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The financial camps are divided between paying off your smallest first vs. your highest interest student loan. So who’s right?
Finance people can agree on a few things. Some debts like payday loans and IRS back taxes are worse than others and ideally, you should get rid of all debt that keeps you from having a positive net worth.
But how do you decide what goes first? This is something I stressed over when we started out. I had a large high-interest student and a small low-interest car loan while my husband had a moderate student loan with moderate interest. A total conundrum.
Also read: Is Being Debt Free Worth it?
So if you’re struggling to figure out where to start here’s a look at my theoretical friend and her theoretical $60,000 of student loan debt. She took out federal and private loans and doesn’t have a career that qualifies her for any student loan forgiveness. (Or this could be a couple’s student loans combined, however you want to look at it.)
Her theoretical student loans are:
a. $20,000 @ 4% interest with minimum payment of $150 p/m
b. $40,000 @ 6.5% interest with minimum payment of $300 p/m
I wanted to keep monthly payments as similar as possible so I adjusted the number of months for payment of the first loan accordingly keeping the total repayment for both at 36 months.
Pay off the Smallest Loan First
a. $1574.60 per month for 13 months. Total interest paid= $469.77
+$300 p/m for the minimum payment of other loan= $1874.60 total monthly payment for first 13 months.
b. After 13 months of minimum payments, the balance is now $38,879.74 with $2,780.72 of interest paid during this time.
The new monthly payment becomes $1,802.44 for 23 months and we end with $2,577.18 more in interest paid.
Total interest paid over 36 months: $5,827.67
Pay off the Highest Interest Loan First
b. $1653.49 per month for 26 months. Total interest paid= $1,803.49
+$150 p/m for the minimum payment of other loan= $1,803.49 total monthly payment for first 26 months.
a. After 26 months of minimum payments, the balance is now $17,763.60 with $1,641.55 of interest paid during this time.
The new monthly payment becomes $1,809.03 for 10 months and we end with $327.28 more in interest paid.
Total interest paid over 36 months: $4,959.65
Difference= $868.02 saved by tackling higher interest loan first.
To compare, I calculated paying both at the same time.
Monthly Payment= $1,816.44 for 36 months
Total Interest Paid= $5,391.83 Less than option 1, more than option 2
I then further calculated to see what the difference would be if my friend paid off her loans in 5 or 10 years:
5 years= $9,058.59 in interest paid (There’s that car she just financed)
10 years= $18,801.86 in interest paid (There’s that down payment on a house she said she couldn’t afford!)
The moral of the story is that if $800 keeps you up at night you should pay off higher interest loans first, especially if they’re big behemoths.
But if $18,000 keeps you up at night you need to get out of bed and start hustling.
Paying $1800 a month on student loans looks like a big number but maybe your loan is smaller, maybe you have the means to move in with more roommates or cut the cable and eating out.
Also Read: How to Make Paying off Debt not Suck
If you have smaller loans within your student loan pay those off in order of smallest to largest or break it down into milestones. Rewarding yourself with attainable benchmarks will help keep you motivated.
Whatever it is it’s time to start looking into the future and think about what you want to be doing with your money instead of giving it to the bank. Because the one thing everyone in the world can agree on is that it’s not fun to give away your money to banks when you don’t have to.