Tag Archives: interest

Student Loans: They’re Baaaaaack!

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The last few years have been a very weird time in the financial aid world.  At the start of the Covid-19 pandemic, the federal government put a pause on federal student loans.  All loans in the Federal Direct loan program stopped accruing interest.  And no payments were required on these loans for borrowers who were in repayment status.  At the time when this started, we all expected the pandemic to be short-lived and everything would go back to normal in short order.  But we all know that the pandemic (and the student loan pause) continued for quite a while.  Covid-19 has become an endemic and we’ve accepted that it is something we will just have to deal with going forward.  And the student loan pause extended many times.  But it has finally come to an end.

Starting September 1st, federal student loans began accruing interest again, for the first time since March 2020.  For borrowers who are in school (or in their six-month grace period following leaving school), this means that the loan servicer has started keeping track of the interest that is accruing each month, and when the loan goes into repayment that accrued interest will be added to the principal balance of the loan (this is called capitalization).  For borrowers who are already in repayment, this means that October is not only going to bring fall foliage, pumpkin spice latte, and spooky decorations.  October is going to bring a student loan payment.  For many this will be their first student loan payment ever.  For many more, this will be their first payment in several years.  This is going to take a little getting used to!

Thankfully, along with this new era of interest accrual and required payment, this fall also brings us a new income-driven repayment plan (IDR). IDRs base the amount of monthly payments on the amount the borrower is earning, instead of on the amount that was borrowed.  The Saving on a Valuable Education (SAVE) plan is replacing Revised Pay as You Earn (REPAYE), and it is without question the most favorable of the assorted income-driven payment options.  This plan boasts the following benefits:

  • The portion of the borrower’s income protected from being included in the calculation of the monthly payment is 225% of the federal poverty guideline, as opposed to the 150% offered by most other IDR plans.  This will yield the borrower a much lower monthly payment.
  • If the borrower’s monthly payment is not large enough to cover the accruing interest, the excess interest will be forgiven rather than being tacked onto the principal of the loan.  There will be no negative amortization!  Even if you only ever pay interest on the loan, the total balance due will never grow larger.  This is a game changer.  Gone are the days where a student borrows $40,000 for their education and then after years of payments find themselves owing $152,000.  The balance will never get bigger than where you started in repayment.
  • Married borrowers will have a way to remove their spouse’s income from the calculation of the monthly payment.  Borrowers will no longer have to make a choice between having the lowest monthly payment or legally wedding their soulmate.  If a borrower is married and wants to exclude their spouse’s income from the calculation, they simply need to file their federal income tax as married filing separately.

There are more changes to follow starting next summer, but the three listed above are already in place, and will have the greatest impact on law school alumni.  You can find a detailed description of the SAVE plan here, and a great description of how SAVE differs from the old REPAYE here.

Getting ready for student loan repayment after a three-and-a-half-year break will likely feel daunting.  You can find some guidelines here and here.  And your friendly neighborhood financial aid advisor is also here to provide help if you need it.

Big changes are arriving right now.  But with a little focus and a little help from available resources, this will be manageable.

 

The Best Kind of Super-Spreader

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In elementary school we all learned about multiplication. And we all know how practical that is in solving math problems. But it’s pretty important in other issues as well. Today I’m going to focus on compound interest. Compound interest means that as your investments grow, you earn interest on your accruing interest. This makes your investments grow faster and faster as time passes. This is why it is so important to start your retirement savings when you are young.

Until recently, the best example I had of how compound interest multiplies is this shampoo commercial from my childhood:

But this is 2020. Everything is being viewed in a new light this year. So I’m going to go ahead and say it. Compound interest on investments is like a Covid super-spreader event. A group of people gather and one of them unknowingly carries the coronavirus. By the end of the even, the virus has spread to 10 more people. Each of those 10 goes home and spreads the virus to one or two more people. Who then spread it to another one or two. Who then spread it to another one or two. And so on. And so on. And so on. Before you know it there are 100 cases of Covid that all link back to that super-spreader event.

Ok. Enough of the 2020 doom and gloom. Let’s get back to talking about money. When I was in graduate school (back when dinosaurs roamed the earth) I was furious that the Community College where I was externing withheld $300 per year from my meager stipend to go into the Ohio State Employees Retirement Fund. Retirement was the last thing on my mind at that point when I was having trouble making rent. But I couldn’t stop it. Fast forward a few years and I rolled it into an IRA and forgot about it. Now I look at that tiny $600 investment in an entirely new light. That IRA has grown more than tenfold (despite the Gen-X curse of having three “once in a lifetime” stock market crashes [2001, 2008, and 2020] between the initial investment and now). And the bigger it gets, the faster it grows. I wouldn’t want to try to retire on just that, but it never ceases to amaze me how that tiny amount has grown over the years…all because I’m earning interest not just on the original $600, but also on all of the interest that has accrued on it over the years.

Invest early. Even if it’s only a little bit. It could (and SHOULD) turn into a super-spreader!

Time Really Is Money

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As some of you already know, I’ve been taking classes through Penn State’s World Campus to lead me (hopefully) to become a Certified Financial Planner.  My goal is two-fold.  First, I think this education will help me to better help my student population.  Second, I think this will lead me to a nice side-gig that I can pursue for a bit of extra income after I retire from Penn State.  This semester I’m taking a class in Corporate Finance.  At first I had my doubts about how practical this class would be for me.  But it turns out I really enjoy it.

Last week we started learning about something I’ve been preaching about for years:  the time value of money.  A dollar today has a different value than that same dollar a year from now.  If you put in into a savings account with a 2.0% interest rate that dollar is worth $1.02 in a year.  If that dollar was borrowed from a Grad PLUS Loan with a 7.6% interest rate, the use of the dollar is costing you an additional $0.076 for the privilege of using it for the year.  Whether you are saving or borrowing (I know…borrowing is much more likely at this stage in your life) it is important to understand the power of compounding interest.

There is a reason you’ll always hear someone telling you to start saving for retirement at the very beginning of your career.  The earlier you start, the longer your money has to grow.  The older the dollar, the more time it has to age.  That dollar that was worth $1.02 after one year is worth $1.48 after 20 years—and that’s at 2% interest.  With a more typical 10% retirement investment return that dollar is worth $6.73 after 20 years.  $17.45 after 30 years.  $45.26(!) after 40 years.  The longer the money has to grow, the more exponentially it is able to grow.

Much like you want your interest to compound for as long as possible when you are saving, you want it to compound for as short a time possible when you are borrowing.  Because student loan numbers can be scary, let’s look at a car loan.  Let’s assume you are borrowing $15,000 to buy a used car.  Your interest rate is 4%, regardless of the repayment term.  If you take 7 years to pay it off you will pay $205.03 per month and you’ll pay a total of $2,223 in interest.  If you shorten that to 6 years, you will pay $234.68 per month and you’ll pay a total of $1,897 in interest.  Shorten it to 5 years, and the payment is $276.25 and the total interest is only $1,575.  The shorter the term, the less interest you pay.  The same rules apply to your student loans and someday your home mortgage.  The shorter the time you take to repay it, the less you will pay in interest.

Next time you make a deposit to your savings account or borrow a little extra loan money, take a moment to think about the time value of money.  Every dollar is worth more (or less) than you think!

Interest Rates Rising

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Last week the Federal Reserve raised its base interest rate for the first time since 2006.  The Fed rate is the rate at which banks lend money to each other.  During the financial crisis of 2007-2009, this rate quickly spiraled down to zero, where it has remained ever since.  Until last week.  With the economy strengthening the Fed finally felt secure in starting to move this rate upward by 0.25%.  Tiny moves like this are expected to continue throughout 2016 until we land at a Fed rate of 1%.  Which is still very, very low.

So what does this change in interest rates mean in real life? Savings interest has been ridiculously low since the financial crisis.  And this is not likely to change anytime soon.  It will probably be late 2016 or even 2017 before we start to see any movement there, as banks are slow to pass on interest gains to savers.  Consumers of credit, however, will see changes right away.  Mortgage rates, car loan rates, and credit card interest rates will all rise almost immediately.  If you have any variable rate debt that can be converted to fixed rate debt, it’s best to do that sooner rather than later.  Most existing student loans will not see any change, as federal student loans made in the last ten years all have fixed interest rates.  But interest rates on student loans borrowed after July 1, 2016 will likely have higher rates than loans made in the year prior.

This interest rate increase is a sign of hope to me.  Hope that we are finally returning to a more normal economy.  The reality is that a 1% Fed rate is still extraordinarily low, and while credit interest rates will be rising, it won’t be by enough to break anyone.  Normalcy in the economy has been completely absent for most of the last decade, so now we move forward and learn what our new normal in America is going to be.

The Power of Compound Interest

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The power of compound interest never ceases to amaze me.

I’ve read countless articles about how important it is to contribute to retirement funds beginning with day one of employment.  They say the funds will grow and grow, so the earlier you contribute, the better.  But I didn’t really get it until I recently took a look at my own retirement account statement.

When I was in graduate school I received a small stipend from my graduate assistantship as an academic advisor.  During those two years, a percentage was held out of my pay and went into the Ohio Public Employees Retirement System.  I remember being annoyed at the time because the $300 per year that was held out of my pay was a significant amount of money to me at that point.  But there was nothing I could do about it.

A few years later, when it became clear that my career was not going to be in the Ohio public university system, I rolled that small retirement fund into an IRA.  It was still a really small amount at that time.  Maybe $700…which is still larger than the $600 I had contributed.

Now fast forward 20 years to 2015.  That IRA that I started with just a few hundred dollars is currently worth over $3,600.  I never contributed another dime to that account.  Just the initial $600.  But it has grown to six times its original size.  And it still has many years to grow before I retire.  This is the power of compound interest.

When you leave law school and venture into full time employment, you should start saving for retirement as soon as possible.  It may seem like a better choice to wait until you’ve made a dent in your student loan obligations.  But it’s not.  The earlier you start saving for retirement, the more time your money will have to grow.  Contribute early.  Contribute often.  Retirement savings is never something that should wait until later.