Prepare for Student Loans: Consider these 5 Steps

By Cindy Scott, CFP®, ChFC®

Navigating the return of student loan repayments can be daunting, especially if you're carrying significant debt like the $50,000 in loans I faced after my college graduation in 1997. That was overwhelming, especially because my loan balance was bigger than the salary of my first job. I can tell you though, with careful budgeting and financial planning, it is possible to manage your debt, pay the loans off over time, and even save for other goals like retirement. Here are five ideas to help you prepare your budget for the return of student loan payments this fall.  

Step 1: Review your financial picture. 

During the pandemic, 53% of Americans with student loans added credit card debt, 36% took out new auto loans, and 15% took out mortgages and unsecured personal loans, according to a Transunion study. So, you may have additional debt to manage on top of your student loan repayment.  

To get a clear understanding of where your finances stand, create a list of your income and current expenses, and be sure to add your new student loan payment. Take a look at this monthly budget planner to get started. This will be the start of your new spending plan. Determine how much—if any— discretionary income is left over each month.  

Once you've created your new spending plan, incorporating your minimum monthly student loan payment, be sure to make your student loan payment on time each month. As you repay your loan, you're establishing credit history, so it’s critical to make the minimum payments on time.  

If you have money left over after essential expenses, that's fantastic. What could you do with that extra money? If you are contributing to your 401(k) for retirement, make sure you get at least the employer match. If you are carrying high-interest rate debt, like credit cards, consider using the extra money to pay it down. Also, consider putting money into an emergency fund to cover at least three months of essential living expenses.  

If, however, you find yourself short on funds after you review your income and expenses, the next section can help you determine next steps.  

Step 2: Identify areas to cut back. 

It's possible your new spending plan may show a deficit once you add in new monthly student loan payments. If this applies to you, don't panic. It's time to take an honest look at your spending habits and identify areas where you can cut back. Focus on non-essential spending like streaming subscriptions, memberships, eating out and going out, or even changing the brand of grocery store items you buy. By making intentional cuts to your spending, it could be possible to free up the money you need to cover your student loan payments. Going forward, get in the habit of tracking your expenses on a regular basis. This can help you avoid overspending and help to keep you focused on your spending plan.  

But what if you still don’t have enough to close the gap? Check to see if you qualify for an income-driven repayment plan. Most federal student loans are eligible for an income-driven repayment plan, which is meant to offer "affordable" monthly payments based on income or family size, according to the Department of Education (ED). There are four plans that may allow you to extend your loan repayment over a longer time period, reduce monthly payments, or apply for temporary deferments and forbearances. If you qualify, you can change repayment plans at any time for free. 

You may be wondering what happens if you miss a payment. To protect the most vulnerable borrowers as student loan repayments begin, the ED created a temporary "on ramp" phase. During this 12-month period, the ED will not report late, missed, or partial payments to credit bureaus. So, struggling borrowers won't be considered delinquent, reported to credit bureaus, placed in default, or referred to debt collection agencies during this time.  

Step 3: Balance debt repayment and saving for retirement. 

Now let's talk about balancing multiple financial goals at the same time. In my financial planning practice, I've met clients who want to postpone saving for retirement early in their career to focus on their student loan payments. They say, "I have college loans to pay off. I'll get started saving for retirement later."  

I say, if your budget allows it, why not do both?  

I know it's hard to visualize yourself 30 years from now and to prioritize saving for retirement when your budget feels like a juggling act where you are stretched in many directions, from groceries to childcare. But, if you can, it is important to prioritize contributing to your 401(k) to get your employer match, if available to you, while you pay down student loans. When you start saving early for retirement, even with small contributions, you can take advantage of compounding interest over time. Play around with this compound interest calculator. See the difference that compound interest can make over 30 years if you start saving now, versus waiting for 10 years to pay off your student loans before you start saving.  

So, here's my suggestion: If your budget allows, contribute to your 401(k) plan to get at least the match amount. The extra 3, 4, or 5% from your employer is essentially free money to help build your retirement nest egg.  

If your company match is 4% and you can contribute just 2%, that's okay. As your income grows, or certain expenses decrease—like once your kids are out of daycare—you can redirect that freed-up income toward your retirement savings. While retirement may be decades away, consistent contributions now could significantly impact your financial security later in life.  

Step 4: If you want to pay extra money on your student loans—how to decide which ones? 

If you're fortunate enough to have extra money to pay down your student loans beyond your minimum payment each month, you may be wondering which ones to pay down faster, since the interest rate on your student loans may vary. But, before you start adding payments to your student loans, consider checking off these important financial goals first:  

• Pay off high-interest credit card debt. 
• Create an emergency fund to cover three months of living expenses. 
• Contribute to your employer retirement account to get at least the employer match.

After you've achieved these goals, now it’s time to consider which student loan to pay off first. Generally, prioritize paying off private student loans over federal student loans. Federal loans have greater protections for borrowers (such as loan forbearance due to the pandemic), may have greater repayment flexibility, and have potential for forgiveness that make them advantageous to pay off later.  

Next, prioritize paying off higher interest, variable rate loans over fixed, lower interest loans. Variable interest rate private student loans are common and can spiral when interest rates are high. One way to manage this is by consolidating into a lower, fixed-interest rate student loan, but be aware that there may be a fee. 

If you are exploring paying extra money on your student loans, consider using an avalanche or snowball method. The debt avalanche method means you make minimum payments on all your student loans and then add additional money to pay off the loan with the highest interest rate first. With the debt snowball method, you pay the minimum payment on all your student loans and add additional funds to pay off the smallest loan first. 

The numbers generally work out better when you attack the debt with the highest interest rate first—starting at the top of the mountain—with the avalanche method. The reason is that you are paying off the most expensive debt first. But some people can get a psychological lift when they pay off a loan in full faster and, for them, the snowball method could be a better choice. So, depending on your personal preferences and circumstances, choose the debt payoff method that is better suited to you.  

Step 5: Stay focused on the big picture. 

The return of student loan payments can feel overwhelming. But remember that every small step you take now will help bring you closer to the day you pay off your loans. Don't feel stressed. Just do what you can now. Looking back at my own situation with student loan debt, I know firsthand how important it is to focus on it now. Be persistent, and you can see that loan shrink over time. Keep your eye on the prize. Eventually you can pay off student loans, and that will free up additional money for other goals, like saving for a down payment for a house, saving for a child's education, and putting away even more for retirement.  

Next Steps: 

• Explore more personal finance topics.  
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The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision.

All expressions of opinion are subject to change without notice in reaction to shifting market conditions. Data contained herein from third-party providers is obtained from what are considered reliable sources. However, its accuracy, completeness or reliability cannot be guaranteed.

Examples provided are for illustrative purposes only and not intended to be reflective of results you can expect to achieve. 

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