Loan payment strategy: Private vs federal?

Question

I am a young professional trying to determine the most efficient/cost effective method for paying off my student loans and would greatly appreciate any advice. Currently, I have about $170,000 in loans, with $110k in federal, and $60k private. Below, I will break down the situation a little more.

I recently refinanced my private loans to a lower interest rate (5.3% fixed), and to a 10 year repayment term. My minimum monthly payment for this loan is $680.

I have 11 federal loans that total $110,000 with varying fixed interest rates ranging from 3.98% to 7.65% and am in the middle of a 20 year payoff plan. I currently have a minimum monthly payment of $548 because I am on the Income Based Repayment plan (IBR), otherwise, the normal monthly payment would be $1,232.

My strategy as of now, is to pay the minimum on the private loans and to tackle one of my federal loans with the highest interest rate ($15,000 at 7.65%) by making my minimum IBR payment and then make an overpayment on the high interest loan ($800 extra per month).

I am reaching out to you all to see if my strategy is the most efficient method, or if it would be better to tackle the private loans first before federal? Should I get off the IBR and just pay the non-IBR minimum, but then not be able to make any overpayments on the single largest/highest interest rate loan? All in all, I have budgeted $2,000 per month for loan payments. I just want to know how to best make payments.

Thanks in advance

Answer 1

You mention "most efficient/cost effective" in your question. Let's tackle it from that standpoint first.

The mathematically efficient approach

List all of the loans in order of interest rate. Pay the minimum payment on each individual debt, and then throw as much money as you can at the debt with the highest interest rate.

Now let's consider an alternate approach.

The Debt Snowball approach

Dave Ramsey advocates an approach that he calls the Debt Snowball. It prioritizes knocking individual debts out completely as soon as possible, primarily for the psychological effect that such progress provides.

List all of your loans in order of outstanding balance. Pay the minimum payment on each individual debt, and then throw as much money as you can ("attack it with a vengeance") at the debt with the smallest balance. You'll pay off that loan quickly, and that will give you the mental boost of seeing one loan go away entirely. Plus, you'll then be able to take what had been the minimum payment on that one and start applying it to the next smallest debt.

This approach isn't strictly mathematically the best, but in your case, with the interest rates all being fairly close together, it won't be terribly far off. Mr. Ramsey finds that people have better long-term success with this approach than with a purely mathematical approach. To paraphrase him, getting out of debt is more about behavior than it is about math.

Answer 2

I don't think interest rate is the biggest problem here. You have a huge balance that needs to be dealt with. Yes, paying off the highest interest rate first will save you the most interest if you pay the same amount each month, but you can save even more interest by upping your repayment amount. At your current rate it will take you 9-10 years to pay off all of the debts regardless of which loans you pay first (the actual repayment period depends on the interest rate(s) of the other debts). If you instead put another $500/month towards them, you cut that down to around 7-8 years. The more you pay, the shorter the timeframe.

Since the highest interest rate is a relatively low balance, I see no problem tackling that one first and trying to knock it out in 6-9 months. Hopefully it will energize you to start putting even MORE towards these debts to get them knocked out faster. What I would NOT encourage you do to is chip away at a single huge balance just because it has a slightly higher interest rate. I think you'll be encouraged more by knocking out some low balances and applying those payments to the next highest one (the "snowball" method). Unless there are large differences in interest rate, my experience is that the psychological benefits of knocking out debts helps you

Do not enter into any deals that create barriers to early repayment. If you have $2k right now to put towards these loans, keep the higher minimum payment (you're going to be paying it anyways) and keep the option to pay more as your income increases.