Dealing with the Middle Class Dilemma

Michael Lux Blog, Strategy, Student Loans 1 Comment

One of the most common complaints we hear about borrowers’ student loan situations is that they feel like they are stuck in the middle.  In high school they were a good student, but not a great student.  This means there were several college options, but few scholarships.  The family income was middle class — too much money to qualify for need-based aid, but not enough for the family to pay for school.  This college funding problem often leads to using student loans to fund an education.  Upon graduation, many borrowers find themselves stuck in the middle again.  Too much income for loan forgiveness programs and lender aid programs to help, but not enough income to aggressively pay down the debt or to qualify for student loan consolidation and refinancing services.  This can mean a lifetime of minimum payments on student debt.  Perhaps worst of all, children of these borrowers can end up in exactly the same situation.

Today we will discuss some strategy to end the cycle we will call the Middle Class Dilemma.

Best Route: Avoid Student Loans

This one sounds obvious in theory, but far too many people reject this option without enough thought.  Getting in to your “dream school” is great, but if you are going to break the bank to attend, it could be a huge mistake.  Many community colleges are substantially less expensive options and if you plan ahead, you can transfer your credits to the expensive school you want to attend for years three and four.  Spending less on housing and tuition can make a huge difference in future years.

Along the same lines, delaying school to earn some extra money or attending school at night while you work during the day can be a wise choice.  Not only will going this route help you show future employers you have a great work ethic, but it will also mean that your short-term sacrifices will have long-term benefits.

The Realistic Plan: Pay a little extra each month

Suppose you are stretched thin paying $800 per month on your student loans.  An extra $20 per month might not seem like much but it can make a huge difference in how fast you pay off your loans.  The key number to look at on your monthly payment is not how much you are paying.  Instead, look at how much of your payments are going towards the principal balance.  For borrowers with high interest rates or extended repayment plans, often only a very small portion reduces the principal.  That little bit extra you are able to pay goes directly towards the principal balance.  Reduce the principal, spend less on interest each month, and more of your payment reduces principal.  It really can have a snowball effect.

Tip: Make sure you are paying as little as possible

The term minimum payment is misleading.  For example, on the standard federal student loan repayment plan, most borrowers make payments so that their loans will be paid off in 10 years.  This is the default plan.  When that first bill comes in the mail, the minimum required payment may be far more than the minimum you actually have to spend.  Options like the income-driven repayment plans can dramatically reduce your monthly payments.  Paying less on these loans does extend the amount of time it takes to pay them off, but it is important to look at the entire student loan picture.  Suppose you have low-interest federal loans and higher interest private student loans.  If you can lower the monthly payments on your low-interest loans, you can direct more money to the higher interest loans.  This will get your debt paid off faster.  Finding ways to reduce monthly payments and focus your cash on high interest debt is a great way to get out of the Middle Class Dilemma.

The Next Generation: Set money aside for 529 plans

If it is already too late for you and you want to protect your children from the Middle Class Dilemma, a 529 is a great way to ensure their future free of student loans.  The laws on 529 plans vary from state to state, but these plans have huge tax advantages and are a great way to get the most bang for your buck.

Bottom Line

When you are stuck in the middle on student loans it can seem impossible to get ahead.  Facing a lifetime of student debt or the possibility of failing to pay off your loans is a devastating situation to be in.  Fortunately, there are ways to get past this problem.  It certainly isn’t easy, but it definitely can me done.