Sallie Mae says pay interest on a private student loan while in college? Not smart

The College on a Dime series is written by Zac Bissonnette, a junior at the University of Massachusetts, Amherst. His book College On a Dime will be published by Penguin in the fall.

In a press release issued this morning, Sallie Mae suggests that students use private student loans provided by Sallie Mae -- and then make the interest payments while in college to "save a lot later."

According to the press release, "As families make college admission and financial aid decisions for next school year, Sallie Mae recommends building interest payments on student loans into the budget. Keeping up with accruing interest prevents loan balances from growing each month beyond the original balance. After graduation, when it's time to pay down the principal, young professionals start out their careers with smaller IOUs. That means they can pay off their debt faster than their fellow alums who deferred their interest."

Here's the problem: instead of making interest payments on a student loan while you're in college, why don't you just borrow less money and send the cash to the school?

Sallie Mae's rationale here is laughably self-serving: It suggests that you should, as the student in its example did, work at the dining hall during college to make interest payments on a loan, without doing anything to pay down the principal.

Why the heck would anyone do that? Let's use some hypothetical numbers here, just for fun (simplified to make this easier to follow. I crunched these numbers a few different ways and couldn't figure out a way where it ever makes sense to borrow more money than you need to to make interest payments):
  • You borrow $50,000 to pay for college at an interest rate of 10%, which means you'll have to pay $5,000 per year in interest just to keep the balance from growing. You work at the dining hall for four years, earning $5,000 per year, and put a total of $20,000 toward the interest payments on the loan. Your loan balance at graduation? $50,000.
  • You were going to borrow $50,000 to pay for college but instead, you borrow just $30,000 because you're going to earn $5,000 per year working at the dining hall. You don't make any interest payments on the debt while you're in school because you're using the money to pay for school. Over four years, that $30,000 debt load grows to $43,923.
Bottom line? It never makes sense to borrow more money than you need so that you can pay the interest while you're in college. It makes great sense for the student loan company -- you're sending them $5,000 per year without reducing your principal -- but it's a terrible option for the consumer. Instead of making interest payments, make principal payments by not borrowing at all or by borrowing less money. If you don't have the cash available immediately, most colleges offer monthly payment plans that allow you to spread out expenses over the course of the semester without paying any interest charges.

Instead of just avoiding interest charges for a few years, you'll avoid paying interest for the entire life of the loan. Now that's a much smarter option than Sallie Mae which is always, for students looking for ways to finance college, a Stupid Option.
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