To get a good ROI on your college education, you got to do two things. First, you got to study your tushy off. Take tough classes and pursue tough majors. Sociology-of-Lady-Gaga classes and Animal House partying may be fun, but they’re ROI killers. Second, you got to be as frugal as possible when it comes to tuition, fees, and all the other associated costs of higher education. It makes no sense to go to a designer-label college (i.e., a pricey private college) when a store-brand college (i.e, a modestly priced state college) will do the trick. Again, designer-label colleges are great for your ego, but they increase the chance of you ending up with a dismal ROI.
One of the goals of this blog is to question the business model of the college-industrial complex and help young people become better consumers of higher education. That’s why I was so happy when Lauren Davidson reached out to me with a guest post idea. Lauren just graduated from Pennsylvania University, and she introduced me to a simple but effective way of reducing the interest bite of one kind of student loan. Take it away, Lauren.
To the 70% of college students who have taken out unsubsidized federal loans or private higher education loans, knowing they don’t have to worry about making any payments until six months after they graduate may seem like a big relief. After all, they have more important things to worry about. And once they achieve their main objective (i.e., getting a marketable degree), they will be in a better position to tackle their loan payments. While that sounds good in theory, the reality is if they paid just a little attention to their loans while they were in college, they would have much less to worry about later.
The fact is, while students may sleep better not worrying about their loans, the interest on their unpaid debt never sleeps and it feeds on itself, growing bigger and bigger each day. Suddenly, a $5,000 loan becomes a $6,200 loan. But, it doesn’t stop there, because all of that extra interest continues to build on itself until the entire loan is repaid. Over a 10-year period the total amount of interest to be paid on the loan mushrooms into a couple of thousand dollars.
Understand the Awesome Power of Compound Interest
You are probably familiar with the term “compound interest.” It is most commonly applied to accumulating money through savings, where interest earned also earns interest which compounds the growth of your money. It’s actually a phenomenal concept, which can make a millionaire out of anyone who has the discipline to regularly set aside money in savings and leave it alone.
Unfortunately, the concept can work in reverse for people who fail to understand the power of compound interest on debt. Interest left to accrue on debt is also charged interest, which can compound the growth of the debt. Consider a $10,000 loan at 6% interest taken out in the first year of college. If left to accrue interest for 48 months, it will grow to $12,400. If you make the minimum monthly payment of $142 a month over the 120-month term, only $65 is initially applied to interest each month. The remaining interest is charged more interest, until the total amount repaid tops out at $17,000. The math gets even worse for students with private higher education loans. Interest rates on private loans can reach double digits! Madness.
If instead you managed to at least make the interest payment on the loan starting from the beginning, the total paid loan would amount to just over $13,000. Reversing back the compound interest concept to accumulating money, think about how much more money you would have at retirement had you saved that extra $4,000 (about $20,000 if invested at 6% over 25 years).
Easing Your Pain
The small amount of pain it might cause to squeeze out $50 a month is nothing compared to the amount of pain many borrowers feel when they have to delay life due to crushing student loan debt. While you can’t know the great sense of relief this far in advance, you should know that you are keeping a small problem from becoming big enough to consume your life.
Before allowing another dollar of interest to accrue to your debt, you can take responsibility for your financial future by taking a few simple measures:
Embrace your frugality: You are a college student, so budget like one. $50 can be found with four fewer trips a month to a fast food restaurant or ten fewer coffee drinks a month at Starbucks. Spend your money with the purpose of saving thousands in loan interest.
Squirrel away your money: If you don’t have a part-time summer job, get one. Set aside a small portion of your earnings in savings to cover your monthly interest payments.
Work part-time at school: Just three to five hours a week will earn you enough money to make a monthly interest payment.
Granted, it can be a struggle for some college students to come up with an extra $50 a month to pay towards a loan they are not contractually required to pay. However, the younger you are when you can fully grasp the awesome power of compound interest—forward and in reverse—the sooner you will be able to claim financial independence.
Mr. Groovy here again. Thank you, Lauren. I never heard of blunting the pain of student loan debt by making interest payments on the unsubsidized debt while in college. What a clever idea. I think this will help a lot of young people.
Also, I did a quick Google search on this topic and found several articles. If any reader is interested, here they are. Peace.