The temptation when you receive your first student loan bill 6 months after graduation might be to put that $300 debt amount into the “bill” section of your budget. However, this is one of the biggest debt mistakes you can make. Yes, it is an amount of money you pay every month, but your student loan payment is not like a regular utility bill. You are not paying for a current service, like you would an electric bill or phone bill. A debt is something that is owed to someone else. The danger comes when you treat this $300 sum like you would any other monthly utility.
You get no utility from paying off your student loans over 10 years!
Equating the two types of bills is where your thinking starts to break down. You get no utility when you dutifully make your $300 payment each month. Instead, you are only paying off your student loan provider, and typically only about two-thirds (or less) of your payment is actually going towards the principal.
You cannot pay off your phone bill the same way you can pay off student debt. You pay your phone bill in order to receive a service, while a student debt payment is just that: a debt payment. If for some reason you cannot pay for phone service, then that month you cannot use your phone. Once you start paying again your service picks right back up where it was. Conversely, if you cannot make your student loan payment, your loans go into default. While in default, your total amount will increase and you will end up paying more over time. The amount you owe keeps increasing, even if you are not using any service. Not to mention that you will have loan sharks calling you and your credit score will take a big hit. This is the exact opposite of a phone bill, and is reason the two are not comparable.
Student loan borrowing agencies have a slick way of portraying this: say you bring home $3,000 each month after taxes are paid, and your monthly student loan bill is $300. Your loan provider will spin it as, “Your bill is only 10% of your monthly take-home amount! That’s easily manageable!” If you need some help calculating your take home income, check out this link. In reality, after you spend your money on ACTUAL necessities, like food, rent, gas, ect, you may be left with only $500 at the end of each month. What that means is, $2,500 of that $3,000 income is already allotted for things you need, and you only have $500 to spend on things you want, a.k.a. your disposable income.
Following that train of thought, it’s better to think of your $300 student loan bill coming out of your disposable income, instead of your total take-home income. In our example, a $300 bill actually accounts for 60% of your disposable income. Oh wow! Now, instead of $500, you only have $200 a month to cover anything above and beyond paying to live. Not to mention that this $300 is only the minimum required payment per month, and on average you will owe this same $300 every month for the next 10 years.
You need to change your thinking from take-home income to disposable income.
It is this sense of urgency that should drive your desire to pay off your debts early. Applying this math takes a change in mindset from total income to disposable income. When you look at your required minimum student debt payment as 60% of your disposable income vs. 10% of your total income, the urgency, or perhaps fear, starts to become real.
It was exactly this mindset that drove my wife’s and my decision to pay off our $71,000 student loan in 2.5 years. Now, with that $339 per month of debt gone, we essentially got a pay increase of $339 of pure disposable income to use as we wish. It is no longer a line item to be paid over the next ten years, but now an extra $339 that is 100% ours.