The Hidden Tyranny of Student Loan Debt Interest
Nothing is more dangerous than an idea whose time has come – Victor Hugo
I have introduced a very powerful financial concept—income driven repayment coupled with forgiveness. This is what I call Plan A. However, to fully understand the beauty of this system, you have to understand what’s happening out there today—the dysfunctional solutions that most people unwittingly get thrust into. In plain terms, it’s a nightmare. But we have to look at this nightmare to grasp the genius of the solution.
Right now, across our great nation, the average outstanding student loan amount is $37,172. What I see in my practice is slightly higher—usually about $50,000 on average. This is the amount I use as a benchmark.
So someone graduates with $50,000 in debt. Everyone is “granted” a 6-month grace period after graduation. Once finished with the grace period, they get put into a Standard Repayment Plan. “Standard” means the default program - it’s what everyone gets put into automatically. I went into depth about this program in my article How to Avoid the Standard Repayment Plan Trap. What you need to know here is on average, they determine that your monthly payment should be 1% of the total loan. So if you borrowed $50,000, you’d pay $500 per month. If you borrowed $70,000, you’d pay $700 a month and so on.
After someone leaves school, goes through their grace period and gets their first student loan bill, one of two things happen:
They pay it, or;
Let’s imagine that they pay. They’re paying and paying. But then something happens in life. If you talk to any insurance salesman or financial advisor, they’ll tell you that life happens. So maybe:
They get in a car accident;
They have kids;
They get married;
They can’t move out of their parents’ house;
Or like 73% of Americans, they can’t find a job after graduation in the field they studied for. So they have to go get a McDonald’s job.
Point is, life happens, and the first thing people do when they run into financial trouble is they stop paying their student loan debt. Why? Because no one can repossess an education. So hopefully they call up their loan servicer and ask for help. And they’ll be put into what’s called forbearance or deferment. Forbearance or deferment—in most people’s minds—is like a pause on the loan, so people can get back on their feet and start paying again. But in my opinion, forbearance and deferment are the biggest scams being perpetrated on the American public today. I went deep into this when I wrote my article The Deferment and Forbearance Scam. Now it’s time to dig into why I said it and why I stand by what I said.
Student Loan Debt Interest
Student loan debt interest is calculated much, much differently than any other type of interest. It’s calculated on what’s called Simplified Daily Interest.
That’s a fancy mathematical term for an algorithm that is currently crippling our country. The term is a way of saying that the interest compounds very, very rapidly when you don’t pay; and it’s very, very difficult to pay down when you do. I use the analogy of walking up a down escalator—that’s accelerating over time! Borrowers put in a ton of effort but get nowhere. And they can actually head backwards.
In many ways, the situation recalls the Greek myth of Sisyphus. (Per Wikipedia, for those not steeped in Greek mythology: “Sisyphus was the king of Ephyra… He was punished for his self-aggrandizing craftiness and deceitfulness by being forced to roll an immense boulder up a hill, only to watch it come back to hit him, repeating this action for eternity.” Albert Camus observed that “[the gods] thought with some reason that there is no more dreadful punishment than futile and hopeless labor.”)
Let me give you a hypothetical example of what could happen in order to illustrate this further:
Let’s say you are one of those people who got their $50,000 in student debt, and you set out on a crusade to pay it off. You said, “I’m going to pay this $500 a month for 10 years and never miss a payment; I’m going to get this done.” So you set out, and you get 5 years in, never missing one payment. You’re half way to your goal. Then “life happens” and you call your servicer and get put on deferment or forbearance for 1 year to get back on your feet. Guess what? It’s like you’ve only been paying your loans for 2 years, not 5. That is how much is recouped in student loan debt compounding interest.
Don’t believe me? In my next post, we’ll take a look at real world examples of student loan insanity—with math that will leave you so angry, you may have to restrain yourself from throwing things at your computer.