Tuesday, January 5, 2010

Conquering The Psychological Aspect Of Loan Repayment

When many law students and new associates consider their loans, they often make inaccurate assumptions.  One assumption that we previously mentioned here is that they often underestimate just how large their loans will be.  Another assumption that is often wrong is how long it will take them to pay off their loans.  For example, in this previous article, we set out a hypothetical financial snapshot of a new associate earing top dollar and illustrated that the associate may have much less available for loan repayment then may be initially estimated from their salary.  However, in practice I have seen that the psychological aspect of loan repayment is often just as important in determining whether the associate is going to be able to pay off their loans on schedule.  Unfortunately, the psychological aspect is often ignored or not appreciated by the new associate until they are a year or more into their repayment plan.  Below we will discuss some of the psychological aspects of loan repayment and how you can use them to maximize your chances of being able to pay off your loans on your schedule.

First, before they actually start paying off the loans, many law students and associates underestimate how psychologically grueling it is. It is tough - really tough - to see a huge amount of your paycheck getting taken away every month - and that huge amount, which would let you do so many fun things in your life, only reduces your outstanding loan balance by a miniscule 1-2%.

The first year of repayment is usually ok, but people start breaking down after 2-3 years. During the first year, many associates are still kind of operating on "student" mode and repaying loans (although it always requres discipline) does not face that much pressure.  However, by year 3, the pressures mount when they have:
  1. Been a lawyer for as long as they were in law school
  2. When they see their peers - and even lawyers younger than them - spending it up and living an "attorney" lifestyle rather than a "student" lifestyle
  3. When their families start putting pressure on them "You're big time lawyer now, why don't you...."
  4. When the girlfriend starts thinking about an upgrade
  5. When you may already have kids or may have them soon
Also, it is really hard to see that much of your income going to a goal that seems like it will take forever.  You have made 24 payments - two years of denial and austerity - and you do the math and say sacrastically "Wo-hoo!  Only another 37 months to go."  Another 37 months of inconvenience and pain when I could spend just a little bit of that money and make my like a little more comfortable - it's my money after all - and "I deserve it!"  Thus, the pressure mounts on your repayment plan.

I know many people who started off as young associates and whipped out their calculators and whipped up a handy 5 or 10 year repayment plan - often planning down to the penny.  However, I would say that the percentage that actually stuck to their plan's time frame for 3 or more years is probably only around 25%. 

Don't get me wrong- I'm not saying that 75% of people fail to pay off their loans.  Instead, what happens is lifestyle creep.  Their initial repayment plan was predicated on a certain inexpensive lifestyle, but maintaining that inexpensive lifestyle gradually becomes impossible in the face of mounting pressure and life changes.  Thus, as the lifestyle rises from $2K/month to $3K/month, there is less left over to go to the loans and the loan repayment time frame becomes longer.

One interesting aspect that I have noted is that the people that concentrate on paying their loans off ASAP - those that take the first year and keep living like a student, seeking ways to be frugal so that they can maximize their loans - typically have far, far less extension of their plan time frame than others.  They still experience lifestyle creep, but because they started with their lifestyle so low, it creeps up more slowly.  For example, if lifestyle creep is going to be 5%/year for anny associate, an associate with a 25K lifestyle is only experiencing $1250 worth while an associate living a 100K lifestyle experiences $5000 worth.

This attitude is in contrast with another attitude that I sometimes see - that associates figure that they will just pay the minimums on their loans now, but will put more toward their loans as their compensation goes up.  I suppose it sounds logical, but I have seen this fail time and time again.  In fact, I have never seen it work.  What happens is that the associate gets used to a certain lifestyle and then the lifestyle creeps up - often faster than the associate's compensation rises.  A $10K raise really only puts about $6K in your pocket at our tax rates - and that's only $500/month.  Some high-living associates might blow that on two dinners (with wine) a month. 

Also, the price of everything you buy is going to increase with inflation every year.  If you are living the $100K lifestyle and get a 10K raise, then recognize that the 6K that you are netting is going to be substantially reduced by the inflationary increase on your lifestyle.  Inflation bounces around, but if you assume that it is going to be 3%, then your $100K lifestyle is going to cost you an additional $3K next year - that's half of your pay increase right there.  The associate living the 25K/year or 50K/year lifestyle is going to be a lot less impacted.

In summary, make your loan repayment an immediate priority.  Try to live like a student (or worse!) for as long as possible.  However, recognize that you are going to face a lot of pressure - and it is going to increas as time goes by.  The more you pay down early, the better.  Lifestyle creep is going to happen - the inflation rate pretty much guarantees it even if you keep your lifestyle the same.  However, try to resist lifestyle creep as long as possible. 

Don't get disheartened if your loan repayment is going to take a few months longer than you first thought.  Keep focusing on it and get it done. Don't focus on your belief that you are "failing" because you are going to take 8 months longer than you first thought.  This feeling of failure is going to leave you psychologically vulnerable to further non-budgetary spending in an attempt to alleviate it.  Just ask yourself "will I feel better or worse if I am over by 9 months rather than 8?"  That's usually
enough to motivate people.

Finally, be of good cheer.  You are doing the right thing by paying off your loans.  You are going to be so much happier and have so much more free cashflow each month when you are done.  I know it sucks, but keep it up!  Good luck!


  1. Hi Managing Partner: Came across your blog just today and I am loving it -- very good stuff. Can I make a request for a future post? What is the wisdom in paying for law school using money in a ROTH IRA as opposed to taking the money out in loans? I saved a lot in my teens and 20's for the money that's now in my ROTH, and I can't help but wonder if it would be a good idea to use it now (tax-free as a "qualified educational expense") to pay for law school instead of burdening myself with new loans. (I'm about to start my last semester of school, so I suppose this won't matter too much. But surely there are at least a few others out there that could benefit from your insight.) Thanks in advance!

  2. 5:11 - That's an interesting question. I will be happy to give you some of my thoughts on it in an upcoming post. Thanks for the post idea!