Debt Reduction and Wealth Accumulation
Gaines H. Liner, PhD
So you've finally graduated from college. Chances are if you're like the thousands of other students to graduate this year, you've accumulated at least a few college loans; and like most college graduates, you're concerned about paying them back.
Like most financial matters, prioritization is key here. Find the loans with the highest interest rates -- these are the most costly loans -- and pay them off as soon as you can. To see the advantage of this, let's look at some examples:
Our first example is a $10,000 loan with a ten year payback period and an interest charge of 7% per year. For this loan, you will make 120 payments of $116.11 per month (excluding the final payment), over the course of ten years. All in all, you will pay #13,932.94 to the loan company. Notice that you will pay $3,932.94 in interest payments.
Our second example is also based on a $10,000 loan with a ten year payback period, only this time with an interest rate of 3.5% per year. While you will still make 120 payments, they will be only $98.99 per month. This makes for a total of $11,866.21 over the course of ten years.
When given the choice of which of the above two loans to pay off first, it is obvious which you should pay off more quickly. If you can pay off one of the loans right away, but pay the other over the ten year period, choose the higher interest one for immediate payment. By doing so, you'll save $2,066.73.
Prioritizing your payments is one step -- but actually making them is another. How exactly will you keep up with the required loan payments? If you're going to keep a good credit rating for future loans (for purchases such as a house, a condo, a loft, or a car), it is imperative that you not miss a payment on your current loans. Rather than writing a check each month (or directly wiring payments to the loan company,) it would be a good idea to set up an automatic transfer from your checking account to the loan company (this is sometimes called automatic direct debit.) With direct debit, you won't have to remember to write a check or transfer funds each month, so you're less likely to miss a payment.
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