Recently my boyfriend and I had a conversation about refinancing his student loans. I had occasionally brought this up…REAAAALLY SUBTLY, but the conversation never really led anywhere. I never pursued it further because I really knew nothing about the details of his loan nor did I know much about refinancing, but the refinancing seed was planted in my brain via the personal finance blogosphere.
Finally one day a couple weeks ago, I asked if I could see the details of the loans. I knew roughly the amount, but I didn’t know anything else. I was shocked. He’s been paying them for a couple years, but I discovered that out of the total he paid…only about 26% of it was towards the principal! He was shocked too! He had never seen the total numbers or ratios, but he knew he was dutifully making the monthly payment and that one day it would be paid. Needless to say, we’re looking into refinancing now, potentially with the lenders below. We’re trying to negotiate a better rate by seeing if one company can beat the other’s offered rate.
I had really only ever thought about credit card interest and credit card debt, but this was all “debt” I could immediately pay off before being charged interest. Because I had never personally had student loans before, this got me thinking about the different ways different people approach thinking about long term debt. On one hand, there’s the very normal “I’ll just slowly pay it off using the calculation my lender says I need to pay to pay off the principal within the allotted timeline”, than at the other extreme are the super #finlit personal finance bloggers who are all about eliminating debt as quickly as possible.
So how do you think about long term debt? Which debt personality are you?
The Monthly Payment Type – Worst
The Monthly Payment Type in my book is the worst debt personality. They usually don’t think at all about the amount of Interest vs. Principal they’re paying on a month to month basis and really only see the monthly minimum payment they have to make. They may not even know how long their loan term is or how much the original loan was. They think:
If I keep paying $540 a month, eventually my loan of ?? amount will be paid at ?? time in the future.
It’s all the same to this type whether $400 of their $540 monthly payment is going to interest or going towards the principal. Or they would care about it if they stopped to assess what % was actually going to interest vs. principal, but their weakness is they haven’t stopped to assess and probably just don’t know.
This personality type is the most dangerous because they don’t really have a mental picture for how long they have to be making these payments nor do they even think about how their total loan balance is affected month to month. All they see is this long stretch of minimum payments ahead of them. Who knows, the loan company could tack on a few extra payments after the loan’s paid off and they would never know. They have no goal in sight.
I don’t blame them, they usually have very large loans, with multiple interest rates, they might not make enough to pay more anyway, and it’s human to automatically simplify the problem if the solution is 25 years away. It took me 2 days to analyze and chart all my boyfriend’s student loan data, and that’s literally because I love personal finance.
Maybe it seems natural that someone with a loan should think it’s a good investment of their time to spend a couple days figuring out what’s the best way to handle it. But our financial system and culture has really normalized debt that most don’t even realize they should give more thought to it.
In fact, they do the responsible thing, they minimize the pain of paying by setting their loan on Autopay and call it a day. They don’t realize they can do more than the bare minimum. Doing the bare minimum is the norm, while anyone who actively tackles their loans with extra payments is newsworthy. That’s the really sinister thing!
The Total Loan Balance Type – Bad
The Total Loan Balance Type is a step better than the Monthly Payment Type. They have a good idea of how their monthly payments affect their total loan balance, which also means they have a rough idea of when their end date is. They think:
If I keep paying $540 a month, eventually my loan of $76,000 will be paid in 25 years.
Though this personality has a fixed goal in mind and knows how and when their current actions will take them there, they still don’t see the full picture. They still don’t see the relationship between how reducing interest saves them both money and time by allowing higher principal payments.
The weakness of both the Total Loan Balance Type and Monthly Payment Type is their only goal whether vague or clear is to pay off the loan principal.
Because their goal is fixed on paying off the loan principal, there isn’t incentive to pay more. Eventually the loan will be paid off. Neither of these types like to think of the long term pain interest brings to their bank accounts.
There’s a phrase I’m sure you’ve heard: “Prepare for the worst”. If you think about it, it means attempting to minimize the worst outcome through planning. How can you prepare for the worst without ever considering what the worst outcome is?
The Monthly Interest vs. Principal Type – Good
The Good, Better, and Best Debt Personalities also focus on the worst: having their financial goals obstructed by all the extra money they lose to interest. So these types all have one additional goal to paying off the principal of the loan, their goal is to minimize the amount paid in interest in order to have more money for their other goals.
This goal naturally incentivizes doing more than the minimum–more payments and paying the loan off sooner–because as long as there’s a principal, there will be more interest and money falling out of their pockets.
The Monthly Interest vs. Principal Type is the first debt personality type to step in the direction of accounting for the cost of interest. This debt personality is aware how much interest affects their ability to pay the principal. They realize they’re losing 75% of their $540 payment to interest as long as they continue paying the minimum every month.
They understand the relationship between paying only the minimum and how little their payment will decrease the actual principal. Their focus is scoped to the month to month idea that money is being lost to interest, and their goal is to prevent this. They think:
If I pay $50 more every month, I can be paying more principal than interest 3 years sooner, AND I can be done paying the loan 4 years earlier.
The weakness of this debt personality is they ultimately still have a short term perspective, and so they may not as aggressively tackle additional payments. They do not see the full picture of exactly how much money they’ll lose over time to interest.
The Total Interest and Principal Type – Better
Even better than the Monthly Interest vs. Principal Type is the Total Interest and Principal Type. The strength of this type is they are very aware of the long term consequences of interest. They understand just how much total they’ll be paying in interest. They know if they keep paying only the minimum, they’ll have paid a little more interest than they even paid for the loan itself!
Because the total loss to interest is such a concrete number for these types, they may have even more incentive than the Monthly Interest vs. Principal Type to try and make MORE payments. They think:
If I pay $100 more every month, I can be paying $21,000 less interest, AND I can be done paying the loan 6 years earlier.
The Real Total Paid Type – Best
The best debt personality is the Real Total Paid Type. This type is marginally better than the Total Interest and Principal Type. They both share the strength of long term concrete perspective, but this type takes their knowledge one step further by also understanding the TOTAL amount that will be ultimately paid.
It’s natural for even those who are attentive to interest to forget about the principal because that part of the loan will never change. The principal will always be a fixed balance you have to pay.
Instead of seeing the interest and principal as separate balances, the Real Total Paid Type sees them as one. They see the fully realized amount paid at the end of the loan term. And they try to minimize the total cost. Trying to minimize $150k in your mind is really different than try to minimize $75k! They think:
If I pay $200 more every month, I can be paying $122k instead of $153k, AND I can be done paying the loan 10 years earlier.
If you want to think/learn more about the student loan experience, I highly recommend checking out WNYC Death, Sex, & Money’s ongoing project on student loans!
So which debt personality are you? And did this article help change the way you might think about long term debt??