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paying off student loans
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Paying Off Student Loans? Try the 20% Rule

When it came time for Melissa Ellis to counsel a young, professional couple with about $60,000 in combined student loans, she helped them layout exactly what they could afford to erase that debt as quickly as possible.

Ellis, a Certified Financial Planner with Sapphire Wealth Planning in Overland Park, Kansas, was stunned at how quickly her clients were able to pay down that $60,000.

The couple—he’s a chef and she’s in sales—kept their rent low by living in an older home that hadn’t been updated, drove older cars with no payments and lower insurance, skipped their vacation and ate all of their meals at home.

Within one year, their debt was gone.

“Any additional cash, regardless of the amount, that they received went towards student loan debt reduction,” Ellis said. “Their one year of sacrifice gave them financial freedom for the next 10 years.”

Ellis’ clients were extremely driven to erase their debt as quickly as possible. But for other student debt holders, it might not be that simple.

Knowing how much of your monthly budget should go towards your debt is something that can trip up even the most organized of debt holders.

Pay too much and you will be struggling to make ends meet, or you could face a devastating financial crisis in an emergency. Pay too little, even just the minimum, and your debt could actually get higher thanks to mounting interest.

“A good rule of thumb would be 10 to 20% [of annual budget] to get it paid down quickly.”

“A good rule of thumb would be 10 to 20% [of annual budget] to get it paid down quickly, although you don’t always get to choose how much you pay, depending on how much you borrowed to begin with,” said Ellis, who estimates that half of her clients are saddled with student loan debt.

Read more: How Much Should You Save in Your Emergency Fund?

Put Your Tax Refund Toward Your Debt

She advises clients to set aside not just a fixed amount each month, but also any additional cash that comes their way, whether that’s a tax refund, a gift from relatives during the holidays, even a side job. All of those things together can help add up to an average of 20% of their annual budget over the course of a year.

“You have to look at your cash flow,” she said.  “If you just are charting your cash flow in a detailed form and doing a projection over the next five years, then you can see how much you have available or when you have extra money available.”

She also advises clients to have their monthly debt payment debited right out of their account each month, for as much as they can reasonably afford, while still beating that minimum payment. Not only do you erase the risk of being late with a payment, but many lenders will often offer an additional discount on the interest rate for the direct billing.

Earnest estimates its clients have average monthly payment of $789 for an average loan size of $75,00 with a fixed rate of 5.5% and a 125-month term. That’s a large chunk of cash for many working professionals.

“A lot of our clients are struggling with student loans,” said CFP Danna Jacobs, a founding partner at New Jersey-based Legacy Care Wealth just outside New York City. “Some have lower student loan balances of $10,000 to $20,000 and it still stresses them out. Others, I’ve seen clients with over half a million in student loans. Unfortunately, we’ve seen everything.”

Jacobs, who also encourages an average of 10 to 20% per month going toward student loan repayment, agreed that while those minimum loan payments are enticing, they can add up to a big financial mistake. Earnest enables clients who want to pay more each month to customize their payment with Precision Pricing—and offers customized rates based on the monthly payment.

“I take a look at the total student loan balance and their average annual income. And if the average annual income is more in line with or more than what than student loan balance is, we can make an aggressive repayment strategy and have it paid off in a few years,” she said.

“It’s when we start to see the balance is significantly larger than what their earnings are that we have to start being a little bit more creative with our repayment strategies.”

Reduce Your Cost of Living

Those creative strategies have included telling clients they need to pack their bags and move.

While the standard formula for housing costs sits around 30% of your income, Jacobs’ clients are mostly based in New York City, which boasts some of the highest rents in the country.

“I have made recommendations to folks in the past actually to move out of their apartment,” she said. “Their apartment was 50 or 60% of their overall income, and that doesn’t leave much wiggle room for any other planning.”

Read more: Ignore the 30% Rule When It Comes to Rent

While CFPs and certified financial analysts are taught in school about traditional spending formulas, Grant Bledsoe, a CFP, and CFA with Three Oaks Capital Management in Portland, Oregon, eschews them entirely.

“I really don’t like to use the hard and fast guidelines,” he said. “There are a lot of special circumstances. And what we do, is we go line item by line item and see where do you have room. Does it make more sense to put a little bit more towards the loans, do you have that flexibility?”

Bledsoe also likes to take into account the client’s lifestyle—do they go out to eat a lot, do they like to travel, what part of the country do they live in and what’s the cost of living there? Then he tackles their debt goals.

“The way I would go about it,” he said “How comfortable are you having this debt? Do you want to pay it off as quickly as you can or do you want to maximize your wealth because those two things are usually mutually exclusive.”

For clients that want to pay off their debt quickly and have the means to do so already in place, refinancing to get a lower interest rate is a smart move to decrease that monthly payment.

“If you’re going to pay it off anyway, and you want to get rid of it,” he said, “you really want to find the best interest rate you can.”

For everyone else, Bledsoe said, he advises them to take advantage of federal loan perks such income-based repayment, which rise and fall with a person’s salary, and loan forgiveness programs for clients working in the public sector.

“Everybody and every budget is just so different,” said Bledsoe, whose clients’ student loan debt ranges from $10,000 to $350,000. “It’s really hard to apply a rule.”

Regardless of which formula or strategy you use to pay off your student loan debt, there are tips for figuring out exactly how much you can and should be paying each month in student loan debt — and a few ways to bring in some extra cash.

Quick Tips for Conquering Your Student Loan Debt

  • Cut the cable cord to save money, Jacobs said, and review your credit card statements to find recurring charges for services you may not need or may not even be using anymore.
  • Ask your private lender about discounts or interest rate deals for having your payment debited directly from your account each month.
  • Check with your employer about employee loan repayment benefits, a growing trend.
  • Use Earnest’s student loan calculator to see how much you could save by lowering your interest rate.
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