How to Best Use Your Grace Period: Create Your Debt Attack Plan

Editor’s Note: We’ve got a guest post on the blog today! This one is for those of you who will be graduating soon – are you ready to tackle your student loans after graduation? Liz from Less Debt More Wine has the scoop on how to create a plan during your grace period. Take it away, Liz…

The period after you finish school can be both very exciting and very overwhelming. It seems student loan servicers know this and they give you a break by not making you start paying back your loans right away. Which means it’s the perfect time to get organized and decide on how you will attack your student loans and any other debt you have.

First, you’ll need to know how long your grace period will last. Second, you’ll need to evaluate the state of your debt. Third, decide on a debt payoff method that will work best for you. Lastly, you can start practicing making those payments and start saving some money.

What is a Grace Period?

A grace period is a set amount of time (typically six months) after finishing or leaving school, where you are not required to make loan payments. If you end up going back to school then the grace period resets. You will once again have six months after leaving school before you have to make a payment towards your loans.

Editor’s Note: Always check the terms of your specific loans. I had one where the grace period restarted when I went back to school, and another where it did not. This meant that after I graduated after going back to school (following a leave of absence), I had to start making payments on that one loan immediately!

So that you don’t end up overwhelmed when your repayment term starts, it’s a great idea to use your grace period to prepare and practice making payments.

Evaluate Your Debt and Your Options

First, you need to evaluate the type of debt (typically student loans) that you have. Different debt presents different repayment options.

Private Student Loans

Private student loans typically offer fewer repayment options, but there are some benefits as well. Unlike federal student loans that offer income-driven repayment plans, private student loans usually have a set repayment term.

The good news it, it is easy to figure out your monthly payment and what a difference paying just a little bit extra each month can make. Private loans also mean you can refinance without worrying about losing flexible repayment terms.

Refinancing is typically done to lower your interest rate and save you money. If you have several private student loans, you might also consider consolidating your loans. Consolidating would take your multiple loans and combine them into one big loan. Meaning you only have to worry about paying that one loan servicer instead of several loan servicers.

Since private loans typically do not offer any flexible repayment plans like income-driven repayment, it’s worth it to see if you can save money through refinancing or consolidation.

Related: Reader Question: Should I Refinance My Student Loans?

Federal Student Loans

If you have federal loans, then you have several more repayment options available to you. Besides standard repayment, you have income-driven repayment, extended repayment, and graduated repayment as well.

You also have the ability to consolidate your federal loans at the average interest rate of your loans with a federal consolidation loan. If you consolidate with a federal consolidation loan, then you still have access to those flexible repayment plans.

The downside of federal loans is that you cannot refinance federal loans without giving up things like income-driven repayment plans. If you refinance, you have to do so with a private loan. If you have a significant amount of debt and a lower salary (for now), you may need to take advantage of the income-driven repayment plans, which calculate your monthly payments based on what you earn.

Student Loan Forgiveness

You might be thinking that an income-driven repayment plan is the way to go, not only because it’s what you can afford right now, but because leftover loans get forgiven at the end of the repayment term. The only instance where the loans are truly forgiven is if you make payment under the public service loan forgiveness plan.

If you make payments under Income Based Repayment, Income Contingent Repayment, PAYE, or REPAYE then at the end of the 20 or 25 years, the amount “forgiven” is considered taxable income. That means that if your monthly payment doesn’t even cover the interest that accumulates each month, your loans will grow. If your loans grow for 20-25 years, you’re going to end up with a very large tax bill.

So, while taking advantage of income-driven repayment plans may be your best option for now, make sure to consider the long-term consequences. Since there is more flexibility and protection regarding federal student loans, you might consider making minimum payments through income-driven repayment plans for now so that you can work to pay off any private loans first.

Miscellaneous Debt

If you have other debt, such as a car loan or credit card debt, you won’t have a grace period to pay it off. However, you can take advantage of your student loan grace period, when you aren’t making payments on your student loans to pay extra towards your other debt.

Decide on a Repayment Strategy

Once you’ve gathered all the information on the types of loans you have and the repayment options available to you for each loan, you can start to plan your attack. First, you will need to prioritize your loans.

You will, of course, make the minimum payments on all of your loans, but you will prioritize your loans based on the order you want to pay them off. Focus on one loan at a time, so that you aren’t spreading yourself too thin and can actually make progress on your debt.

How you decide to prioritize your loans may depend on what debt repayment strategy you decide to use. There are two main debt repayment strategies known as the Snowball and Avalanche methods. Then you can use the snowflake method in addition to the snowball or avalanche method to help speed up debt repayment.

Snowball

The snowball method has you order your debts from smallest to largest. You make minimum payments to all of your loans and put all extra money towards your smallest loan until you’ve paid it off.  You then apply all extra money to the next smallest loan and continue to do so until all the loans are paid off. As you pay off your loans, your extra payment will snowball and make paying off each of the larger loans go by faster. The reason most people like this payment method is because of the quick emotional payoff of getting rid of that first loan.

Avalanche

The avalanche method has you order your loans by interest rate with the highest interest rate first. Similar to the snowball method you make minimum payments on all your loans and put all extra money towards the loan with the highest interest rate. You keep going until the loans are paid off. Since you are making payments by interest rate, this method will save you the most money over the life of your debt repayment.

Snowflake

The snowflake method can be used to help with the snowball and avalanche method. Any time you find some extra money, be it a quarter on the street or a $5 rebate, you put it towards your debt right away.  If you don’t put it towards your debt right away, you’ll end up spending it on something else.

Related: How to Pay Off More Than One Debt

Estimate Monthly Payments and Practice Making the Payment

Once you know what order you will be paying off your student loans, you can estimate your monthly payment. You can use the Repayment Estimator to approximate your monthly payment under different repayment plans. Even if you have private loans, you can get an estimate of the standard repayment cost using the Repayment Estimator tool or sites like Student Loan Hero.

Once you know roughly how much you will have to pay each month, start pretending to make that payment. Take that amount and set it aside in a separate savings account. The benefit will be two-fold. First, you will get used to making the payments, and spend accordingly. Second, you will build up some savings as an emergency fund to help you when something comes up, or money gets tight.

Photo credit: Avi Richards

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