As I’m sitting here wondering how my fiancée can fastest pay down her two highest-interest student loan debts, a strange idea came to mind. But first, let me preface my idea by noting that her two highest-interest student loan debts are private loans she received from a local credit union before starting college. She tried having the interest rates lowered on multiple occasions over the past few years but the canned response from the credit union has always been a resounding “there’s nothing we can do.”
For perspective, the balances on the two high-interest loans are $13,759.13 for one and $8,166.02 for the other. The interest rates are 8% and 11.25%, respectively. Ridiculous! The monthly minimum payments for each one are $219.40 and $108.77. The worst part, though, is that out of the two minimum payments, only about $155 is being paid down in principal each month…combined! So, we’re looking at a monthly expense of $328.17 and approximately $173.17 is being dumped in the trash! Over half of the monthly bill goes straight to interest charges!
I normally agree with the Dave Ramsey philosophy of paying down debts with the lowest balances first, but since these private loan rates are so high we’re going to knock the two private loans out first and then jump back to attacking other student loans with the lowest balances. I mean for goodness sake, in 2014 she paid $2,065.14 in student loan interest on just those two loans!
But as I mentioned at the beginning of this post, an idea came to mind as I was sulking over my frustration about her throwing away so much money each month. Obviously, this credit union is making a killing off of this pair of student loans. Imagine if we were to walk into the credit union tomorrow with a checkbook, ready to write them both off in full (we can’t afford that by a long shot right now, but hang with me here). Mathematically, if we paid them off right this instant, the credit union would be out thousands of extra dollars they could be receiving in interest charges if we continued to make minimum payments until they were both paid off. So, couldn’t that be a bargaining chip for lowering the interest rates, even if just a little bit?
Unfortunately, as we all know, this scenario would never happen. First of all, if we really had the money to write them off we’d be fools not to go ahead and pay them in full right away. Second, the bank probably doesn’t care if we pay off the loans in full right this instant since they’re making money off of thousands of other suckers, too. And it sure is a shame, especially because this is a credit union we’re talking about – owned by the depositors – the community!
At the end of the day I know we won’t get those high-interest loan rates lowered, and trying to consolidate those loans with another lender would probably dig deeper holes. But, regardless, the situation does make us fired up and want those loans out of our lives as soon as possible. Thank goodness for the tax benefit of getting back money on paid student loan interest. And thank goodness credit unions pay out dividends each year!
This is an area in which I don’t think Dave Ramsey is right. There is something to be said for the motivating feeling gained by knocking out the smaller loans quickly. However, the approach will cost you more money in the long run. It’s about quick gratification.
Paying off the higher interest loans first seems to be about delayed gratification. After all, you won’t see a bill eliminated for much longer. However, you will pay much less money in interest over the long run and your monthly minimum payments will go down faster. This means you will have more money to put towards extra payments on the principle of your debt. This system is often referred to as a Power Pay or avalanche plan.
I don’t know about you, but when it comes to my money, delayed gratification seems to be the wiser choice. Save for that new TV and pay cash instead of using credit. Putting more money into savings now so that compound interest has more time to work its magic means that years from now, I will have more money in savings to live off of in retirement or to put down on that home I want.
Thanks for the thoughtful comments Tim! I think there are definitely benefits to both approaches depending on individual circumstances. The math game (and delayed gratification game) vs. the short-term wins game. In the end everything just takes time. We always want the quick fixes!
Sam,
I’ve been thinking about the private student loan issue. The problem is that your credit union has no motivation to make changes to your existing student loans. They know that you don’t have any real alternative but to pay off the loans. They are going to get their money.
You don’t want to consolidate your private loans with your federal loans (you can only do this by taking out a new private loan) because you will lose protections and payback options that you have with the federal loans. You won’t see your interest rates go down either. So, there is not much that you can to about them but pay them off as fast as you can.
I can give advice about ways to manage your debts in light of your bigger financial picture, but you are already on top of your finances and need no help there.
Good luck.
Tim