5 Things Lawyers Should Do During the Extended Student Loan Freeze
Executive Summary
The extension of the student loan payment freeze is a relief to many law school borrowers. For some lawyers, it is an opportunity to make payments on their student loans without any interest being added. But that isn’t the most financially optimal decision. Instead of making payments, there are 5 other ways lawyers can take advantage of this extension:
- Contribute to their emergency fund
- Pay off other debts
- Contribute towards 2021 contribution limits for some accounts
- Save for other financial goals
- Avoid increasing their monthly spending patterns
On December 22nd, President Biden announced an extension of student loan relief until May 1st. The extension gives lawyers with student loans another three months to determine how to pay off their loans and begin making payments.
Some lawyers may hate the idea of having student loans. For others, it may be an opportunity to pay off their student loans without adding any interest to the total amount owed.
For most borrowers, this extended student loan freeze offers an opportunity to take money that would have otherwise gone towards student loan payments and put it towards other things.
When student loans have a 0% interest rate and are not mandatory, a lawyer’s money is nearly always better used on other things. For lawyers who want to know about some ways they can take advantage of the student loan freeze extension, here are five things lawyers can do to put themselves in a better financial position before student loan payments resume.
Contribute to your emergency fund
A piece of advice I commonly give is to build up an emergency fund. Why?
Because an emergency fund is critical to protecting lawyers from unexpected financial events. Lawyers can’t be sure that they won’t lose their job when student loans restart or that they will face an unexpected medical or car expense.
When lawyers begin repaying their student loans, many law school borrowers may face monthly payments that will exceed $1,000 per month. These payment amounts can be a significant financial burden. If another unexpected event happens too, it could become difficult for a lawyer to manage financially.
To help protect against an unexpected expense or losing a job, lawyers should consider saving up 3-6 months of expenses in their savings account. These 3-6 months of expenses should include 3-6 months of student loan payments.
Doing so gives a lawyer a financial buffer to handle any unexpected events. It also means that a lawyer won’t have to worry about making their student loan payments and attempt to save at the same time.
Pay off other debts
For most lawyers, their student loans have interest rates between 5-7%. A general rule of thumb is that you should pay off debts with the highest interest rate. If a lawyer is deciding between paying off their debt or investing, then they should compare the interest rate on their debt against an expected investment growth rate.
When student loan interest rates are 0%, other debts most likely has a higher interest rate than 0%. Most investors also expect to get a higher than a 0% growth rate on their investments.
If a lawyer has credit card debt, a car loan, a mortgage, or private student debt, making payments on all of these will likely be a better use of a lawyer’s money than student loans.
For lawyers with credit card debt, interest rates on average are over 15%. A 15% interest rate is much higher than 0% and higher than most investors can reasonably expect to earn over an average investment year. Therefore, lawyers with credit card debt should seriously consider using money that would have gone towards student loans to pay off their credit card debt.
Contribute towards your 2021 contribution limits.
There are financial accounts subject to annual contribution limits for a year. Some of these accounts will allow people to continue contributing to the prior year’s contribution limit even into the following year. These accounts include:
IRA
Roth IRA
Archer Medical Savings Account
Coverdell Education Savings Account
All of these five accounts allow you to continue making contributions up to April 15, 2022.
For lawyers who have money that would have gone towards student loan payments, this money can now go towards one of these accounts. Some of these accounts even have tax benefits! Meaning that contributing in early 2022 can lower a lawyer’s 2021 tax bill.
Saving money on taxes offers a better return than making payments on a 0% student loan during the freeze.
Save For a Goal
For most lawyers, paying off student loans is not the only goal in their life. It’s likely not even their most important goal. Some lawyers want to buy a home or a car. Others may want to go on vacations or start a family.
Lawyers who face a future $1,000+ monthly expense for student loans can now apply that money towards their other goals. $3,000+ of extra savings and investments makes a difference when pursuing financial goals.
Figure out what goals are most important to you, then put that money towards saving for it. If you have multiple goals, contribute a percentage of the would-be student loan payment towards each of them.
There may not be many future opportunities to put these student loan payments towards other goals once student loan payments resume.
Don’t Increase your Monthly Expenses
This pause in student loan payments appears to be temporary. But there is always the possibility of another student loan freeze extension. Many borrowers will notice the extra money in their account each month and increase their expenses because they can afford to. Unfortunately, if/when the student loan payment freeze ends, borrowers who do increase their monthly expenses will have to cut back on these monthly expenses to make their student loan payments.
Budget cuts can be challenging because the payment amounts may require a lot of spending cuts over different spending categories. Borrowers also grow accustomed to these expenses. When they have to make spending changes, it can leave borrowers feeling like they are forced into a lower standard of living.
To avoid these pains, borrowers should be aware that it is more likely than not that student loan payments will resume in May. That gives borrowers three months to carve out the student loan payment from their typical spending habits. Changing spending patterns is not easy, but it is better to make the changes over a series of months instead of all at once.
Lawyers who receive raises between now and when student loan payments resume, should try to maintain and not increase their monthly expenses. Doing so should make it much easier to make payments than cutting back on future monthly spending habits. Lawyers are typically comfortable with their current standard of living, so it should not be too challenging to maintain their current spending and use the raise for future student loan payments.
The purpose of the student loan payment freeze is to provide relief to Americans during COVID. For those lawyers who could have started making payments in February before the freeze extension, the payment relief may not be necessary to live the life they’re currently living.
Be conscious about your spending and try not to increase your monthly expenses if possible. You’ll be happy you did when student loan payments resume.
The extension of the student loan freeze is a great opportunity for young lawyers to make progress across many financial goals. For lawyers who want to make better financial decisions during this extension period as well as once student loan payments resume, financial planning can be a great way to prepare and execute on these decisions. Developing Financial offers both a one-time student loan repayment analysis and ongoing financial planning. To learn how the Developing Financial Process can help guide you through these decisions, schedule a 30-minute Meet & Confer. This meeting is complimentary and there is no commitment to continue to the second free Discovery Meeting. Schedule your Meet & Confer right now!
Disclaimer: Nothing in this blog should be considered financial advice or recommendations. Your questions are unique to you and your own personal financial circumstances. You should consult with a financial professional before making a financial decision. See full blog disclaimer.