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By Joanna Nesbit
February 25, 2021
A slice of a coin of college Graduate.
Mark Wang for Money

Most federal student borrowers haven’t been required to make a payment in nearly a year now. During this interest-free pause, some borrowers have taken advantage by skipping payments and redirecting that money elsewhere. Others continue to pay, hitting their principal debt.

Whichever camp you fit into, this break might be a good time to assess typical payments. How much of your money should you actually be allocating to student loans each month in an ideal budget?

The US Department of Education recommends students not borrow more than 8% of their projected gross income or 20% of their “discretionary income.” The problem is many students borrow without understanding prospective salaries for their career path, nor do they understand the difference between discretionary, take-home, or gross income. Sometimes they don’t know until they graduate how much debt they’ve accrued.

Whether you’re a student trying to figure out how much you can afford to borrow, or you graduated years ago and are simply trying to get a handle on your loans, some basic budgeting fundamentals can help you balance student debt with other financial needs and goals. Here’s what financial planners say you should know about budgeting for student loan payments.

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Determine your budget

Start with your total monthly income. After subtracting deductions including federal and state taxes, Social Security and Medicare taxes, and pre-tax contributions to employer-based healthcare and retirement funds, you have your net income, says Patti Hughes, owner of Lake Life Wealth Advisory Group in Chicago. That’s the money that hits your bank account, and that’s what you’ve got to live (and budget) off of.

Consider the 50/30/20 rule and tweak it for debt

Once you have your net income figure, there are a few different ways to divvy up your money. A common one is the 50/30/20 rule, a starting point that some financial planners use to develop budgets. The rule breaks down accordingly:

  • 50%: basic/fixed needs (rent, utilities, transportation, insurance, healthcare, car payment, minimum loan payments)
  • 30%: wants or variable expenses (dining out, clothing, cable subscription, entertainment, travel)
  • 20%: savings and debt (emergency savings, additional debt payments)

But to tackle larger debt, both student loan and credit card, experts say you’ll likely need to reduce expenses to find at least 15% in your budget to pay for debt. It may mean reducing variable expenses, or if your housing costs are high, it could mean moving to a cheaper place, taking in a roommate, or even moving home for a period. If you can’t cut expenses, then your other option is taking on a side hustle to bring in more money.

Instead of forcing your budget into the 50/30/20 breakdown, some financial planners instead tweak the rule to better reflect the reality that millions of Americans owe five- or six-figure student debt. Hughes, for example, uses a 60/20/20 breakdown to create a budget:

  • 60% fixed needs (includes monthly student loan payment and credit card payment if used for fixed expenses)
  • 20% variable/discretionary expenses
  • 20% savings and debt (if already saving 15% in your 401(k), put this 20% toward emergency savings, college savings, and extra debt payments)

Lauryn Williams, a financial planning consultant with Student Loan Planner, uses a slightly different version, the 50/15/15/20 breakdown.

  • 50%: fixed expenses (including car payment and possibly minimum student loan payment if budget allows)
  • 15%: debt (credit card and student loan)
  • 15%: savings in an emergency fund (assuming you’re already contributing to a 401(k))
  • 20%: variable/discretionary expenses (she puts groceries here)

Everyone’s budget will be slightly different so take these percentages as guidelines. Some expenses that may seem non-negotiable to you could be easy to cut for someone else. Williams suggests imagining you lost your job to identify your fixed expenses and which variable expenses can be cut or adjusted. For example, to look for a new job, you’d still need your phone and Internet, and possibly a car.

Calculate how much your loan costs each month

Sometimes, it’s easier (or necessary, if you don’t have a job yet) to figure out your monthly loan payment first and then determine what your ideal budget would look like. Hughes typically starts here when working with clients.

Let’s say you just graduated with $27,000 in undergraduate federal student loans. On a 10-year standard repayment plan with a 2.75% interest rate, your monthly payment is $257.60. (Loans dispersed before 2020 have a higher interest rate, so the payment would be higher.)

To meet this payment comfortably—at the recommended 8% gross salary limit—your minimum salary must be $38,641, according to the Mapping Your Future calculator.

If you’re earning more and $257 per month feels easy, that’s great—but it’s important not to skip building your emergency fund at the same time as paying down your debt, experts say. Tempting as it is to pay off student loans, it’s crucial to “put on your own oxygen mask first,” Williams says. And if you carry high-interest credit card debt, that’s more important to pay off before throwing extra money at low-interest student loans.

On the other hand, if you’re earning a low salary that makes federal loan payments on a 10-year-plan uncomfortably high, an income-driven repayment plan can help you keep payments at the 10% threshold. You can see what your monthly payments would be with the income-driven loan calculators at Savingforcollege.com or the federal loan simulator. Remember, private student loans don’t qualify for these payment plans. You’ll have to build that payment into your budget.

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What to know about payments on income-driven repayment plans

The income-driven repayment (IDR) plans can be key if the numbers don’t add up under the standard repayment plan. For these federal programs, the Department of Education generally allocates 10% to 15% of a borrower’s “discretionary income” for the monthly payments under three income-driven repayment plans available to students.

These plans allow borrowers to pay loans on a 20- or 25-year schedule and then the government will forgive any balance that’s left over at the end. You might end up paying more in interest over this timeframe, and you must recertify each year to verify your family size and income—but income-driven repayment may be the best plan for your salary.

It’s important to keep in mind that your discretionary income differs from other definitions of income. The government calculates it based on your adjusted gross income and the federal poverty rate. Here’s how it works:

Let’s say you’re single and your adjusted gross income is $60,000. The federal poverty rate for one person in 2021 is $12,880. Multiply that by 1.5 for the figure to subtract from your AGI.

  • $12,880 x 1.5 = $19,320
  • $60,000 - $19,320 = $40,680 (this is your discretionary income, according to the government)
  • $40,680 x .10 = $4,068 (10% is the typical annual income-driven repayment amount. Some plans require 15%,)
  • $4,068 ÷ 12 = $339 (monthly payment)
  • $339 = the amount the government says you could afford on an income-driven plan when you take home $60,000.

If you’re able, Hughes says contributing more to your 401(k) lowers your adjusted gross income, and in turn lowers your payment amount on an income-driven repayment plan. Keep in mind, at the end of 20 or 25 years, you may need to pay taxes on the forgiven amount.

Before you borrow, research career salaries

If college is still in your future, the best plan to avoid getting in over your head is to research prospective salaries for your career path. Then work backward to determine how much you can afford to borrow. That also helps you determine which colleges are more affordable, Williams says.

Limiting borrowing for graduate or professional programs (medicine, law, dental school) may be trickier, but knowing possible debt outcomes still helps you plan your career path. Hughes recommends using PayScale.com as a starting point.

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