Editorial Note: This content is not provided or commissioned by any financial institution. Any opinions, analyses, reviews or recommendations expressed in this article do not represent financial advice.

I’m going to say something controversial: the common advice around debt repayment is costing you money and is therefore bad advice.

People rush to pay off loans in full ASAP but forget that loans are not inherently bad — they are only as bad as interest rates are high.

Think about it: if you had the choice between paying $12,000 today or taking a loan and paying $1,000 per month for 12 months, you would pick the latter. Assuming you have $12,000 available today, you would keep part of it in cash for the upcoming payments and then put the remainder into a savings account or low risk investment so that it can earn you a return. I realize that this scenario is imperfect because it assumes an interest rate of 0%, which is unlikely to happen, but it does communicate the point that a loan is only as bad as its interest rate is high.

Therefore, if you have taken the decision to try and pay more than the minimum monthly payment towards your loan, then the goal should not be loan elimination, but rather minimization of interest WHILE maximizing return on investment.

In general terms, it means the value that you receive for every dollar of investment. In loan terms, it refers to the interest that you save for every dollar that you spend (after your minimum monthly payment). If paying $100 more than your minimum monthly payment saves you $110 of interest, then your return is 110%; alternatively, if that same $100 saves you only $90 of interest, then your return is 90%.

Timing and loan principal balance. In my last article, I explained that the financial benefit (ROI) of paying more than the minimum monthly payment will depend on when the extra payment is made — an additional payment earlier in the life of a loan, when principal balance is higher, will have a higher ROI than the same payment amount later in the loan term, when principal balance is lower.

The approach is analogous to changing your nutrition — you’re not supposed to pursue one goal at the expense of others, but rather, balance a healthy diet with exercise and rest, simultaneously. A similar sense of empowerment can be developed for your financial health profile, even if you are the type of person who generally refuses to “step on the scale” and lives by the “out of sight, out of mind” philosophy.

To help you fulfill your goal, I have created a FISCAL HAPPINESS tool (link is available later in this article) which consists of three parts, as outlined below.

When it comes to physical fitness, one of the first things a personal trainer does is measure your starting weight and BMI. Similarly, think of yourself (or me) as your financial fitness trainer. Using the FISCAL HAPPINESS tool, we will gather basic inputs that will allow us to measure your target emergency fund value and Net Cash Flow (NCF = income minus expenses). This will help us benchmark the max amount of money that you have available to pay towards your loan every month, after your minimum monthly payment. We will also make some assumptions about how your monthly Net Cash Flow might change over the course of your loan term since it will be foundational for PART 3.

We are all born with a baseline metabolism that we inherit from our parents, but it will fluctuate based on external inputs such as diet, exercise and medication. Likewise, your loans have a baseline metabolism in the form of a repayment schedule that is determined by the loan value, loan term and interest rate. The schedule will fluctuate based on how much your payments deviate from the minimum monthly loan payment. Similar to the way personal trainers evaluate your baseline metabolism so they know how to effectively balance the external inputs and achieve fitness goals, you need to understand your loan(s) before setting financial goals. The FISCAL HAPPINESS tool will help you structure the pieces of information that you need to gather.

Current loan balance, remaining loan term, and current interest rate will be most influential during PART 3, but other considerations that you should be mindful of include: is your interest rate fixed or variable? Is your student loan federal or private? If you have a variable rate loan, then you need to be aware of the fed’s economic policy and how it can impact student loans. If you have a federal loan, then you may benefit from some flexible repayment options but, unless you qualify for certain forgiveness options, you will have to pay the loan back in full, plus interest.

How many times have you arrived at the gym and been unsure what the right workout should be for your fitness goal? For me, it happens almost every time which is why I default to the elliptical and free weights. A similar conundrum happened with my student loan repayment.

I graduated with nearly $200K of student loans but found a job that paid $55,000, which meant that more than 50% of my monthly paycheck was going towards the minimum monthly payment. My cost of living was low so I didn’t go on an Income Based Repayment plan. Fortunately, my earning power increased fairly quickly and I decided that I wanted to pay off my loans faster. But what was optimal for my financial situation? I wasn’t able to find any repayment calculator that understood my baseline, nor was I able to account for variability in my monthly net cash flow. Family and Google searches told me to just live frugally and put everything I can towards my loans, but I wasn’t convinced. I’m the type of person who thinks about tradeoffs, and asks questions like:

— What is the financial benefit of putting money towards my loans instead of towards something else?

— What if I only apply my bonuses towards my loan?

— Can I establish an investment portfolio while still paying down debt?

— Is there a way to benchmark what the return from another investment needs to be to exceed the interest I would save by paying more than the loan’s minimum monthly payment?

After more than two years of conversations and research, I have developed the FISCAL HAPPINESS tool which answers all these questions. Additionally, I have discovered concepts, such as the “Allocation Crossing Point” (ACP) and “Step-Down Method” which are essential to achieving our goal of interest minimization plus ROI maximization.

Allocation Crossing Point (ACP) is defined by the month when less than 50% of your minimum monthly payment starts being allocated towards interest, meaning every additional $1 contributed towards your loan will save less than $1 of interest.

Step-Down Method represents the repayment technique that you may seek to employ after the ACP is passed. Since ROI of every additional $1 drops below 100%, you should start contributing less than your maximum available net cash flow if you want to optimize repayment.

Before diving into your Financial Fitness Profile, let’s clarify some basics about how loans (that are in repayment) work.

Every month, you have a minimum monthly payment due. That payment is calculated by accounting for your starting loan balance, interest rate, and loan term. If you have a fixed rate loan, then this payment will never change. If you have a variable rate loan, then your minimum payment value may change every month or every quarter. Regardless of your interest rate type, interest is allocated across principal and interest in the same way — more of the minimum monthly payment is allocated towards interest earlier in the loan term, when the principal balance is higher. This hypothetical example of a $110,000 loan with interest rate of 6.9% over 15 years shows how the minimum monthly payment of $900 is allocated to interest (orange line) and principal (green line).

Representation of Allocation Crossing Point

The graph also identifies the “Allocation Crossing Point” and demonstrates that, after that month, less than 50% of the minimum monthly payment starts being allocated to interest. The table below summarizes the length of time that it takes to reach the “Allocation Crossing Point” for 10-,15- or 30-year loans at varying interest rates.

Allocation Crossing Point Standard Table

Before the “Allocation-Crossing Point,” contributions in excess of the minimum monthly payment will have a bigger impact on interest savings. That means you should use this table to benchmark how much time you have to maximize your interest savings.

After this point, ROI of every additional $1 drops below 100% so you are more likely to need to evaluate additional contributions by asking the two guiding questions:

(1) How much interest will I save for every additional dollar that I pay towards my loans?

(2) Does the interest saved outweigh the possible return I could receive if I applied the same money towards other investment(s), and what is the riskiness of the other investment(s)?

You are ready to begin evaluating your financial fitness profile! Remember to think of me (or of yourself) as your financial fitness trainer. If you are comfortable working with numbers and eager to optimize your repayment, then you can dive into the FISCAL HAPPINESS tool yourself. If you are not comfortable with spreadsheets, then I hope the information presented below will spark your interest so that you contact me. I am happy to have conversations (free of charge) with you because I have personally experienced how difficult it is to independently develop a financial plan, and I hope to help more people achieve fiscal happiness.

This step will calculate your monthly Net Cash Flow, which is essential to understanding the maximum amount that you have available to contribute to your loan every month, after making minimum monthly loan payments. Additionally, you should be aware of how much you should target to set aside in an emergency fund since financial security and emotional happiness are intertwined, and therefore should not be overlooked.

You should account for your monthly fixed income, monthly fixed expenses, and monthly variable expenses. We also want to account for your non-monthly income and expenses, but it will not factor directly into the future calculations. You can click here to access a sample Financial Fitness Profile worksheet and populate it with your information.

Your fixed and variable monthly expenses are automatically calculated for the Target Emergency Fund values and for your monthly Net Cash Flow.

Your monthly net cash flow represents the total amount of money that you have available every month to contribute to your student loans. I have applied a 3% annual growth factor to your monthly net cash flow since we need to know what this looks like over time.

Before moving on to the next section, I want to recognize that it’s natural to feel a range of emotions when evaluating your finances. The range of responses that you might experience include:

  • Feeling like you want to look away immediately and put all this out of sight until you earn more money.
    Keep your mindset focused on the process rather than on your current situation because any form of fitness is about holistically evaluating behavior. It might help you to remember a comment that Professor Scott Galloway from NYU made during his recent appearance on Good Life Podcast; he said that wealth is determined by “burn rate”- income minus expenses — not absolute income level.
  • Feeling surprised by some of your spending habits, and noticing areas of improvement that will increase your monthly Net Cash Flow
  • Realizing that you could benefit from increasing your emergency fund before you start allocating anything extra to your loans. The American College outlines that an emergency fund should cover 3–6 months of expenses, and varies based on other sources of income or your employability. This is an ideal benchmark and many people are unable to meet this threshold. If this is your reality, then shift your mindset towards the process of keeping a close eye on your financial fitness rather than setting a specific loan repayment or savings goal. This will help you steer clear of adopting avoidant tendencies and putting thoughts of your financial fitness out of mind.
  • Deciding that your monthly Net Cash Flow is satisfactory, and you are ready to put the money to work

Regardless which of the above responses resonated with you most, you should feel a sense of accomplishment because you have just gained a level of awareness that has equipped you with the knowledge necessary to be financially fit!

Many borrowers are unaware of their interest rate and current balance, so you may find it helpful to evaluate all of your loans whether you have only 1 or up to 10.

For this step, you should gather information about your loan(s) such as the balance(s), interest rate, payment date, (remaining) payment term, and payment amount.

If you need a motivation boost at this point, remember that you work too hard to pay more interest than is optimal or receive generalized advice about how to repay your loans.

Approaches such as the Debt Snowball and Debt Avalanche methods are oversimplified because there is a perception that borrowers are not capable of understanding loan repayment. I vehemently disagree with that!

People who advocate for general approaches are essentially pointing the finger at borrowers, rather than directing the problem towards confusing loan terms, under-trained customer service reps, and conflicting information. If we, the borrowers, had access to clearer information, then we would be more likely to understand the financial trade-offs and start optimizing our loan repayments without feeling overwhelmed.

At this point, you have stepped on your “financial fitness scale” and understand the maximum amount you have available to contribute to your loans beyond your minimum monthly loan payment. Additionally, your “loan metabolism” assessment has provided you with a birds-eye view of your loan details and might have encouraged you to ask questions like, “is this the best interest rate possible given my current credit score, loan balance, and overall market conditions?” We will discuss refinancing in a future post but, for now, we are ready to craft your custom repayment plan.

STEP 1 — LOAN INPUTS: You will be asked to select one of the loans that you outlined in PART 2: LOAN METABOLISM and these details into the “Your Answers” column. Your minimum monthly payment is calculated automatically based on your inputs, but please confirm if it is correct.

STEP 2 — SCENARIO TESTING: You will be given an opportunity to try out five different repayment scenarios. The net cash flow calculation from the Part 1: Financial Fitness Profile will factor into this area and will represent the “Max Wallet” scenario, explained below.

A few guidelines for the five scenarios:

Scenario 1 Max Wallet: This scenario MUST represent the largest potential monthly contribution to your loans. All other scenarios must represent contributions that are less than or equal to this one

Scenario 2 Percent of Max Wallet: Represents 80% of Max Wallet’s contribution

Scenario 3 Optimizing A: Contributions are structured with the Allocation Crossing Point and Step Down Method in mind. Payment mirrors Max Wallet before the Allocation Crossing Point, however, it will begin to “step down” (pay 30–50% less than the max wallet) contributions after this point. Will still include large inflows (bonus, tax credit, etc.)

Scenario 4 Optimizing B: Similar to Optimizing A, but it will step down payments more quickly. When large inflows are available, do not apply the full funds (e.g., if have $15,000 available, will only apply $10,000 towards loans)

Scenario 5 Optimizing C: Contributes less than the max wallet even before the Allocation Crossing Point is reached and steps down payments more aggressively. Do not apply any large inflows in this scenario.

STEP 3 — OPTIMIZING OUTPUT: This is where the eye-opening magic happens!

You will be able to receive a personal evaluation of each scenario and determine which one makes the most financial sense for your situation. I have done that by calculating the return on investment that you would need to receive to outweigh the interest you are not saving on your loan.

You will be given two ROI metrics — “Full Term ROI” and “Annual ROI Necessary to Exceed Interest Savings from Max Wallet”. You will be looking to maximize the former and minimize the latter.

The Full Term ROI metric will tell you how to get the best use out of your money in terms of minimizing interest expense without paying too quickly.

This is only one half of the puzzle however and the Annual ROI calculation is required to understand whether or not diverting funds could be financially beneficial.

The Annual ROI helps you answer the question: If I divert funds from my loans and towards other investments, what is the minimum annual ROI that I will need to receive in order to make up for the interest that I am not saving on my loan?

Looking at the “Annual ROI Necessary” will help you:

(1) Understand if any of the scenarios represent a reasonable benchmark based on current market conditions

(2) Understand how much of your net cash flow you may want to consider putting towards other investments

Looking at both the “Full Term ROI on Interest Saved” and “Annual ROI Necessary” will help you optimize the value of every dollar you spend towards minimizing interest on your loan while also accounting for the minimum return necessary to outweigh interest saved.

As you can see in the example below for a $125,000 loan with an interest rate of 5.8% and loan term of 180 months, “Scenario 3 Optimizing A” (which followed the “Allocation Crossing Point” and “Step Down Method” for repayment) represents one of the highest Full Term ROI of all the scenarios and also represents a minimum 6.10% annual return necessary to exceed the interest savings and investment potential of the Max Wallet scenario.

Factors that you may want to consider when deciding which scenario is right for you include, but are not limited to:

— Your risk profile

— Current market conditions and average market return (NerdWallet recently wrote about Average Stock Market Return)

— Your future financial profile (changing jobs, buying a house, having children, etc.)

I hope the FISCAL HAPPINESS tool and the information outlined in this article has helped you think differently about loan repayment, whether it is a student loan, mortgage, or personal loan.

Emotional Health | Student Debt | Career Advice. Repaying my student loans w/ a proprietary method & helping others save tens of thousands too. Let’s talk debt!

Get the Medium app

A button that says 'Download on the App Store', and if clicked it will lead you to the iOS App store
A button that says 'Get it on, Google Play', and if clicked it will lead you to the Google Play store