When I speak to recent graduates about their student loan grace period, I often hear two very different comments. The first, “I want to start paying my student loans immediately so I can save money.” The second, “I do not need to worry about my student loans because I’m in my grace period.” Who’s right?
The first is somewhat correct because it depends on your goals. The second is always incorrect because you need to understand and plan a student loan repayment strategy as early as possible…and no, ignoring your student loans is not a strategy. It is a costly mistake. This article discusses strategies for you to implement during your student loan grace period.
Table Of Contents
- What Is The Student Loan Grace Period
- Goal #1 During Your Student Loan Grace Period: Starting An Emergency Fund
- Accrued Interest: Should I Be Paying It?
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What Is The Student Loan Grace Period
First things first. The student loan grace period occurs immediately after you graduate. You are given six months whereby you are not required to make payments on your student loans. Each Federal Student loan has one student loan grace period. Therefore, if you already used it you do not get another one.
For example, if you received an undergraduate degree and then worked. After a year or two you decided to go to grad school. Post graduation, your undergraduate loans do not get another student loan grace period. However, you can call your loan servicer and request that they put you on administrative forbearance.
Goal #1: Starting An Emergency Fund
Many recent graduates want to immediately begin paying off student loans during their grace period. The reason is they want to save the most money. This is a good mindset to have but there are other actions to take first.
The first action you should take is to establish an emergency fund. A reserve account is another name for a rainy day fund or an emergency fund. Having a reserve account allows you to weather financial shocks. These include changing jobs, being laid-off, having to move, etc… The question to answer is how much money do you need in reserve?
There are a number of factors that determine how much to have in reserve. The most important are your risk tolerance and what profession you are in. For example, if you are in an in-demand profession, you should be able to find employment fairly easily. Therefore, you could potentially have a lower amount in your emergency fund.
Risk tolerance simply means how many months of “buffer” you need to feel comfortable should your situation change unexpectedly. This buffer is simply how long you would want to “survive” having zero income and being able to meet your monthly expenses.
To calculate your reserve account, you must first estimate your monthly expenses that are necessities. Items such as food, utilities, rent, etc… Then determine how many months you would like saved up and multiply by your monthly expenses. For example, if your monthly expenses are $2,000 and you would like a 3 month reserve, then you would need $6,000 ($2,000 x 3).
Accrued Interest: Should I Be Paying It?
Some of you won’t be able to save for the emergency fund before your student loan grace period is over. That is OK. Enter repayment, make the minimum payment, and save as fast as you can. Once you have the emergency fund then implement your student loan strategy.
Others of you will be able to establish your emergency fund before your student loan grace period is over. The number one question we get from those that do this is, “Should I pay off the accrued interest on my loans?”
It depends. Are you paying off your student loans or going on an income based repayment plan?
Student Loan Grace Period & Paying Off Your Loans
Its as simple as 1) Make payments ASAP, 2) Don’t pay the accrued interest, and 3) look into student loan refinancing.
Make Payments ASAP
If you have chosen to pay off your student loans then you’ll want to start making payments during your student loan grace period as soon as you have your emergency fund saved.
This will save you money and get you out of debt sooner. I will illustrate with an example. We will make the following assumptions:
- The loan is 10 years
- Student loan grace period of 6 months
- $100,000 loan balance
- 100% of the loan is unsubsidized
- The loan has a 6.85% interest rate
If you deferred your loan during the student loan grace period, it would accrue $3,425 in interest. After the six month student loan grace period ends the interest is capitalized. This means that the $3,425 is added to your loan balance and your new principal balance is $103,425. Over your ten year repayment period, you would pay a cumulative amount of $143,144.
To compare, let’s assume you were actually working during your student loan grace period, you had a reserve account, and you could afford to make payments. Therefore, you started repaying your student loans immediately upon graduating. Your cumulative payment amount over the life of the loan would be $138,404. In other words, not deferring interest during your student loan grace period would save you $4,739.
Do Not Pay Your Accrued Interest… Kind Of
You will be getting notices saying that you have accrued interest. If you don’t pay it, then it will “Capitalize“. All this means is the deferred interest you accumulated gets added onto the loan balance.
You want to make a payment. However, you don’t want to throw it across all your loans which is what happens if you simply pay the accrued interest. Instead, you want to target specific loans. For example, you have multiple student loans. You can choose to pay off the highest interest rate loans (or the low balance loan) which will save you the most money. Yes, your accrued interest will capitalize on your lower interest rate loans but your high interest rate loans will have a lower balance.
Look Into Refinancing Your Loans
If you are paying off your loans and you have your emergency fund, its time to look into refinancing. Refinancing is replacing one loan with another. The key is that you’ll want to look into it…you’ll not necessarily do it but you want to look into it.
Student Loan Grace Period and Income Driven Repayment Plans
If you have your emergency fund saved and you are going to use an income-driven repayment plan, start saving for the tax. If you would like more details on how to save for the tax be sure to check out these four essential resources:
Steps To Take During Your Student Loan Grace Period
Here are the steps to take:
- Build your emergency fund
- Decide if you are going to pay off your student loans or go on an income-based repayment plan
- Implement your student loan strategy