The First Steps to Budgeting and Living With Loans

Typically, when discussing finance and local business we tend to focus on examples or success and expansion, because frankly those are positive stories and we can try to draw some inspiration or practical knowledge from the proprietors. People like reading about their favorite restaurants getting new locations or winning awards. We like seeing that our financial advisor is winning awards for excellence and trustworthiness. It’s comforting. It’s uplifting.

Debt is not uplifting. Paying rent is not comforting. Budgeting for health insurance and a 401(k) contribution doesn’t have the same sexy vibe as attending the gala reception for a local business award ceremony. Yet a good bulk of the people attending those galas, at one time or another had to deal with all of those issues. Long before they were winning awards for excellence, most local business owners were just getting in on the ground floor: earning a living wage, moving out of their parents’ house, and probably sleeping far less than physicians generally recommend.

Getting started can be especially tough in Westchester. Minimum wage is lower than in the City, rent is higher than everywhere else but the City, and local school systems are by and large very good, meaning it’s very likely a recent college graduate has come home from a very good (and potentially debt-inducing) university.

Katherine McGinn is a Certified Financial Analyst with Pell Wealth Partners, a private advisory practice based out of Rye Brook, under the banner of Ameriprise Financial Services, Inc. She earned her bachelor’s degree from Bard College in Dutchess County, lives in South Salem with her husband and their dog, and in 2016 she made the Business Council of Westchester’s “Rising Stars: 40 Under 40” list. She has also — very, very generously — agreed to provide us with her professional counsel as we try to figure out how get life into first gear in Westchester.
 

How to Start from Nothing When You’re Already Behind

To say we’re “just starting out,” is kind of a disingenuous thing to tell people when most of us have barely left collegiate life and are already responsible for tens of thousands of dollars in financial debt. We’re not so much on the “ground floor” as we are kicking around the sub-basement.

According to Forbes, the national average for student loan debt as of 2016 was $37,172. That’s about the cost of three full semesters for an on-campus, in-state undergrad at a typical SUNY college. The average interest rate on those loans was at minimum 4.8 percent, while private loans can reach as high as 8 percent.

Here’s the hitch: Loan payments are typically made monthly, but student loan interest is accrued daily. That’s five percent divided by 365, multiplied by your current balance. On a typical $35,000 debt, that works out to $4.80 per day, or about $144 per month, for the total $1750 per year you’d expect.

Unfortunately, loan payments always pay off interest first, before reducing any balance. This means that if your monthly payment is less than $144, your debt actually increases. Regardless of what number you may have been told, this is your actual minimum monthly payment if you ever want to get out of debt. So let’s budget this.
 

The Budget

At $30,000 a year, about one-quarter of your salary goes to taxes. A third to as much as half will go towards rent. (Yes, the conventional wisdom is one-third, but as recently noted, rents in Westchester far exceed what conventional wisdom has historically dictated as reasonable.)

This leaves somewhere between $700 and $900 per month to live off of. And by “live off of” we mean ‘pay other bills’ like utilities, phone, insurance (health, dental, prescription, life, disability, renter’s, car, etc.), groceries, transportation, and — oh yeah — loans.

$144 of that has to be earmarked for loans each month just to break even.

The math isn’t very forgiving. Even ignoring any semblance of a social life, how much could a person reasonably expect to set aside to pay these loans down in a reasonable period of time? What would even constitute a “reasonable” period of time, then? Ten years? Fifteen? Twenty or more? If you’re starting to panic, McGinn says to relax a bit:
 

“Before you stress about paying more than the breakeven amount on a loan, consider this: Where would you find the cash if you had car trouble, or a large medical bill?

I suggest building up a cash reserve, that way you have a source to pull from for unexpected emergencies. Ideally, you’d have at least three months of rent and other fixed bills set aside as a cushion. That can take a while to build up, but in most cases it should take priority over paying down your loans on an accelerated schedule.

If you don’t have an emergency cash reserve, you could be tempted to put unexpected expenses on credit cards. Eventually it becomes very difficult to tackle student debt and credit card debt all at once, and the debt can build up exponentially over time.

It’s also important to consider your future earning potential. Are you in a position that has advancement opportunities where you can earn more down the road? If so, it could be best to ramp up the loan payments when you have more discretionary income.

Fitting accelerated loan payments and cash reserve savings into a tight monthly balance may be challenging, but if you can afford to tackle these two goals – and pay more than the minimum on your loans – you’ll likely be better off in the future. The key is to be honest with yourself about what is important to you and to shape your decisions about what you spend your money on based on your personal values.
 

If you’re still concerned that even the barest minimum loan payments leave you untenably strapped for cash — perhaps you had a job but were laid off, or incurred some long-term situation that prevented you from working for extended periods — McGinn suggests looking into the option of deferring or forbearing your student loans. The process is murky, sometimes seeming purposefully so, but it can definitely be worth it to buy yourself a little extra time in building that buffer before tackling the bulk of your loan debt.

Interested in loans, healthcare, 401(k)s, and other getting-started finance topics? Check out future installments and get in on The Ground Floor.