This article was co-authored by Nathan Digmann, Associate Advisor at Wipfli Hewins Investment Advisors, based in Milwaukee, WI.
A college education can teach you many things — from building and running a business to managing and balancing your time. However, there is one area in which the education system may have failed you: handling your personal finances. Don’t get us wrong; we love to hear commencement speakers encourage all of the dreamers in the room to keep dreaming. But where are the speeches discussing the role your financial health will play in your success?
We’ve outlined some key points that you can either implement yourself or use to help a loved one who is going through this exciting, yet daunting life transition.
Managing Your Student Loans
Gather Your Loan Information
In 2016, the average college graduate finished school with more than $37,000 in student debt.1 Unless you’re one of the few who will escape college without it, the first step to eliminating your debt is to understand the key features of your student loans so you can create a repayment plan that’s appropriate for you. Here are some of the important details you need to know:
Federal vs. private loans: Federal student loans are funded by the U.S. government, while private student loans are made by a financial institution acting as your lender. You may be familiar with the Federal Stafford and Perkins loans, which are two of the most common loans available to students. There are many important distinctions between federal and private loans, which you can find on the Federal Student Aid website.
Loan repayment term: Loan repayment terms may vary with private lenders, but the default term for many federal lenders is 10 years. Some providers offer income-driven repayment plans, which can extend the term of the loan.
Loan interest rate: Your interest rate will be dependent on when you took out the loan, and whether the loan is federal or private. It’s also important to determine whether the rates are variable or fixed. Variable interest rates will vary over the life of the loan, depending on market interest rates, while fixed interest rates are just as their name implies: fixed, or permanent.
Grace period: Available with certain lenders, this is a set period of time after you graduate in which you are not yet required to make a loan payment. Please note that interest still may accrue on your loans during the grace period. Be sure to check with your lender(s) about the terms of the grace period on your loan(s), if this information is not already provided to you.
Should You Refinance?
Refinancing refers to taking out a new loan with new terms to pay off your existing loan(s). Here are a few reasons why you may want to consider this strategy:
Lower interest rate: If you have been out of school for a couple of years and are building up your credit score, refinancing may be a good option if you can secure a lower interest rate. If your new rate is variable, be careful; it may increase if market interest rates go up.
More flexible repayment terms: Consider refinancing if you need more flexible debt repayment options than what your current loan provider — whether it be federal or private — can offer.
Simplification: Many students graduate with loans from multiple lenders, which can be overwhelming and confusing. If you fall into this category, you may consider refinancing your loans to a single provider for the sake of simplicity, so long as you don’t sacrifice favorable interest or flexibility to do so. However, keep in mind that the consolidation of multiple federal loans into a single federal loan does not reduce your interest rate; instead, you would get the weighted average of your existing interest rates.
An important note: if you are a teacher or work in public service, you may be eligible for loan forgiveness on certain federal loans. You can find more information on the Federal Student Aid website.
There is a lot to consider when it comes to refinancing, and the option is not for everyone. Do your research prior to making a decision to avoid giving up key benefits that may be available to you.
Learning What You Can Afford
Create a Budget
Start with your monthly take-home pay: Your monthly take-home pay is calculated by taking your monthly salary and subtracting all payroll deductions, including federal and state taxes, Social Security and Medicare taxes. This simple calculator can help you estimate your total take-home pay. Assume that you won’t be contributing to a retirement plan to get a complete estimate of your base income.
Net out your monthly expenses: Below, we’ve listed some of the most common expenses you may incur, tips for estimating them and a general rule of thumb for how much monthly income you should consider allocating toward each:
1. Rent/Housing: Remember to tack on utilities, water, cable and internet if they are not included in your rent. Monthly Income Allocation: 30%
2. Student Loan Payments: Now that you’ve followed the steps we laid out above, you should have a good idea of what your monthly loan payments will be moving forward. Monthly Income Allocation: 15%
3. Transportation: This includes car payments, car insurance premiums, gas, bus fare, parking at home or at work, etc. Monthly Income Allocation: 10-15%
4. Food: Take a look at what you are currently spending on food, as your eating habits probably won’t (and shouldn’t) be terribly different post-college. Monthly Income Allocation: 10%
5. Savings: This category includes funds contributed toward your emergency savings fund and your retirement. Monthly Income Allocation: 10-20%
6. Leisure: This includes travel, nights out with friends, clothes, your gym membership, etc. Monthly Income Allocation: 10-20%
People often refer to investing as a behavior they should control, but we think this same logic can apply to your budget, as well. Think rationally — key essential expenses into your budget plan and build out your discretionary spending from there. You’ll be forced to confront the sometimes-harsh reality of what you can, and more importantly, cannot afford to do.
Build your emergency savings fund: Prioritizing saving into your emergency fund is critical to your cash flow plan. It may seem unnecessary right now, but this fund will protect you from unexpected events like losing your job, a car accident or unanticipated health care bills. The general rule of thumb is you should have three to six months’ worth of your non-discretionary living expenses (i.e., rent, food, student loan payments, etc.) saved up in a liquid account, such as a savings or checking account.
Retirement savings vs. prepaying student loans: If you find yourself losing sleep over the seemingly insurmountable debt you’ve amassed after finishing school, you’re not alone. Managing debt is a common concern for many new grads, but there are a few factors you should consider before putting all of your excess income toward paying off your student loans as quickly as possible. We often refer to student loan debt as “good debt,” in the sense that it is tax-efficient debt. Depending on your income, any student loan interest you pay up to $2,500 in a given year could be tax-deductible to you. Check out the IRS’s website for more details about student loan interest deductions.
From a purely statistical standpoint, another key consideration you should keep in mind is the interest rate(s) you pay on your loans. If you’re paying a relatively low interest rate, it may be more beneficial to forgo prepaying your student loans, and invest in an aggressive portfolio comprised of mostly stocks within your employer-sponsored retirement plan (such as a 401(k) plan). For example, say the interest rate on your student loan is 3.76%2 and the expected annual return of the investment portfolio in your 401(k) plan is 7%. The spread between these two rates is more than 3% per year.
Not to mention, you could also receive a tax deduction for your retirement plan contributions. If you make traditional, or “pre-tax”, contributions of your salary into a 401(k) plan, those funds will be excluded from your taxable income in the year you contribute them. Your employer may also offer to match your contributions up to a certain percentage of your salary.
Yes, this is free money contributed toward your retirement savings — don’t leave it on the table!
Other Key Considerations
Opening up a credit card: You may or may not have started using credit while you were in college, but it’s certainly a must by the time you graduate. From building a good credit score to accessing tools that make tracking your spending easy, using credit in the right way can be great for your financial health. Here are a few tips to help you get started.
Employer-sponsored benefits: Be sure to educate yourself about benefits available to you through your employer. Meet with a representative from your company’s human resources department and review all of the details in your benefits package to ensure you are taking full advantage.
Healthcare/financial powers of attorney: If you are involved in an accident or become incapacitated, most states will not allow your parents to make health care and financial decisions (or even receive your medical records) on your behalf without these legal powers in place, which grant an “agent” the authority to do so. Consult a financial advisor or estate planning attorney to assist with completing these documents.
Life insurance: Life insurance may not be necessary for you, unless you have dependents, such as a spouse or children, who are relying on your income to make ends meet. However, this type of protection eventually will be necessary as you cross major life milestones. When you’re ready, here are a few guidelines for assessing how much coverage you should have at various stages of your life.
We’ve covered a wide range of topics, because there are many areas you should consider to make sure you’re leaving college with solid financial standing. Nonetheless, there is no need to feel overwhelmed; address your financial concerns one at a time. You should feel proud that you are being proactive and taking ownership of your finances. By spending a little time to prepare and understand what we’ve discussed, you’ll be on the right path toward financial independence (that’s the adult version of “cool”)!