Student Loan Repayment: Dave Ramsey or High Interest Rate?

By Joseph Reinke, CFA, CEO of FitBUX

Many have used FitBUX’s MyFit Student Loan Solution and have asked us about implementing Dave Ramsey’s Snowball Method for repaying student loans. This article reviews the cost tradeoff of this strategy relative to repaying your highest interest rate student loan first, an example, what not to do regardless of your choice, and which method is the best one to use.

Snowball Method vs. High Interest Rate First

Dave’s method of repaying debt involves repaying the lowest balance loans first.  This works because it helps build discipline and reduces how much you owe on a monthly basis.  For example, if you have credit card debt of $2,000 and a monthly payment of $30 as well as a car loan for $15,000 with a payment of $250 then paying of the credit card first would reduce how much you owe on a monthly basis by $30 and you can pay this off much quicker than the $15,000 car loan.

The high interest rate method involves paying off the highest interest rate loan first regardless of the loan balance. This method will always save you more money in the long-run relative to Dave’s Snowball Method.  Does this mean his method is bad? No and we will explore this later in the article but first let’s show an example of how much you would save using the high interest rate method to repay your student loans.

Student Loan Repayment Example

The following is an actual example of a physical therapist student loan repayment plan from a Member of FitBUX.  The individual had a total student loan amount of $146,000 and ten loans.  The following are the details for each loan:

Loan 1: $1,696 at 5.00%

Loan 2: $3,082 at 5.75%

Loan 3: $3,950 at 5.35%

Loan 4: $4,744 at 3.15%

Loan 5: $4,786 at 4.25%

Loan 6: $11,853 at 4.00%

Loan 7: $19,212 at 5.96%

Loan 8: $19,920 at 5.16%

Loan 9: $31,963 at 8.25%

Loan 10: $45,145 at 6.55%

Assuming a ten year repayment plan and a $200 monthly prepayment, this individual would save over $6,500 by paying off the high interest rate loans first relative to Dave Ramsey’s Snowball Method.

There are two factors that determine how much more you save by paying off the high interest rate loans first:

1) The spread in interest rates. In this example, the lowest interest rate is 3.15% and the highest interest rate is 8.25%. The greater the spread the more you save by paying off the high interest rate loans first all else equal.

2) Which loan balances have the higher interest rates? If your largest loans have the higher interest rates, as is the case in this example, the more you save by paying of your high interest rate loans first.

What Not To Do Regardless Of The Method You Choose

If you stay in your Federal student loans, you absolutely do not want to consolidate your student loans. If you do that then you can not pay off the low balance loans or the high interest rate loans because you no longer have multiple loans. Therefore, if you consolidate your Federal student loans to one Federal consolidated loan you will cost yourself dearly regardless of the choice you choose.

So when do you consolidate?  If you choose to refinance your student loans, then you may want to consolidate.  We highly recommend working with FitBUX to customize your repayment strategy so you can see if refinancing is right for your situation.

Which Method Is Best

And the answer is….whichever one you are going to follow.  If you are looking to build discipline and want to feel the accomplishment of paying off your loans then Dave Ramsey’s method is great.  If you have good discipline already and want to save as much money as you can you’d want to pay off the high interest rate loans first.

The bottom line is whichever you feel the most comfortable following, DO IT.  There is no reason to do the “most efficient” option because someone else told you to if after a few months you are going to stop doing it.  A good strategy is one you are comfortable with because that means you will do it and that is the most important thing you can do when putting yourself on a good financial path…..

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