Published July 15, 2013
Getting adjusted to a post-college lifestyle and accompanying expenses can be tough enough, but recent grads burdened with heavy debt may have a much harder time getting a strong start in the real world.
A recent study from Fidelity shows that 70% of the class of 2013 is graduating with an average debt load of $35,200, including federal, state and private loans, as well as debt owed to family and accumulated through credit cards.
What’s more, even with the coverage of the rising costs of college and challenges of student debt, 50% of 2013 graduates with student loans still say they are surprised by how much debt they have accumulated.
Recent grads are in the early stages of building up a credit history, a crucial time to eliminate debt and establish good financial habits that will last a lifetime, says Steven Smith, CEO of Finicity, maker of money management program Mvelopes.
“Credit history is critical when renting an apartment, applying for utilities, cable TV or even a cell phone plan,” he says. “Everywhere we turn, our personal credit history is being verified in order to access basic services, so it’s critical we behave in such a way that helps us establish and maintain a positive credit history.”
When faced with different kinds of debt, account balances and interest rates, here’s what financial experts say to consider when prioritizing debt repayment.
Where to Start
Creating a budget where every single dollar is assigned to a specific spending category can help grads stick to those boundaries, suggests Smith, as the commitment to live within their means will make or break someone’s debt repayment.
“Younger people often have a laundry list of financial goals they would like to consider focusing on, but they still want to pay down their debt aggressively,” he says.
If cash flow is an issue, grads may need to create more breathing room within the monthly budget in addition to emergency savings as savings is a fundamental part of overcoming the debt cycle, Smith says.
“Once you pay off one debt, consider taking that payment amount and open up a savings account where you can start building an emergency fund--having that extra cash set aside will not only help you emotionally, but it will also give you that extra cash support in case something unexpected comes up.”
How to Decide Which Debt to Pay Off First
If grads have a variety of debt, such as credit card debt and student loans, it’s crucial to first review debt interest rates, says Sabol.
“Typically the plan should center around the [balance] with the highest rate first, with minimum payments to all the other balances,” he says.
Private student loans should be a high priority, as they are often subject to variable interest rates and can increase since they are tied directly to an index.
“Unlike with federal student loans, private loans carry a much steeper penalty for missed payments and defaulting on your private student loan will almost immediately impact the credit history,” says Smith.
Although federal student interest rates can range from 3% to 6.8% which are lower than most other forms of consumer debt, student loan balances also tend to be higher than a typical credit card bill or car loan and is the only type of debt that, in most cases, cannot be dismissed even though bankruptcy, Smith explains.
“In order to pay the least in the long run, you should stick to your original payment option, plus pay extra if possible,” he says.
Paying Small vs. Large Balances
When looking at debt repayment in terms of small versus large balances, the experts say it’s important for grads to consider their personal finance habits and what motivates them.
Knocking out smaller debts as quickly as possible through what is termed as the “debt snowball” technique can be beneficial if grads are looking to see results quickly and feel encouraged from early success in debt reduction, says Yen-Sheng Lee, associate professor of Finance at Bellevue University.
“This tactic motivates you to stick with the debt reduction progression, but the drawback is that you will not save as much interest as possible when the account with the smallest balance is not the one with the lowest interest rate,” he says.
No matter how grads decide to tackle debt, it’s important to continue the commitment to repay all obligations in a timely fashion and with purpose, says Smith.
“Once one debt is eliminated, instead of absorbing that payment amount into the monthly cash flow, it should be reassigned to the next debt payment, and then to the next one.”