,000, interest rate 19.20%
Federal Student Loans: Loan A- $30,000, interest rate 5%. Loan B- $15,000, interest rate 5%*
*Most federal student loans are actually a group of several loans with several separate interest rates. Please be sure to calculate the interest on each loan.
Step 1: Using Bankrate’s Student Loan Calculator, enter how many years are left on your loan, the balance, and interest rate. For this example, I’m going to assume the loans have 5 years left. Then click “Show Amortization Table” to see the amount each payment would be, the amount toward principal, and the amount of interest. That is the rough amount of interest accrued.
Loan A: Monthly accrued interest- $125. Principal payment- $441.14. Total interest remaining to be paid over life of loan: $3,968.22
Loan B: Monthly accrued interest- $62.50. Principal payment- $220.57. Total interest remaining to be paid over life of loan: $1984.11
Step 2: Using Bankrate’s Credit Card Calculator, enter your card balance and interest rate. It defaults to the payment as the monthly interest accrued + 1%. Leave it there. Then click “Show Payment Schedule” to see the interest accrued amount and the payment amount.
Credit Card: Monthly accrued interest- $90. Principal payment- $60. Total interest remaining to be paid over life of loan if making minimum payments: $8,423.16
Step 3: In this example, I’m going to assume an extra payment of $600 per month, so a total of $1800 extra paid before the end of the year. This is assuming a $0 payment on the student loans since they are deferred and a $150 payment already budgeted for the credit card. Even though the monthly payment goes down as the card balance goes down, I’m leaving this as a $150 monthly payment since many folks will keep the budgeted amount the same to pay down their card.
Step 4: Do the math and subtract the $1,800 in payoff money from the student loan principal balances, then re-run the monthly interest calculation using the Bankrate Student Loan Calculator.
Loan A: $30,000 – $1,800= $28,200 new principal balance
New monthly accrued interest- $117.50. New principal payment- $414.67
Loan B: $15,000 – $1,800= $13,200 new principal balance
New monthly accrued interest- $55. New principal payment- $194.10
Step 5: The math is a little more complicated since the interest is still accruing and there’s also a $150 monthly loan payment. So do the math as shown below, then re-run the monthly interest calculation using the Bankrate Credit Card Calculator.
October Credit Card: $6,000 – $150 standard payment -$600 extra payment= $5,250 new principal balance
New monthly accrued interest- $78.75. New principal payment- $52.50
November Credit Card: $5,250 – $150 standard payment -$600 extra payment= $4,500 new principal balance
New monthly accrued interest- $67.50. New principal payment- $45
December Credit Card: $4,500- $150 standard payment -$600 extra payment= $3,750 new principal balance
New monthly accrued interest- $56.25. New principal payment- $37.50
Step 6: Compare your savings!
Loan A- Monthly accrued interest- $125. Principal payment- $441.14. Balance- $30,000. Total interest: $3,968.22
After the extra payments that dropped to New monthly accrued interest- $117.50. New principal payment- $414.67. Balance $28,200. Total interest: $3,730.13
Loan A Interest Savings: $218.22
Loan B- Monthly accrued interest- $62.50. Principal payment- $220.57. Total interest: $1984.11
After the extra payments that dropped to New monthly accrued interest- $55. New principal payment- $194.10. Balance: $13,200. Total interest: $1746.02
Loan B Interest Savings: $238.09
*Note: this calculation is only for non-capitalizing loans and estimates that student loan interest is paid in full from monthly payments. If you are on an income-driven repayment plan and run this calculation, you will still have interest capitalized annually and will have to account for that as well. I would look for an online interest capitalization calculator which factors in the unpaid interest on your loans which you can calculate based on your income-driven repayment plan.
Credit Card: Monthly accrued interest- $90. Principal payment- $60. Total interest remaining to be paid over life of loan if making minimum payments: $8,423.16
After the extra payments that dropped to New principal payment- $414.67. Balance $28,200. Total interest: $3,730.13. Total interest remaining to be paid over life of loan if making minimum payments: $5,048.17
Credit Card Interest Savings: $3,375.99
Wow! That extra $1800 turned into major savings! In this exercise we continued to pay the $150 per month payment on the credit card which added $450 to our $1800 extra debt money for a total payment amount of $2,250 toward the credit card. But the savings on the credit card still were higher. Paying off your high-interest credit card debt is the real money saver, even over paying off your big, hairy federal student loan.
Thanks to ungodly interest rates of 18%, even a credit card balance that is $6000, less than half or a quarter of the other student loan balances, can have massive interest payments. Hence, your money goes farther if you pay the credit card monster instead of the student loan monster. The student loan may be larger and seem scarier, but it walks a whole lot slower than the credit card monster that is smaller, faster, and has sharper teeth.
I know it seems so scary to see that massive student loan balance and feel like you need to do something, anything, to make it go away. But right now, the best bang for your buck may just be paying your credit card and continuing to float your massive student loan on the 0% interest wave.
Of course, if you don’t have any other higher-interest debt, like credit card debt or even a car loan, then by all means, pay ahead on those pandemic-deferred student loans and get yourself back $200+ for your efforts.
**Remember, I’m just a stranger writing on the internet. Any advice given is general advice. Please consult your financial professional for your specific financial situation. And please do not invest in meme coins unless you like lighting your cash on fire for its entertainment value. Thank you.**