Wednesday, July 22, 2015

Don't Borrow the Maximum

An article on student loans at The Federalist includes this piece of advice, similar to advice heard frequently from the "financial aid" world:
I was so scared of my looming financial commitments that I didn't attempt to make a single payment while I was in school... If I could go back in time, I would tell myself to put some money on my loans each month, instead of hoarding it all in my savings account.
There is a much more direct way to address this.

1. Mathematically, if you are making loan payments while in school, you have borrowed too much. You have borrowed money in order to make loans payment on that borrowed money. Do not simply accept the full loan amount offered. In college and law school I scratched out thousands of dollars in student loans from my financial aid offer every year. Loan offers were based on inflated estimated student budgets (cost of attendance). I could have borrowed tens of thousands of dollars and made payments while in school, but instead I lived within a reasonable annual budget and declined any loans that went beyond that budget.

Here is an example from a U.S. News article: making in-school interest payments on a $5000 loan could save $71 over the term of the loan. However, according to the calculator they used, simply not borrowing the extra $292 which was used to make payments would save $374 over the same term.
Default (Borrow $5000, make no early payments): Costs $6410.
Recommended (Borrow $5000, make payments immediately): Costs $6339.
Better (Borrow $4708, make no early payments): Costs $6036.

U.S. News example has 3.9% interest rate, 18 months deferment, and 10 year repayment term.
The savings come from both the reduced borrowing and not having to pay interest on money that was only borrowed to make loan payments.

2. If you do find yourself hoarding student loan money in a savings account, you should make significant payments as soon as you realize it. This means right away, not a little bit every month. Making payments can help, but the practice of borrowing student loan money in order to make student loan payments is convoluted and costly.

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