Payback Time: Dealing with Grad School Loans
When Shakespeare wrote "Neither a borrower nor a lender be," it was clear that he wasn't addressing future MBAs. According to graduateleverage.com, a student debt advisory service, 90 percent of all MBAs borrow the maximum amount available through federal loan programs, and many also borrow from private lenders. With the total cost of attending a top business school (including tuition, books, and living expenses) exceeding $60,000 annually, it's easy to see why. But it means you're looking at over $120,000 in student loans to repay after graduation-assuming undergraduate loans aren't pushing the figure even higher.
Fortunately, your new degree will likely pay big dividends. In 2006, the average business school graduate's starting base salary exceeded $92,000, according to research for the Graduate Management Admission Council. On top of that, GMAC reports that two thirds of job offers to MBAs come with an average signing bonus of $17,603.
But when it comes to choosing your first job, MBA and Goldman Sachs alum Michael Fischer warns graduating students not to "be risk-averse because you're $120,000 in debt." Fischer, who is now a financial analyst and the author of Savings and Investing: Financial Knowledge and Financial Literacy That Everyone Needs and Deserves to Have!, says, "The temptation is to take a consulting firm job that starts at $120,000 a year as opposed to a trading-floor job that starts at $80,000 but may have more long-term potential." Instead, he says graduates must remember that payback comes five to 10 years after an MBA, not in year one.
We'll leave it to you to choose your dream job. But we've rounded up the experts to help you navigate your debt once your first payments come due six months after graduation. Here's what they have to say.
1. Settle on a schedule
You have options when it comes to how much you'll be paying over the course of the loan. With standard payment schedules, you pay the same every month at a fixed interest rate. A graduated schedule allows you to make smaller monthly payments early on and larger payments later when you are in a better position to repay. An income-sensitive plan bases payments on your monthly income.
2. Hands-free payback
"Automate everything to make repayment hands-off," says Fischer. When the money comes directly out of your checking account, you don't have to worry about incurring late fees and wrecking your credit. What's more, if you take advantage of this repayment option, most lenders will offer you a slight savings. For example, MyRichUncle, a national student loan company offering federal and private loans, provides a 25 percent discount on your interest rate if you sign up for Automatic Clearing House Debits, with further reductions if you continue to make on-time payments. Other lenders offer similar arrangements.
3. What's the rush
The experts agree that one of the most important tips is also the most counterintuitive. "It may make sense emotionally to get the loans off your back by paying more than the amount due each month, but it doesn't make sense financially," says financial planner Jamie Smith, of AXA Advisors in San Diego. Here's why. With their low interest rates, your student loans are likely to be the least expensive debt you'll ever incur. Early repayment can actually increase your cost of borrowing. While the interest rates on your loans are fixed, you need to consider the real interest rates-taking into consideration inflation and the time-value of money-to figure out the true cost of your debt. Consider the case of a student who carries an interest rate of 2.875 percent on her consolidated loans. If the inflation rate is around 3 percent, subtracting three from 2.875 gives the student a real interest rate of negative 0.125 percent. By borrowing money, you're making money. Got it?
4. Stomp out bad debt
If you're still tempted to put something extra toward your student loan payments and you have credit card debt or other consumer debt (like a car loan) to pay off, make it your priority to pay off that higher interest-rate debt first. In fact, it would be ideal to use the six-month grace period between graduation and your first due date on your student loan to get rid of these debts. Remember, school debt, like mortgage debt (which is tax deductible), is "good debt."
5. The future is now
Even if you're debt-free except for your student loans, you don't want to focus on paying them off at the expense of investing in a 401(k) or Roth IRA, says Smith. "Especially if your employer matches your contributions, it's better to take that extra dollar and put it into your 401(k)." Smith says, "If you put the dollar into your 401(k) and your employer matches it, you've gotten a 50 percent return. But if your student loan has an interest rate of 4 percent and you put the dollar toward the loan, you've saved a mere four cents."
6. Get in sink
Is extra money burning a hole in your pocket and tempting you to send it to your lender to pay off your loans faster? Smith advises that you instead put the cash into a so-called sinking fund that earns a higher interest rate than you're paying on your loans. The most aggressive type of sinking fund you should consider is a mutual fund. If you're more risk-averse, a CD is best. "For example, if your required monthly student loan payment is $500 and you're able to pay $2,000, take that extra $1,500 and put it into your sinking fund each month for 15 years, then pay off the loans," explains Smith. Even if you were to just break even with your sinking fund's interest, building it up is a better idea than handing your money over to the lender early. Having a lump sum gives you added flexibility.
7. Cut interest
If you still want to be more aggressive in chipping away at student loans, Smith advises that you begin making payments every two weeks instead of once a month. "You make the same exact outlay, but you're paying half of it on the first of the month, and the other half on the fifteenth," says Smith. By making one payment two weeks early, you'll avoid paying interest on that portion. You can achieve a similar, interest-cutting effect by making 13 payments annually instead of 12.
8. Consider consolidation
This one isn't rocket science: Group smaller loans into one large loan with a lower interest rate. "Consolidation, which is almost like refinancing, made a lot of sense a year ago when interest rates were at their lowest," says Smith. But it's still a good move as long as your overall consolidated rate is lower than the rate on your individual loans. Shop around for the best deal. Most service providers offer borrower benefits like rate reductions for automating repayment and consecutive on-time monthly payments. Plus, you'll only have to make a single payment each month. If nothing else, you'll save money on stamps.
MBA Jungle, Feb./March 2007