Whether you’re a recent graduate and new federal employee, or perhaps once were and now know one, you likely recognize that the growing list of financial responsibilities that this group faces can feel daunting. Given that the national average student debt is approaching $40,000, you probably also know that burdensome student loans sit atop many young Feds’ list.
But with careful planning, those facing student debt can tackle it in a way that not only leads to long-term financial health but also allows their budget to optimize their many other financial priorities.
Here’s a look at three key questions to consider when embarking upon this process.
Where should student debt rank amongst other financial priorities?
Though it’s rational to assume you should immediately begin overpaying your student loans as soon as possible, I always advise my young clients to focus on two elements of their financial plan:
- Emergency fund: an established emergency fund is not only necessary to cover the many unforeseeable costs that can arrive at a moment’s notice, from a necessary car repair to an unexpected medical bill, but to also protect you from incurring penalties and raised interest rates on your student loans if these sudden costs derail your payments. Ideally, an emergency fund should consist of 3-6 months of expenses in liquid assets.
- TSP: Making matched contributions to your TSP effectively provides a 100% return on investment and is a critical part of every Federal employee’s financial plan. So while new Feds might not be able to stick to (and would need to opt out of) the 5% contribution that they are automatically signed up for upon Federal employment, contributing even 3% is a great start to building wealth.
One question I often hear is whether life insurance should come into play at this stage. While life insurance is indeed another critical element of every employee’s financial plan, it is need-based. Therefore, if an early career Fed has no one to protect – for example children, a spouse, or anyone who has cosigned a loan – life insurance is probably not a necessity at this point. However, if this coverage is indeed warranted, it is another priority as this protection should be kept active to prevent the aforementioned tailspin.
What type of loan payment is best?
Budgeting is incredibly important early in your career given the many expenses and saving requirements that need to be balanced. Therefore, it’s important to secure a loan payment that will work for your budget without straining it.
Achieving a reasonable loan payment starts with choosing the ideal type of loan for you. Some of the top options include:
- Government Directed Student Loans: While these loans have relatively high interest rates and are difficult to discharge during a bankruptcy, they represent access to financial aid with little to no underwriting for enrolled students.
- Private Loans: on the plus side, these generally provide lower interest rates, but they also require additional underwriting.
- Consolidated Loan: consolidating under a mortgage, for example, these loans will usually provide the best loan terms (interest rate and payment) but will turn your unsecured loan into a secured loan – meaning that your home could be jeopardized if you default.
Can I adjust my loan terms if I need to?
Fortunately, there are some strategies available to refinance your loan terms if your budget requires it and your fees justify it. An interest rate reduction of at least 1% is ideal for debts exceeding $50,000, and a rate improvement of 2% is better for debts under $25,000.
Beyond refinancing, deferral is a tool that can allow an employee to focus on his or her emergency fund and TSP contributions. However, I advocate for deferral only when it creates opportunities to prioritize your overall financial health – if you are simply seeking ways to have more frivolous spending money, deferral is not the way to do so and is likely to set you up for long-term and snowballing financial struggles.
Federal employees may also benefit from loan forgiveness depending on the agency or department where they are employed. Before pursuing this, however, it’s important to keep in mind that it usually requires at least a 10-year commitment and that student loan interest is tax deductible. Given this, your income level and filing status may affect your loan payment – for instance, a federally directed loan caps your payment at 10% of your income, which can alleviate a young employee’s burden.
Considering the complexity of these questions and how greatly they depend upon one’s personal circumstances, working with a financial advisor early in your federal career may be the best way to create a solid budget that fits debt reduction among your many other short- and long-term financial priorities. An advisor can also help you figure out what to prioritize and in which sequence; for instance, I recommend paying down debts in order of highest interest rate to lowest. By starting off on the right financial foot, student loans need not derail your budget.