Sunday, October 25, 2009

System For Savings Thousands Per Year On Your Student Loans

As you know, payments for both federal and private students loans are deferred while the students is in school.  That's great because it allows the student to complete their education without having to worry about making a loan payment until after they graduate - and those loan payments can be pretty big.   For most private loans, even though payments on the loan is deferred, the loan continues to accumulate interest during the deferral period.  However, federal student loans many be either subsidized or unsubsidized.  The unsubsidized student loans accumulate interest during the deferment period, but the subsidized student loans do no accumulate any interest.  This leads to an interesting strategy that may be helpful in your situation.  Keep reading to find out!
What if you could:
  • Have no interest accumulate on tens of thousands dollars worth of your loans
  • Not have to make a payment on tens of thousands of dollars worth of your loans
  • Use the money that would otherwise go to these loan payments to more quickly reduce higher interest loans
 You can!  With an in-school deferment.  Hold on a minute and let me explain -

Most lawyers and law students think that they only qualify for an in-school deferment when they are actually in law school.  Not true.  Here's a link to a U.S. Dept of Education website with regard to deferments.  In actuality, you qualify for a deferment as long as you are at least a half-time student at an eligible school.  Half-time is usually 6 semester hours, but check with the school.  Further, almost all schools are eligible - if the school has its students fill out the FAFSA, then it is most likely eligible (but you can also check with the school).

I can hear people groaning about school already - "I just finished school, I don't want to go back."  However, you don't have to go back to a law school and the schooling does not have to be towards a degree.  For example, you can go to a local community college and take underwater basket weaving and qualify as "in school."  For example, I had a friend who went to the local community college and took a recquetball class and a weightlighting class.  I had another friend who took a community college course where they received class credit for going to dinner theater - and going to a Renaissance Faire!  Finally, another friend registered for online courses at a community college and never had to leave his house.

One thing to be aware of - your law school loans come with only "one grace period."  However, if you return to school before the expiration of the grace period, the grace period is re-set.  The grace period is typically 6 months - see definitions here.This means that if you manage your enrollment well, you need not attend community college during the entire year.  Consequently, you would want to register at a community college (CC) in the fall after graduating law school in order to preserve your grace period.  This can be important as shown in the following examples:
  •  You registered at CC in the fall after you graduated from law school - thus preserving your grace period.  You then register in the spring semester, do NOT register in the summer, and then re-register the next fall.  In this case, because your grace period is intact, and the time between the semesters is less than 6 months, you will not have to make a payment during the summer and your grace period will still be 6 months going forward.
  •  You registered at CC in the fall after you graduated from law school - thus preserving your grace period.  You DON'T register in the spring semester, but DO register in the summer.  Assuming that the gap between the fall semester and summer registration is less than six months, your grace period is also still preserved.
  • In this fashion, you would only have to register for 2 of the fall, spring, and summer classes to defer your loans and preserve your grace period.
What is the financial impact of the in-school deferment?
To figure this out, we need to look at three factors: 1) the value we get by having interest subsidized for some loans, 2) the value that we get be being able to concentrate our loan repayment on higher interest loans, and 3) the cost of enrolling in a community college near us.

In this regard, let's consider a hypothetical situation in which a graduating law student has the following loans.  We will keep the example simple with low loan values, but the system actually works better with higher loan values if more loans can be deferred and their payment diverted to higher interest loans.

$36,000   -    $12,000/year of unsubsidized Stafford Loan at 6.8% (current interest rate)

$25,500   -    $8,500/year of subsidized Stafford Loan at 6.8% (current interest rate)
$20,000   -    Accumuated credit card debt at 15%
$81,500   -    Total debt

Value from subsidized interest
When the loan is deferred, the subsidized Stafford Loan will no longer accumulate interest.  This saves us $1734/year or $144.50/month.  In our calculation below, the time period of one year and three months becomes important.  Calculating the interest savings over the one year and three month period yields $2167.50.

One other thing to note is that this system become more useful as the interest rate increases.  For example, if the interest rate on the Stafford Loans goes back to 8.5% (like it was when I graduated), then this system would be saving $2709.38 over our one-year-plus-three-month period.

Value from loan payment diversion
That's pretty good, but we also save a lot by redirecting the loan payments that we would have made for the Staffords to the higher interest debt.

For example, we use a calculator to determine the loan payments per month for the Stafford Loans.

414.29 - unsub Stafford
293.45 - sub stafford
707.74 - Total loan payments for Staffords - per month - which is $8,492.88 for the year

Using this calculator, we find that the minimum payment for our $20,000 of credit card debt is $800/month.  By adding the additional $707.74 per month, we pay off the credit card debt in one year and three months and have a total interest savings over the life of the debt of $7,023 - which is huge.

Of course, we have to add back in the interest that accumulates on the unsubsidized stafford loan over that one year and three month period and subtract that from our total interest savings:
6.8%*$36,000*15/12 = 3060
$7,023-$3,060 = $3,963

Therefore, considering the interest savings from the credit card as compared to the interest paid on the unsubsidized Stafford, we come out nearly $4,000 ahead over a year and three months.

Once the credit card debt is taken care of, we can divert the $707.74/month to the next highest debt:
  • If there are other loans with a higher interst rate than the Staffords, those can be attacked.
  • If the cost to enroll in school is low enough, we may want to pay the unsubsidized Stafford down while still having the subsizided Stafford remain subsidized.
Cost of enrolling in community college
Above we determined that the savings we would see by using this system over a one year and three month period includes $2167.50 saved by not having to pay interest and $3,963 saved by diverting loan payments.  That's a total of $6130.50.

However, in most states community college is not free.  Consequently, our total value earned with this system must be reduced by the cost of attending community college - or otherwise earning our in-school deferment.

In this regard, we note that the cost to attent community college varies widely across the country. 
  • Residents of California may be especially lucky - according to this article, the per-hour costs may be as little as $20/hour in California.  That's about $150/semester - considering there will likely be some fees.
  • In Chicago you can attend several of the city community colleges for $79/credit hour plus a single $25 registration charge.  For a 6-hour semester, that runs you about $500.
  • New York community colleges seem to vary widely, but Westchester Community college seems to be on the cheap end - it charges $148/credit hour with mandatory fees of $43.50.  That's about $930/semester.
Bottom Line Savings
We consider that our time period of one year and three months will likely incurr two semeter's of expense.  That's a total cost of $300 in California, $1000 in Chicago, and $1860 in NY.  Subtracting these costs from the overall savings of $6130.50 yields the following:
  • In California, the system saves about $5830
  • In Chicago, $5130
  • In NY, $4,270
This represents a VERY significant savings - even in NY. 

I hope that this can be of some use to you! Good luck paying off your loans!


  1. WOW! This is the best advice I have seen on a law blog in a while. I'm definetly going to try this tactic out. Thanks.

  2. 3:00 - Thanks! But remember to do your math first. The actual savings are going to depend on your personal interest rate and your cost of attending school. Good luck and let us know how it works for you!

  3. I am trying this tactic out. I was wondering, can you pay down the principal on the unsubsidized loans, even while you elect the deferment? I know you are allowed to pay the interest that accrues, but can you pay more than that? My plan is to pay down my unsubsidized loans first, while the subsidized are at a permanent psuedo 0% interest rate (as long as I take 6 units), and then pay them down. I think you are allowed to do this, but I just wanted to make sure.

  4. 4:29 - I personally did pay down the principal of the unsubsizied loans even while in deferment, so unless something has changed, you should be good.