PETE: Welcome back to How Not to Move Back in With Your Parents here on the IU MoneySmarts radio network. I’m Pete the Planner. Alex joins me as always, hello.
PETE: Phil Schuman joins me as always in studio, as always in terms of every once in a while. Phil is the director of the Office of Financial Literacy at Indiana University. Phil, today’s episode is advice for recent college graduates. And the reality of this topic today, is that's the reason why your department exists.
PETE: It’s funny to think of that your job exists for this podcast episode, kind of.
PHIL: Yeah, I never would have thought of it that way, but that’s absolutely what is going on here.
PETE: The reason you were funded, the reason you became so important for the trustees and everyone in Indiana University to provide financial literacy to its students is, because when you graduate we want you to be in a position where you can make good decisions, wise choices with your career. And you’ve not hindered your chances at that based on the decisions you make while in school.
PHIL: Absolutely, what we want to see you do is walk across that stage, get that diploma, and your options are what you want them to be. And that you’re not being hindered by just massive amounts of student loan debt off to the side. Your choice should based on what you want to do, not based on all this money that’s sitting aside that you have to pay off.
PETE: Alex, I know as an undergrad, when you think about school it is in many ways a means to an end. Trying to get your degree, so you can get your job, start your life. Now you don’t wanna pass by the best years of your life, which many feel are in college and its hard to disagree with that—isn’t it, Phil?
PETE: But how often do you think that, what we’re also trying to prevent on this podcast and also financial literacy, we’re trying to prevent four years of potential financial mistakes that make that walk across the stage that much harder. Do you think that way or not?
ALEX: It definitely needs to be thought in that way, and I don’t think my classmates and myself don’t think about it enough. And that’s why this is so important, and especially this episode is so interesting for me. I almost feel like I’m a spectator as well as a co-host in this, because I’m getting to that point where I’m going to be graduating in a year and half from now. And I’m gonna need to know these things and it's extremely relevant. So it’s so important for us to get off on the right foot.
PETE: So here’s what we're gonna do. The podcast, however you hear it, there’s lots of ways to hear this podcast of how not to move back in with your parents. But if you go to moneysmarts.iu.edu, this episode will be linked up with a blog post. And that blog post is gonna have the ideal household budget on it. And we’re gonna go through that right now, because when you graduate, your financial life becomes about a couple of things. How you deal with student loan debt, which we will discuss in a moment. But how you choose to structure your spending. Now Phil as you know, take home pay generally means after tax, after insurance, after retirement savings. So let’s just define some terms. Gross pay is gonna be your income before taxes and all that stuff. Net pay or take home pay as people often call it, is what we’re concerning our conversation with today.
PHIL: But I would also add in though, that whatever student loan payments you have too, that you should factor that into your net pay as well.
PETE: So Phil jumps the gun, and this is where we go first. So the best thing you can do if you have student loan debt, and I’ll tell you the majority of people don't do it this way. And I would argue, this is why there’s a trillion dollar student loan bubble. Before you set your spending on your new life, your brand new life that you've just won with this beautiful degree from Indiana University. Before you set you’re spending, before you buy your car, before you get your apartment, before you do anything. Your food budget, anything. Figure out exactly what your student loan repayments are going to be, where your payments are going to be. Now this information is not easily offered to you right away. You gotta go out and find it, because for a lot of people, Phil, we’re not seeing those first student loan payments due until January 1st of the following year, right?
PHIL: Absolutely, most people have a six-month grace period.
PETE: Here’s what’s not graceful about a grace period. The clock is ticking, you’re wasting time. And I know that seems harsh, but it’s not six months to help you find a job. You gotta get on it. Again, extraordinary financial thought and focus will bring you extraordinary results. The ordinary thing, Alex, is to say, all right, let’s focus on my career. Let’s focus on these things, and then in January, I’ll get surprised by a student loan bill. And it just whips around and hits people pretty hard.
ALEX: Right, and so this brings up a question I have. And it may be obvious, but I think it will answer a lot of people’s questions. So you have a grace period. You have the time when you’re not paying your loan with the interest, things like that. Can you just go in to the company, wherever you’re getting your loan from and say, “Here’s 2,000 bucks.” Can you just make a payment, and it will go directly off the balance you have? Is it that simple?
PHIL: I mean, you have six months before you have to start paying, but by all means go into the system and just start paying.
PETE: The longer you hold a debt, the longer interest is taken away. By it’s nature, when you go buy a house some day. A 30-year mortgage, if you have a 30-year mortgage, you will pay more interest on that 30-year mortgage than you do on a 15-year mortgage. The longer you hold a debt, the more interest you’ll have to pay. So if you shorten down the time frame by making big chunks of payment towards your student loan, you’re gonna shave off so much interest, so much time, and it makes a lot of sense. So here’s the tip that Phil alluded to. Before you set your spending—the ideal budget which we’re about to go through—subtract your student loan payments off the top. So here’s the example, Alex: let’s say your take home pay upon graduation is $2,500 a month, okay? We’re just gonna use $2,500 a month. Actually let’s use $3,000, because then it makes the math easier. Here’s the thing, it’s not a math podcast. This is not a math podcast. Let’s use 3,000 bucks. And you find out that $300 a month is your student loan payment. Then before you set the rest of your budget off that $3000 a month, just knock off $300 a month. Now you’re setting your budget on $2,700. Here’s what the majority of people do. They set their budget of 3,000 bucks. They lived six months with that budget. They form new financial habits, many of them bad, because they’re first time budgeters. And then their student loan payments come due, and they have no money to make their first student loan payment. I’ll be honest, that system is broken. Phil?
PHIL: How could you argue that, that it’s broken?
PETE: That makes no sense, right? For six months you form habits, with not very much confidence, ’cause it’s your first time out. You’re learning, you’re making mistakes as anyone would. And then hey, six months later, here’s a significant bill that you did not factor in.
ALEX: Yeah, that makes sense how that will blindside you and you’ll be, wait a minute. Because I mean, if you’re living on that six months, it only takes 26 days to make a habit? And once you’re in there, then you’re stuck. [INAUDIBLE].
PETE: Were you watching Oprah? Where did you learn that, 26 days to make a habit?
ALEX: It’s just been in my head for a while, probably school somewhere, got us in.
PETE: School. All right, so here’s the ideal household budget. After you subtract out your student loans from the net pay, you’re ready, ready to write this down? You’ve gotta also find it, remember at moneysmarts.iu.edu. It’s gonna linked up on the blog at this time. This is Pete the Planner’s ideal household budget. This is how to spend your money: 25% towards mortgage payment or rent, 25% towards mortgage payment or rent. Rent is probably your best choice while you get your feet on the ground; don’t be in a hurry to buy house. Maybe that can be a future episode, because that’s a big topic. 15% towards transportation (car payment, insurance, and gas). If you happen to live in a city, it has mass transit, or you are able to walk to work. That is a great way to make headway as a recent graduate, is to not spend on a ton on transportation, but I’ll tell you, that’s one of the top two things that people blow money on upon graduating from college. Because they graduate, like I can stop driving this ’86 Honda whatever, and I can start driving something nice, a newer Honda. What are Honda references on this podcast?
ALEX: My ’98 Honda Accord. I still miss her.
PHIL: It’s like the official car of college students.
PETE: I think it is. I had a Pontiac Grand Am, which was the official car of college students when...
PHIL: Another classic.
PETE: It was a classic.
PHIL: Was it red?
PETE: Of course it was red.
PETE: It’s the only color they made, red and teal, red and teal.
PETE: I saw a teal one the other day. 12% towards groceries and dining out, 10% toward savings. So if your net pay after student loans is $2,700 a month, you should be saving $270 of that towards an emergency fund immediately, at least until you get $1,000 in it. 10% towards utilities—again, this is an opportunity for savings. Utilities will sneak up on you your entire life. 40 years from now, you and I are having this conversation about retirement. I sound much older and have no hair at that point. Utilities will still be a thorn in your side. And if you’re renting, it will become a little bit less of an issue, especially if you’re in an apartment complex or something like that. 5% towards charity, 5% towards clothing. The reality is you’ll probably you need to build up a professional wardrobe. So some of the savings you have in the other categories may have to go towards that 5% towards clothing. It’s not about shopping and entertainment at that point in time, it’s really more utilitarian than that, it’s about building up a wardrobe. 5% towards entertainment of course. If you deal with a ton of debt, frankly that's gonna get cut out. And what a lot of recent grads do, is move that 5% of entertainment budget down to dining out. So they have 17% for dining out, because it’s more of a social activity at that point in your life. 5% towards medical expenses which is gonna be more prescriptions and co-pays. And then 5% towards holidays and gifts, always a part of your life. You’re gonna enter that stage of your life pretty soon, where all your friends are getting married and having babies. And all of a sudden it becomes a financial problem of yours, so just know that’s coming. And finally 3% towards miscellaneous, which can include getting a pet, grooming your pet, whatever. So that’s the ideal household budget. Again, you’re gonna find it at moneysmarts.iu.edu. Gentlemen, before we go, anything to add?
ALEX: I have one quick question as well.
ALEX: So if you’re making that minimum payment, right? You take it out of your net pay to make a smaller number, you can live with the most means. If you want to make that time shorter to pay it off, instead of just making that payment you have to, where do you recommend that comes from?
PETE: Here’s what you need to do. Great question. You need to save. That 10% of your money you’re saving of your take-home pay. Once you accumulate about $1,000, which is a starter emergency fund, then use that extra 10% of your income to then flow towards student loan principal. Don’t pay ahead, because if you don't designate your money and your extra money going in, sometimes it will be counted as extra payments, which those extra payments include interest payments. It needs to be designated as principal. One of the biggest mistakes people make when they try to purposely pay off debt, is they do not designate the extra money. It’s actual principle. Great question. Phil, anything to add?
PHIL: The only thing that I would add is, if you go on to the MoneySmart website, we do have a couple of calculators on there. The first one is a paycheck estimator, where you can take what salary you think you’re gonna have or what salary you’ve been offered. Plug that in, you can see what your net pay is, and your net pay minus your student loan if you enter that information as well. So I think that’s really helpful for students to be able to figure out what to budget. The other calculator that we have on the site is a payoff estimator, where you can see how much your minimum payments are gonna be on whatever loans you might have. But you can also see how much less time it would take to pay off those loans if you added an extra amount of dollars to those loans. It’s pretty eye opening how much time you can save off paying those loans if you just add an extra $20–$30 a month.
PETE: Again, you’re gonna find those at moneysmarts.iu.edu. We thank you, as always. Phil, thanks for being here. Alex, you had no choice, and I was glad to be here with both of you. So thanks for listening to How Not to Move Back in With Your Parents here on the IU MoneySmarts radio network.