The Avalanche Strategy for Student Loan Repayment
On the topic of financing your first home, its important to practice sound financial principals when paying off any large amount of installment debt. One obvious form of installment debt that comes to mind is student loans.
It’s becoming more and more apparent that college graduates are sinking farther into debt. The “Project on Student Debt”, a nonprofit independent research and policy organization dedicated to making college more available and affordable to people of all backgrounds, estimates that 37 million Americans have outstanding Student Loan debt. When you factor in the fact that the average amount of debt for each borrower is somewhere between $24,000 and $28,000, you come to find that the total amount of outstanding student loan debt is about $1 Trillion! This is a staggering number that will undoubtedly continue to grow. It’s also a scary number when you consider we are living in anything but a “stable” economy.
Student Loans can be quite intimidating when you are first starting out on your own. I personally found there to be very limited resources pertaining to how to go about paying back your loans. Lenders offer several different options to help you afford your loan payments. However, one should be weary about doing anything other than paying back using the “standard repayment plan”. At the onset, it might be tempting to defer your loans to the future. But this will lead to a longer repayment period and ultimately more money paid in interest. In this post, I’m going to explain a very simple strategy that will allow you to take control of your student loans, accelerate your repayment, and minimize the amount you pay in interest.
The Avalanche is nothing more than a repayment strategy that stresses the importance of eliminating your high interest loans. The strategy takes advantage of small supplemental (or “snowball”) payments to speed up your repayment process. Here’s how it works:
- Set up your loan accounts to automatically pay the minimum amount each month. Not only is this a good practice to make sure your loans get paid on time, but almost every lender will offer some sort of interest rate reduction for setting up automatic payments. All of my loan accounts reduced their interest rates by 0.25% just for setting up auto pay. You can sleep easy knowing you won’t default on your loans, and you ultimately pay less in interest. If you have not done this yet…do it now!!
- Determine a certain amount of money you can dedicate toward a “snowball” payment each month. The key here is that you allocate something. It does not have to be a huge amount! If you can afford your minimum payments…you can afford to make an snowball payment. Whether its $5, $25, $50, $100….it will benefit you in the long run by accelerating repayment and minimizing interest. Start small and increase if you can.
- Automatically transfer your monthly snowball amount to your highest interest loan. No matter what you hear, it is simple fact that paying off your highest interest loans first will minimize your interest and total repayment time. You get charged interest for every single day you have a loan outstanding (Even weekends!!!). The total amount due to your lender actually increases by the day. At one point in time, I was racking up more than $20.00 per day in interest. That means that just by doing nothing…I was “spending” $20 every day. That is why it is absolutely crucial to eliminate your high interest loans as fast as possible. This will limit your daily interest expense and speed up your repayment.
- Reduce your Minimum Payments -> Increase your Snowball. After you eliminate your highest interest loan, your total monthly minimum payment will decrease. This does not mean you should pay less each month toward your loans! You should continue paying your current snowball + the savings on your lower minimum payment toward your next highest interest account. This means your total monthly contributions to your loans remains the same…but that contribution is more impactful. This has the effect of “increasing” your snowball or additional payment toward your loans. The “Avalanche” effect is what allows you to accelerate your repayment. As you continue to knock out your high interest loans, your snowball increases and your repayment gets faster and faster.
Let’s see how it works!
In the following example, the borrower has 4 different loan accounts all with different minimum payments and interest rates. His total minimum monthly payment is $1,232.52. Based on his income and spending habits, he decides that he can allocate an additional $100.00 per month to his loans. This $100.00 will act as his “initial snowball”. You will see that this snowball will continue to grow and eventually cause an Avalanche that make his loans disappear! In the end, this borrower shaves 1.5 years off his repayment time and saves over $7,000 in total interest!
And that’s all there is to it! Don’t let your debt scare you. Take advantage of the Avalanche, Own Your Loans, and repay your loans faster!