By Michael Stratford
Caitlin Killam, 24
Should I repay my student loans before building savings?
Digging Out of Student Debt
Since graduating from pharmacy school last May, Caitlin has been
attempting a balancing act familiar to many recent graduates. She
is staring down $120,000 in student debt while also gearing up to
buy a house and save for retirement. Fortunately, as a pharmacist
for a major retail chain, she's well compensated, with a salary of
more than $100,000.
Caitlin knows this income gives her options most of her
contemporaries don't enjoy. But that doesn't make managing life a
breeze. "I just don't know what to do with my paychecks," Caitlin
says. "Should I pay off all my loans right away? Or invest some of
the money that I have?" Aside from student loans, Caitlin has no
debt and has $20,000 in the bank. She'd like a new car, and hopes
to move to Hawaii, where her mother lives, and buy a house there in
five to ten years.
Those goals require cash. Caitlin's first step should be to
build up her savings and to set aside a rainy-day fund, just in
case. Because she has a secure job in a growing field, a six-month
reserve fund should be sufficient. Certificates of deposit are her
best bet because CDs aren't easy to spend on a whim. "Having an
emergency fund locked up in a CD makes it harder to nibble away at
it for items that aren't really emergencies," says Andy Tilp, of
Trillium Valley Financial Planning, in Sherwood, Ore.
Caitlin would also do well to buy long-term disability
insurance. "Right now, her ability to earn a living is her best
asset, and it's important to insure that asset," says William
Stewart, of Rehmann Financial, in Troy, Mich. The cost to guarantee
60% of her salary if she were permanently disabled should be in the
range of $300 a month-or less, if she can get a discount through
About those loans.
Because Caitlin has other financial goals, her student loans aren't
a priority. She's currently paying $1,400 a month on a ten-year
repayment plan. If she temporarily extends the term of the debt to
25 years, she'll lower her monthly payment by as much as 50% and be
able to put aside the difference for other purposes.
At her salary, Caitlin should aim to save as much as 25% to 30%
of her take-home pay, advises Paul Baumbach, of Mallard Advisors,
in Newark, Del. He also advises that she rejigger her student-debt
repayment schedule while she saves for a down payment on a house in
Hawaii, where real estate is expensive. In addition, Baumbach says,
she should contribute the full $17,000 permitted in 2012 to her
401(k) once she is eligible for matching contributions. That will
save about $6,300 in state and federal taxes.
Still, the longer the payment period on her student loans, the
more interest Caitlin will pay overall. So if she can afford at
some point to return to the ten-year schedule, she should try.
The principle remains the same even for young people who earn
less than Caitlin: Set up a loan-repayment schedule you can live
with so that you maximize your cash flow for living expenses and
other purposes. Discipline works for everyone.