As of 2015, graduates leave college with an average of $28,000 in student loan debt. While a college degree used to be the golden ticket to a prosperous career, the average income for an individual with a bachelor’s degree is just $36,000. The only reason it’s that high is that there are some very high-earning outliers; a staggering 40% of recent grads will earn under $25,000, which is the cost of living in America. That just barely covers the bare essentials like housing, food, and transportation. Depending on where you live, it might not even cover those necessities. It does not allow very much for paying off debt, leading into the current student loan crisis. When your annual income is equal to or less than your debt, you are in trouble.
Some personal finance experts tout debt repayment plans like “the snowball method” to pay off student loans and credit card debt. However, for fresh graduates struggling to make their payments and pay their rent, the snowball approach can end up costing them thousands over the term of their loans and wreck their financial futures.
Under the snowball method, you list all of your debt in order of the balances, from smallest to largest. Then, you pay as much as you can towards the lowest balance while making minimum payments on the rest of your loans or credit cards. Once the smallest balance is eliminated, you take the amount you were paying on that debt and apply it to the next lowest balance. You keep doing this until all of the balances are eliminated – regardless of the interest rates or type of loan (i.e. federal vs. private).
The idea behind this is that you need little successes to keep you motivated. As you see those small balances get paid off, you feel inspired to work harder at eliminating your debt. But by doing this, you end up costing yourself tons of money. When you are a young professional and every dollar counts, this is a mistake you cannot afford to make.
Instead, order your debt by the interest rates and pay off the highest rate first. For instance, let’s say you have a student loan for $5,000 at 6.8% interest and a credit card with a $6,000 balance at 18% interest. Under the snowball method, you would pay the student loan off first, but that interest rate is tiny compared to the credit card. You’ll end up paying way more in interest on the credit card balance, adding to your debt instead of bringing it down.
High-interest rates compound quickly and can keep you in debt for years. By instead focusing on paying off the high-interest debt first—the credit card balance—you save money and put cash back in your pocket.
Whether you have multiple student loans or a mix of student loans and credit card debt, focusing on paying off the higher interest debt will get you in a good place faster. It may require more dedication since you do not get the thrill of those small “wins”, but in the long run, it will help you build a much more stable financial future.