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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.
3 Benefits of Making Interest-Only Student Loan Payments
How to Make Student Loan Payments While You’re Still in School
Student loans 101: Everything from how much to borrow to paying it off
Great advice! I did this when I got my MBA (actually, I paid down some principal as well) and it helped so much! It even gave me the confidence to cash flow the last few semesters. When I finished up my degree, I was able to knock out the debt in a handful of months by applying every windfall towards my student debt.
You played it right, Emily. Well done!
I’m curious, how did you know to do this? Who were you having financial conversations with at the time?
Another excellent article Lauren. That is a great idea to pay as you go to lessen the blow of interest. However, I think I may have been better off if I started investing during college. The ROI from investments are probably going to be higher than the relatively low interest rates on student loans. So over the course of 4 or 5 years, I would have made more than I would have saved myself paying off the interest. Both great strategies. Probably comes down to psychological or emotional factors about debt and individual situations.
Interesting theory, DD. I think, emotionally and psychologically, it would be very difficult to invest while in school and racking up debt. Maybe knowing what we I know NOW I could.
For me it’s not always about the numbers. And I also feel that when you get out of college and begin your work life, the less debt you have, the more you can focus on the right career choices.
Grea tip. Something I’ll share with my two college-bound children!
Excellent! Hopefully they won’t be in too much debt with the scholarships they’re getting, Brian. But this could ease the situation.
WOW. I guess I didn’t realize – not having a college degree – that interest accrued on student loans while you were still in school!!!! I’m SO glad I know this now. Our second oldest is entering 9th grade this fall and is headed to school for a degree in elementary education. This valuable piece of information will definitely change how we do things: thank you!!!!!
Great! We were hoping this information could help someone adjust plans. Who knew?
Yep, that capitalized interest is a killer, you know you made a mistake when your interest becomes principal and starts getting interest
Also – don’t “take advantage” of the 6 month grace period after you graduate – start paying day 1 (provided you have a job)
That interest is indeed a killer, AE. It’s worse than The Blob! (As per IMDb, the blob was “an alien lifeform that consumes everything in its path as it grows and grows”.)
If only I’d thought about paying that off during those years, I could’ve saved myself a lot of coin. Alas, I would’ve found a way to say I can’t afford it while still going out at least once or twice a week with friends.
I still have what I refer to as my “squirrel fund” for what you suggested – squirreling money away, mostly just from myself. 🙂
I hear ya, Mr. SSC. While fumbling toward my undergraduate degree, I was often late with the rent and my share of utility bills. I also had a nagging difficulty coming up with some coinage for the laundromat. But I always had money for beer and tacos. Meh.
I had never heard of this concept, but it’s brilliant. I was unaware in college that interest was accumulating on my loans, and I didn’t start paying them back until 6 months after I graduated. I wish I had known this back then! I’m sure this will help a lot of students out there.
It is brilliant. With just a little foresight and hustle, one could do themselves a huge favor. Sacrifice two nights of debauchery a month and save 20% on your unsubsidized student loans? Sounds good to me. Thanks for stopping by, Matt.
This is a fantastic concept. We didn’t pay off our student loans until after we got married. Really didn’t even have any grasp of interest and how much we owed until then. I don’t want to know how much was lost in interest.
I was in the dark too, Grant. Lauren totally opened my eyes.
I was totally guilty of burying my head in the sand on this one. I have no idea how much my initial loans were for, and I consolidated some and had them on income based repayment for a while, so I just knew the huge numbers at the end.
It all worked out eventually once I got a grown-up job, and working while in med school would have been really difficult with a crazy schedule, but it would be interesting if I could find those numbers now and see how much interest I paid.
I admittedly was in the same situation early off in college. I really had no clue how my student loans worked or even how interest worked in general! I’m glad you figured it all out! Thanks for commenting 🙂
“Compound interest is the eighth wonder of the world. He who understands it, earns it … he who doesn’t … pays it.” – Albert Einstein
It’s something I learned early on. And I’m happy I did, because I’ve been able to harness the power of compound interest to be for me, and not against me. Thanks for the post!
I love that quote – it’s so true! Compound interest can either drain your finances or make you a millionaire. I guess it’s up to us to figure out how to make it the latter case. Thanks for commenting Tim!
I wasn’t aware of the second half of Einstein’s famous quote. Thanks, Tim. This sums up the financial “game” pretty succinctly. Do you want to be punished by compound interest or aided by it? I’m with Lauren on this one. The sooner you make compound interest your ally, the better.
I was able to pay off some of my student loans when I was still in school, this definitely helped!
Thanks for sharing Lauren
Thanks for commenting Erik!
Haha I really like your intro. When I was in grad school, some students complained that they were in so much debt. But they had all of the latest gadgets you can think of in the market.
I was really puzzled as to why they didn’t just save the money and start paying off their debt more aggressively. I didn’t know their stories, but I’ve met people who live like they don’t owe anyone anything although they do. Being frugal and saving up to pay off debt is key to being an early starter in life.
Exactly! So many people don’t realize how much money they could save if they work to pay off their debt faster instead of splurging on luxuries. Thanks for commenting!
My college had a generous meal plan and at the end of the semester I always had probably $300 left that’s essentially money I already paid for. During the last few weeks I went into the university store and brought $50 of such and such and resold it at a loss to someone who wanted random groceries out of campus for like $20. But I didn’t need groceries, I wanted cash! It’s pretty easy to squirrel away $50 if you get creative hehe.
Despite the dismal ROI, in college I did learn to hustle like a poor cheapskate.
Great strategy! I never thought of that one, I just tried to stuff my face at the end of each semester, haha!
I don’t know, I think Lily was born with the hustle gene! Very ingenious!
Hehehe aw shucks thank you Mrs G! ^_^
Agreed. Lily is a special kind of awesome when it comes to frugality.
Currently: grinning from ear to ear like a moron at the Internet! Thank you Mr. G!!!
So much yes to this! Make interest-free payments on those loans while you can. I know some people who saved up a crapton of cash *before* they went to college so they could pay for it outright. If you budget carefully, choose a profitable major, and go to an affordable school, you can get a degree relatively cheaply.
Hi Mrs. Picky Pincher,
Thanks for the comment! You’ve got the idea!! Too many of my friends blindly take out student loans and pick an easier major so they treat college as a 4 (or more) year vacation. No wonder there is such an issue with student loans nowadays.
When I went to college, you went from high school into a 4-year or community college without giving it much thought. For some it was a vacation, for others it was a bridge to adulthood. Many went without having serious career ambitions or preferences. These days, the costs force you to take your career path more seriously, which in a way, is a good thing.
I treated my first round of college as a 5-year vacation. Huge mistake. Not in a money sense, fortunately, but in an opportunity sense. I went to Buffalo University from 1979 to 1984. College back then was still cheap. During those five years I racked up less than $6K in student loan debt. But I left UB without any skills or discipline. And that really hurt. I wasn’t able to turn my financial life around until I was almost 40. Ouch. Message to young people: Listen to Lauren. Don’t treat college as a 5-year bacchanal. Take it very seriously on the academic front and the ROI front.