Financially Free Gen Z Season 2, Episode 2
The Loan Ranger: Wrangling Student Debt
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Rachel
Welcome to Financially Free Gen-Z, the podcast tailored specifically to Gen Zers looking to level up their financial knowledge and take control of their money matters.
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Joshua
In each episode of we delve into practical budgeting strategies, insightful tips on debt management and essential advice on building solid financial foundation.
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Rachel
Our goal is to arm you with the knowledge to own your financial choices and pave the way for a prosperous future. Join us as we navigate the world of money management together. I'm your host, Rachel Munger.
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Joshua
And I'm your co -host, Joshua Herrmann. We're both Gen Zers ourselves who work in the financial industry. Today, we're going to be taking a look at a topic that has dominated the news headlines for years now. Student loans. I think it's really important to get a clear understanding of how student loans work, because for many of us, this is the first large loan that you take out on your own.
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Joshua
The terms used around lending can be very confusing for those who are new to it. And I think oftentimes people are never really fully explained to them how it all works. The first two important items to understand are principal and interest. Principal is the amount we take out for a loan. So say, for example, you take out a $5,000 loan for a semester of college.
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Joshua
That's your principal. That's the amount that you start out with. Then the second part of your payment is the interest. This is how loan servicers make their money. You pay a certain percentage of your loan each month, basically to pay for borrowing money. Now, that brings in another important term, which is interest rate or APR. Also, known as your annual percentage rate.
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Joshua
According to studentaid.gov, interest rates for federal student loans are typically somewhere between 3 to 7%. That means you are paying that amount of the loan each year in interest. As you pay down your principal, you pay less in interest each month because the percentage of what you
owe is a smaller number. This can be kind of confusing to visualize, so I always recommend plugging your student loan numbers to a loan payment calculator to get a better picture.
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Joshua
These calculators can also help you determine strategies to help you pay your loans off faster. Something like an extra $50 per month may not sound like a lot, but it can make a big dent in the amount of time you're paying off your loans and you'll save on the amount of interest you would have otherwise paid.
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Rachel
Yeah, that's great. I think in addition to those terms, it's also important to understand the different types of student loans. Before researching to get this podcast started, I honestly didn't realize how many different types there are and the little nuances between all the types of loans for federal loans specifically. So there's a lot to break down. So today we're just going to focus on some of the most popular student loans that you'll see out there, starting with first, the direct subsidized loan.
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Rachel
So these loans are available to undergraduate students only who demonstrate some sort of financial need. And I believe that's based off of the FAFSA that you determine whether there's a financial need or not. And so for a direct subsidized loan, the U.S. Department of Education is going to pay the interest on your loan while you're in school. As long as you're in school for at least like half time.
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Rachel
And then there's also then a six month grace period after you graduate or leave school to give you some time to find a job, get started in your career and start making some money before you have to start making payments on those loans. Then there are direct unsubsidized loans, and these ones differ from subsidized loans because they're available to all undergraduate and graduate students, regardless of if there's a financial need or not.
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Rachel
The school that you attend is going to be the entity that determines how much you can borrow, and then you are responsible for paying the interest on these loans at all periods. So even while you're in school, these loans are accruing interest. Another type of student loan is private student loans. These obviously aren't federal, and so these don't come with quite as many benefits as the federal student loans do, things like income based repayment plans, those fixed interest rates, potential payment pauses like we saw during COVID.
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Rachel
You're not going to see that stuff happen with a private student loan. So for my own student loan journey, as we've been paying off my husband's student loans, we really wanted to focus on those
private ones first because mainly those ones weren't on pause during COVID, but also with those, you'll oftentimes see a higher interest rate than you would on your federal student loans.
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Rachel
So as Josh said earlier, it's around 3 to 7% right now for a federal student loan, whereas for private loans, you're looking at more somewhere from four to up to like 15%. And so you're paying a lot more on your money when you're paying 15% interest on your loan. I remember our previous cohost, Emma, when she graduated, she realized one of her loans was up at like 16% or something.
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Rachel
And so as soon as she graduated, she really wanted to go and refinance those to a lower rate so that it makes repayment a lot easier. And those monthly payments will be a lot lower.
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Joshua
Now, taking everything into consideration, there are some strategies for paying back these student loans. I know that we've all heard the horror stories of people who have been paying back the student loans for years and years and decades upon decades, and but somehow they owe even more than their original principal amount. Something like this can happen due to IDRs or income driven repayment plans.
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Joshua
Now, these plans are offered for federal student loans only and allow for you to make a smaller payment on your loans based on your income. These plans have had some major struggles over the years. However, the Biden administration released a new plan known as SAVE in August of 2023. Older income driven repayment plans suffered from balloon payments. For example, let's say based on my income, I qualified for a $75 payment each month.
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Joshua
This means each month I only have to pay $75 for my student loans. But if the interest on my loans each month is $100, that means by paying $75 per month, I'm not even covering the interest on the loan. So each month the amount I owe gets bigger and bigger, even as I continue to pay on my income driven repayment plan.
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Joshua
If I continue to pay less than the interest I owe each month, the loan balance is only going to get bigger, meaning I'm going to owe even more money because that interest is adding to the total amount of the loan. Now, this became an issue for a lot of people and some ended up owing significantly more than they started off.
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Joshua
Now, in August 2023, a new income driven repayment plan was introduced to try and address some of these issues. Unlike some of the other plans, SAVE prevents a ballooning loan. If you are making your payments, any interest unpaid each month is covered by the government allowing for your principal to stay the same. Under this current plan, if you continue to make your monthly payments, your loans may be forgiven in 10 to 20 years, depending on what your original principal was.
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Joshua
This new plan can be very beneficial for someone who feels like they aren't able to make their standard payment. You should check out studentaid.gov to see if this payment option is a thing for you.
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Rachel
Yeah, I think this is a great new income driven plan that was introduced. It definitely addressed a lot of those issues that we saw with the past plans that were available. And hopefully this new plan will allow for people to not get stuck in that debt cycle where their debt is just growing and growing and growing each month.
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Rachel
So I think this is definitely a step in the right direction. But what about those who have private loans or who don't qualify for income based repayment plans? Or even if you just don't want to be making payments for the next 10 to 20 years? If this is you, I'd recommend listening to our budgeting episode. If you want to pay down your debt as fast as possible.
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Rachel
We'd recommend sticking to a strict budget and then following either the snowball or avalanche approach to paying down your debt. So to break those two down in the snowball method for paying down debt. You take a look at all of your different loans, so your car loan, your student loans, credit cards, any sort of consumer loan like that, and you pay them off from the smallest balance to the largest.
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Rachel
So this can help if you feel like you need some motivation to continue paying down your debt. You get a few smaller wins along the way and then slowly are able to pay more and more until you are debt free. In contrast, the avalanche method is similar, but rather than basing your payment order off of the size of the loan, you're going to base your payment order off of the loan with the highest interest rate first and then down to the one with the lowest.
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Rachel
So this is the strategy. My husband and I are currently using what's nice with student loans because the federal ones are broken up into lots of smaller loans and they do have a lot of different interest rates. And so we just start with like the one with the very highest interest rate, pay that one off and
then continue to go until we're down to the one, the lowest one that I think is like two and a half percent.
00;10;14;01 - 00;10;35;08
Rachel
Like, man, those are the days right? But next up, we have a guest joining us from Coulee Bank here to delve even deeper into this topic of student loans. With us today, we have Devoon Plecas, credit analyst at Coulee Bank. Thanks for joining us today and sharing your knowledge with our audience.
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Devon
Hey, guys, How's it going?
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Joshua
It's going good.
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Devon
Going good. Yeah, I mean, like Rachel mentioned, I'm a credit analyst, actually, so loans are kind of my thing. I stare at them all day long, not student loans, but, you know, they all are kind of similar to each other.
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Joshua
Yeah. So, Devon, what what advice would you give to students who are considering taking out student loans to finance their education?
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Devon
Yeah, I mean, I alluded to it a little bit, but I'm actually a pretty big fan of debt. I think the debt can be a very, very useful tool in the long run for things if used wisely. It's kind of the key thing which student loans are hard to kind of use wisely. There's a lot of things that aren't made super clear to 18 year olds, but overarching, I would say, make sure that you pick a school that is within your means to pay back.
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Devon
You know, schools are pretty open about how much they cost. So don't pick a school that's out of your means. And also one big thing is you just got to have an open dialog with your parents. You know, if you're a high schooler, then your FAFSA, the amount that the government is going to be willing to help you pay for your college is going to be based off of their income.
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Devon
And that's that's just kind of the way it is. There's very, very niche criteria for you to not be in that kind of category. So you just kind of got to be real with them and say, Hey, you know, what can we
afford? Can I afford to have $140,000 in student debt, or can I afford to have $5,000 in student debt because it's your parents are what determines that, or at least their income is?
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Rachel
Yeah, I do think it's important to have those open conversations about that. And I do think it's crazy that it's like you're 18 years old and they're basically like, Yeah, we'll give you a loan for $100,000 and you don't understand the terms of the loan. You don't really understand anything. Like I saw, they make you take a little class, a 30 minute class, but that's like online.
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Rachel
While you're also applying for colleges, you have so much other stuff going on. And so I think it's easy to not know all the terms and understand what you're doing until you're into it.
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Devon
Yeah, even that I don't remember taking a class or anything. So, I mean, they must have just shoehorned that in there somewhere because that's news to me.
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Rachel
Even that I was talking to Corbin about that and he's like, Yeah, I don't remember doing that. And like, maybe it's new. It is on there. It's on the the Federal Student Aid website now. So maybe it's something they realized, like, Hey, we need to start educating people on the loans that they're taking out.
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Devon
But yeah yeah, that's that would be a big one I think.
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Rachel
Yeah. On that same topic, what are some of those common mistakes that students make when taking out student loans and how can they avoid them?
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Devon
I think one pretty big mistake that people can kind of fall into the trap of would be and you guys mentioned it a little bit earlier, I think is just allowing yourself to get too caught up in the fear of the amount of debt you're taking on. Debt is not inherently bad. I don't think it's just bad if you use it bad.
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Devon
Does that make sense? It's like we hear about people who take, you know, 30 years to pay back their student loans. Well, those people are more uncommon than they are common. It's just that they
are the loudest minority group there. Most people, if you have just regular federal unsubsidized loans, then your payment plans automatically ten years.
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Devon
So if you make the minimum payment every month for 120 consecutive months, you'll be paid off, which is really hard for some people. Like you guys mentioned, there's income based plans that, you know, not everyone gets great jobs and finding jobs after the pandemic. That's kind of when I graduated college, that was really hard. And other people are going to have their own difficulties and things like that, too.
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Devon
But if you can figure out a way to make those minimum payments every single month, if you have normal loans, you will pay them back in ten years. It's just that's how the math works.
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Joshua
Yeah, that's that's great. That's think thanks for sharing about that because I know some people can get lost in how you know they don't make the minimum payment every month and because they're focusing on other things in life and that that's where those horror horror stories come in of the ballooning debt because they aren't able to make those minimum payments each month.
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Devon
Yeah. And not everyone has those typical loans in there for sure. People with private loans that are on different repayment schedules and there are the subsidized unsubsidized loans like you guys talked about. But if you can find a way to have mostly those typical loans that come with the FAFSA, then you're going to be in pretty good shape.
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Devon
I will say again, that's based off of your parent's income, and there's really nothing you can do to change that and very particular situations you can. But so if your parents aren't willing to help you out, then that's that makes it much more difficult because you're getting handed a bunch of loans based off their income, but they're either unwilling or unable to help you out.
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Devon
So obviously that makes it much, much harder. But then you just need to have kind of a little strengths and weakness, pro/con discussion with yourself to say, Hey, am I in a major that's going to get me a job to help me pay off the type of loans that I want to have? Or am I going to a school outside of my means or things like that, which if your parents can help you out, that's awesome.
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Devon
I was someone who my parents didn't help me pay for school, so I totally feel for those. But then you just have to really think about, Yeah, I'm going to get a job in this field and I need to do X, Y, and Z things to ensure that I can pay them back on time
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Joshua
Well, that kind of leads into the next question that I have is what are some strategies that you have to minimize the overall cost of borrowing for college and reducing the need for excessive student loans?
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Devon
Yeah, that's a really, really good question. Obviously something that people who people who need student loans are going to want to know how to pay them back. Right. Like, that's something that's going to be a really, really common question. I'd say the number one thing to help you repay your loans in a timely manner and, you know, kind of know how to minimize the overall cost is just be real with yourself.
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Devon
You know, have a budget and recognize, okay, do I spend $500 a month on eating out or do I spend $2,000 a month on eating out? You just kind of have to be realistic about those things and realistic about your income. And then you can kind of set everything else there in between. So if you're willing to make some adjustments to your lifestyle, then you'll probably be okay.
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Devon
If not, then you can do what Rachel, you talked about, Emma did this, is you can look into refinancing if you have private debt. That's not really an option if you have FAFSA or federal debt, you can, but you shouldn't because your loan is going to have much lower interest rate. So you then monthly payment is going to be much smaller.
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Devon
But really, I would just make sure that you're you're going through and taking the right steps to find a job that's going to allow you to repay the amount of debt that you took on.
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Rachel
Yeah, I think that was all really great information, Devon. I think to me one of the things that sticks out the most and you and I have had this conversation quite a few times, but debt is not always something that's bad. There's a lot of really good instances where you can use debt and have it be an investment in your future.
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Rachel
And student loans is a great way to do that. And so not being scared of it per se, but also just being smart about how you're going about it.
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Devon
And I think some people too, they, they try to pay off their debt as quick as possible because they just don't like seeing the balance there. But depending on what your interest rate is and things like that, you can look into different types of investments where you might yield, you know, a profit because your your debt interest rate is lower than whatever profit you're making back.
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Devon
Or, you know, maybe you find out you have super high interest rates. So if you were to be in something, then you would really be net losing value. So in that case, it is better for you to just pay back your debt as soon as possible. But I think you guys have talked about mortgages and credit before and last season, but paying back your debt, you know, faster or slower will change your credit score and things like that and make it harder for you to borrow in the future, maybe.
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Devon
So it's really just about understanding what your propensity to pay back that debt in a timely manner. But maybe not too timely kind of understanding what that is.
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Joshua
Well, I think another another way to kind of reduce the amount of debt that you kind of take on. I mean, I in my instance, I, I wanted to go to a four year university for all four years, but it was just out of my price range. So I decided to use community college and community college significantly cheaper than most four year universities and it's for you know, they do have transition programs that are available to go into the the State university's private universities.
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Joshua
Most of those credits are transferable. So like, the difference is like in my instance, I was paying upwards of 20K a semester, not all, yeah 20k a semester. And that was for the 4-year university where as my community college was only it varied, but it was anywhere from like 2 to 3 grand a semester. So that is an option that's out there because I think people kind of forget about those options.
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Devon
Yeah, I think you're absolutely right. Josh A lot of people kind of write off community college when in reality it can prepare you for life after college just as much if not better than any other 4 -year school. You're you're going to class and you're learning things either way. So if you can't afford at that time the more expensive college or university, it's okay and no one's going to judge you or be upset with you for going to community college first.
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Rachel
Especially even for some of those. I mean, I think back to like the generals that I took at Northwestern, it would have been a lot smarter for me to go to, say, Normandale and take like my biology, my statistics, all those classes and would have saved a lot of money. But hey, hindsight is 2020, right?
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Devon
Yeah. And I mean, I can even speak to that as I knew that if I tested out of my science course, then I could graduate one semester early, which, you know, I actually also went to Northwestern and my tuition was right around $23,000 a semester. Like you mentioned, Josh So by testing out of that one class, I got to graduate a semester early and save $23,000, which because of where my FAFSA was and things like that, it wouldn't just actually cost me 23 grand, but it still cost me, you know, eight or nine, something like that, after all of my scholarships and things were done.
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Devon
So it was it was for sure, a good move to test out when possible.
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Joshua
Well, you brought up scholarships. I mean, there is so many scholarship opportunities out there and grants that, you know, prospective students can apply for that will also reduce the amount of debt that you'll need to pay in the long run, because scholarship ships and grants don't. And in most cases, I'm not going to say for all of them, but don't often need to be paid back.
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Rachel
Yeah, there's honestly still a ton we could go into on this topic, so I think it's something that we'll cover again. Sure. And dive in even deeper to some of that stuff, like community college, like scholarships, grants, because there are a lot of great resources out there that I think we would be able to share because it is something that we've all gone through and done.
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Rachel
And so we have some experience there for sure.
00;23;20;29 - 00;23;38;07
Joshua
Well, thanks, Devon, for sitting down with us to discuss student loans. And thank you so much to our audience for joining us this week. Encourage you to follow our podcast wherever you are streaming so that you can be the first to see when a new episode drops. We look forward to talking with you again next month and thanks for listening.