One of the biggest ways to waste money is to use the default repayment schedule offered by the student loan system. A lot of people end up paying way more in interest than they should for two reasons:
• They don’t realize that the interest rate on student loans is no bargain, and
• They don’t realize if they use the default they’ll be paying for almost ten years.
First myth buster: The interest you’re being charged is significantly higher than the “prime” being quoted in the news. In fact, it’s higher than the rate many financial institutions will charge.
If you choose to go with the variable rate loan, you’ll pay prime + 2.5%. Choose the fixed rate option and you’ll pay prime plus 5%.
Why is the rate so much higher than the “going” rate on loans? Well, the system has not been charging interest the whole time Sammy Student was in school. Let’s face it, there’s some catching up to do, right? Okay, so the rate is no deal. Why not just consolidate with another lender for a better rate?
You could. But it would mean giving up the interest rate deductibility and the provisions for aid if you run into repayment problems, and most people are loath to give up that kind of safety net.
Second myth buster: Longer repayment means way more interest paid. The student loan system gives you way longer to repay the loan than any normal lender would: up to 10 years. Assuming you use the 6-month grace period, that’s 9.5 years of repayment.
Hang on, grace period? When you leave school, the system gives you six months before you have to make your first payment. Another illusion people choose to see is that this is a “gift.” It’s no gift. The minute you step out of your role as student, the interest rate clock starts ticking. While you may not have to make a payment, the interest is accumulating on your full debt, and that’ll cost you heaps.
Let’s say you graduate with $30,000 in student debt and you choose a variable rate and the default repayment schedule. The cost? $7,508.63. Your monthly payment will be $335.27, leaving lots of money for beer and wings and to buy that new car you just have to have now that you’re a working stiff.
But what if you decided to halve the amount of time you took to repay the loan? Sure, you’d have to cough up more — $576.07 a month — but you’d save a whack of interest: $3,656.83.
If you were determined to repay your student loans in the shortest period of time for the lowest amount of interest, here’s what you’d do:
1. Consolidate at a financial institution that would charge you considerably less interest, particularly if you were going with a fixed-rate loan.
2. Choose a repayment schedule that had you out of debt in less than 5 years.
3. Buckle down and pay off your student loan so you could get on with the rest of your life.