Making Over Thomas

Thomas is concerned that even after a year of making payments on his student loan, the amount due is higher than when he started. Despite his efforts, he sees himself sinking in a sea of debt.

Thomas took out a student loan with a fixed rate of 8.75 percent. Turns out that was only a "teaser" rate, which converted to a variable rate after one year. Variable rates aren't necessarily worse than fixed rates, especially when interest rates in general are falling. But they do make it difficult to plan because they are subject to change.

A variable rate is usually based on some established and published interest rate, plus a fixed margin. For instance, it could be based on the prime rate (variable) plus 4 percentage points (the margin). At today's prime rate of 7.5 percent, the total interest rate on a loan would be 11.5 percent.

Major lenders periodically change their interest rates, and the prime rate (the rate that they charge their best customers) also goes up or down, producing a change in variable rate loans based on the prime rate.

The Value of an Education

In Thomas' case it appears that his variable rate loan is dramatically higher than the original 8.75 percent. Making the minimum payments on a loan that started at $12,500, Thomas calculates that he will have paid over $42,000 in interest payments by the time he finally pays off the debt, assuming the interest rate doesn't increase. But if it does go up, he could spend as much as $50,000 in interest payments. He's trying to find a way to turn the momentum in his favor and pay the loan off faster.

The most obvious solution is to pay more than the minimum amount due each month. While I'm sure this hasn't escaped his attention, other debts and income issues preclude Thomas from making substantial changes to his monthly payments, making the situation seem pretty hopeless.

As a renter, he's foreclosed from the alternative of taking out a home equity loan to consolidate his debts. (Since the loan is secured by the home, interest rates are generally lower than unsecured debt, and in most cases, interest paid is tax deductible.)

Change the Payment Schedule

One way Thomas might improve his situation with only a minor change is to make half the payment every two weeks. Let's assume the variable rate on his loan is 15 percent and it will take him 30 years to pay it off. That means a monthly payment of $158. If Thomas mails half of that amount ($79) two weeks after a regular monthly payment and then follows up with a $79 payment every two weeks, he will be able to pay of the loan in less than 17 years, almost half the time it would otherwise take.

By paying every two weeks, he ends up making two extra half-payments a year (about $158). Total payments will be about $33,500, with about $21,000 of that being interest expense. That's less than half the $42,000 in interest expense he now estimates under a regular monthly payment schedule.

The other solution involves increasing the monthly payment. Although Thomas already is having problems meeting the current payment schedule, making payments that slightly exceed the minimum can have a tremendous impact. For instance, assuming the 15 percent interest rate Thomas could pay off the loan in half the time by making monthly payments of only $175.

Credit Calculators

Making more than just the minimum payment on outstanding loans requires Thomas to make sure that the lender is giving him proper credit. Many lenders are set up to assign payments to outstanding interest first, and then principal reduction. He'll want to make certain he gets full credit for early repayment of principal.

This may mean writing separate checks — one for principal and one for interest. Don't assume the lender will handle it appropriately. Stay vigilant.

Thomas may also avail himself of assistance from a nonprofit credit counselor, such as Consumer Credit Counseling Service. Don't be tempted by one of the many "credit repair" companies promising instant solutions. He's better off with a nonprofit accredited agency that combines free credit education and a fee-based (often $20 a month, max.) debt-resolution plan.

The education and counseling can help Thomas make sense of and pay down his current debts and avoid getting swamped again.

Guest columnist Kacy Gott, CFP, is president-elect of the Financial Planning Association of San Francisco ( and a principal with Kochis Fitz, a wealth management firm in San Francisco, Calif. ( He's also an instructor in the Personal Financial Planning program at U.C. Berkeley extension.